This article is sponsored by Development Partners International.
Focusing on impact alongside financial returns has become an increasingly mainstream investment strategy over the past decade. A growing range of pension funds and other institutional investors are responding to pressure from underlying investors that demand their money is put to work addressing environmental and social problems. LPs can no longer complain of having a shortage of managers to choose from – the Global Impact Investing Network estimates that more than 1,700 organisations managed $715 billion in assets at the end of 2019.
Runa Alam, Development Partners International’s co-founder and CEO, and Vincent Lecat, impact and ESG manager at the firm, tell Private Equity International that the Sustainable Development Goals have come to serve as the reference point against which impact investment strategies are aligned.
However, they warn, while LPs receive copious volumes of data relating to impact, the lack of common metrics still makes it difficult for investors to judge how funds compare in their contribution to meeting the SDG targets.
To what extent do LPs expect funds to target ‘impact’, rather than ‘ESG’ targets?
Runa Alam: Impact investing has become more mainstream and prevalent among LPs recently, particularly because of the need to put dollars towards climate change mitigation and also because gender and racial disparities have received more attention. The rollout of the 17 Sustainable Development Goals in 2015 stimulated a lot of momentum in impact investing. The human mind needs categorisation and the private sector needs a taxonomy, so the SDGs have played a very important role in enabling fund managers to use a common language in relation to impact investing.
GPs and LPs have had to start talking about impact. LPs now get questions from their trustees or their governing bodies. A public pension fund in the United States might even get questions from the state legislators, such as, ‘What are you doing on diversity? What are you doing on climate change?’
All that has grown, so much so, that now there are pension funds that are creating mandates just for impact investing. Meanwhile, others are saying that at a minimum they must consider ESG in everything they invest in – and ESG touches on impact.
However, impact investing has been around for a long time, well before it had a name. When I started investing in Africa in the late 1990s, we were proactively trying to create impact with some of the things that we did, although we did not refer to this as impact investing at the time.
There is some commonality between ESG and impact. It would be hard to see how you do impact work without doing ESG. However, ESG comes more from thinking about how to do no harm, so you could do ESG without doing impact work.
Impact investing, on the other hand, has a positive focus; it has to involve investing with a pre-identified impact focus in mind. That could be climate change mitigation, it could be poverty alleviation or something else – but there has to be intentionality.
What do investors prioritise in terms of achieving impact?
RA: The part of the impact investing industry that is most sophisticated globally focuses on SDG 13, which is about combatting climate change. No matter what the policies of governments are, when the rubber hits the road, it is the private sector that has to execute on climate change, so impact funds have a hugely important role to play.
Projects in this area – like investments in renewable energy systems or green public transport infrastructure – tend to be significant in terms of size and investment. These appeal to pension funds that like big ticket sizes. Plus, there is a well-developed ecosystem of companies that carry out green infrastructure work. When it comes to measurement systems, more progress has been made on climate change indicators compared to the other SDGs, as it is easier to find quantitative indicators for this global issue.
On a global macro level, I am not sure that institutional investors have the same level of focus on eradicating poverty. However, it is different when you are talking about DPI, since we are an Africa fund. One of the reasons that some LPs invest in Africa, on top of making sure they get a commercial return, is to reduce poverty.
Development finance institutions clearly understand that investing in Africa creates companies, which creates jobs, which reduces poverty. We are a purely commercial fund, but we create jobs and reduce poverty. We employ 49,000 people in our portfolio companies across Africa, and in Africa, in general, one job supports 20 people.
In our own work, we have identified four impact buckets that we focus on: climate change; gender balance; job enhancement; and a bucket specific to each portfolio company. For example, one of our pharmaceutical companies brought in an effluence system for groundwater pollution. We chose these areas because they relate to our value system, and they cover topics that we have worked on.
Vincent Lecat: DFIs focus on various levels of ESG performance. Fundamentally, they are stakeholders of governments, so they reflect government priorities on issues such as climate change. Gender is also a priority for most, reflected in the 2X challenge. However, some of our other investors, such as the large pension funds, are also making deliberate investments based on impact priorities they have chosen to focus on because of their value systems. Our impact focus on job creation and climate change has certainly resonated with this group of investors.
Has the pandemic encouraged LPs to place greater focus on impact?
RA: Covid has certainly increased the appetite for impact investing. We learned during the pandemic that we are one world – a health crisis that started on the other side of the world has impacted us all tremendously. Covid also pushed about 100 million people in the world into extreme poverty in 2020, according to World Bank estimates.
We have also had agitation for social change occurring at the same time and we have seen an outpouring of people with the best intentions wanting to do something positive – and that does translate to people who work in our area. As an example, pension funds have underlying pensioners who have value systems. A lot of teachers’ funds, for example, are comprised in large part by female pensioners, many of whom want to see action on SDG 5, which relates to gender equality. There is a lot of very good intent out there – that is the biggest force in impact investing.
However, the big barrier is that when you are a pension fund you have a fiduciary duty to maintain good returns, because eventually you have to be able to take good care of your people when they retire. If you lose their money, you are not doing any good and you are breaching your fiduciary duty. Therefore, a lot of the impact world has moved to ‘you must give impact while giving returns’.
Will this concern over whether impact investing is compatible with commercial returns hold the industry back?
RA: About $5 trillion-$7 trillion is needed a year to meet the SDGs, according to the United Nations. That sounds a lot, until you realise that the world has over $400 trillion of private wealth, of which about $100 trillion is thought to be in managed assets, according to Boston Consulting Group. Some of the impact investing money is going to have to come from commercial investors and, for them, impact has to be combined with strong returns.
Another part of the impact world includes investors like family offices, foundations, or philanthropic institutions, that used to write cheques to NGOs and to good causes. Many of them are now saying, ‘We are not going to just make charitable contributions; we are going to do impact investing so we know the projects will keep going after our money dries up.’ Instead of making donations, they are now asking for lower than market returns.
What do LPs expect when it comes to measuring impact results?
RA: The impact investing industry is still developing. It is very important that we now have a shared taxonomy through the SDGs, but there is still a whole multitude of measurement systems. The most developed are on climate change. Yet this multitude of measurement systems is confusing for LPs. If you are an institutional investor, and you invest in five different impact funds and they have different measurement systems, how do you compare them on an apples-to-apples basis?
It is a minefield to compare different impact strategies and it is difficult to compare the climate footprint of all portfolio companies. We need to create measurement systems that become generally accepted so that everyone working on the same SDGs can be compared.
VL: Investors are looking for country-level or even regional-level data that they can collate to show the socio-economic impact of their private equity investments. They request data on indicators like the number of people we employ or the number of new organic jobs that we create. Then there is additional information around what our portfolio company employees are paid compared to market rates or to the minimum wage.
We even get questions on how much of the materials used by our companies is imported, compared to what they purchase in-country and where the final products are sold. There is a very wide range of metrics, financial and non-financial, that we collect to allow that story to be told by our investors.