Impact vehicles could benefit from fund model innovation

Long-term funds could be a better fit for impact investing in emerging markets where exits and regulation remain challenging, according to panellists at an EMPEA conference.

Longer-term or permanent capital vehicles could be a better fit for impact investing strategies, according to panellists at the EMPEA Sustainable Investing in Emerging Markets Summit in London on Tuesday.

While the traditional five-to-seven-year fund model is being used by most impact managers, more can be done to affect change in communities with long-duration vehicles, senior executives from AfricInvest, TIAA and impact advisory firm Zheng Partners noted.

However, alignment of interest, as well as impact and return objectives, need to be carefully considered in such fund models.

Regulatory constraints in Africa, for example, are a key reason why impact investors need to be in the region longer, said AfricInvest director Ann Wyman.

“In many markets, if you look at making investments in the banking or financial sector, regulators in Africa are not so keen on private equity structures where you are going to have to get out at a certain point,” Wyman said. “It helps you to be able to take advantage of those opportunities – provide impact and provide financial inclusion – but also allow yourself the time to provide returns that will be required by potential LPs.”

Stephen Lee, principal, impact investing at insurance service company TIAA, noted that investing in early-stage companies via a traditional fund structure may not achieve returns and impact goals compared with a longer-term horizon fund. “Realistically, a three-year investment period is really not going to cut it if you invest in a fund that backs such companies,” he said. “You see a bit of a ramp up in the early years, and only further along will exits become possible.”

Alignment of interest, however, whether in buyout funds or impact funds, needs to be a priority for both LPs and GPs, Geoffrey Kittredge, a partner at law firm Debevoise & Plimpton, pointed out. GPs can ensure this a number of ways, he added, including tying in carried interest to a combination of cash performance and impact performance.

“However, layering in a longer-term fund could stretch the model a bit and add pressure on whether there are interim events that crystallise carry. If we are talking about a long-term fund – 12-15 years or 15-20 years – you have to think about some kind of crystallisation, liquidity events along the way.”

GPs also have to start thinking about the management fee, itself a great source of misalignment and discussion even in the traditional model, Kittredge said.

David Wilton, chief executive of Zheng Partners, an emerging markets and impact-focused advisory firm, added: “Long-term funds at some point would have fees declining. Just to get the message to GPs: this is not fees for life. Yes, it’s a longer-term hold, but at some point you need to structure an exit.”

There are certain circumstances, however, where traditional structures are more advantageous. Wyman pointed out that catalysing private sector capital for Africa means having to be a “certain size”.

“Most of those alternative structures or permanent capital vehicles do have trouble reaching a certain size,” Wyman said. “Our Fund V, which is a financial inclusion vehicle, has a target size of $200 million, but it’s in a ramp up phase and will take many years to get there.

“While the interim goal is to reach $120 million, that’s just not a fund size that is attractive to large pools of institutional capital, which is what we are trying to bring to Africa, which is really going to move the needle on a lot of the impact issues in the region. Being responsible and focused on impact, but also being able to grow the size of your fund is key.”