KKR: Thematic tailwinds drive impact opportunities

Current macro challenges make impact investments even more compelling, says Ken Mehlman, co-head of KKR’s Global Impact strategy.

This article is sponsored by KKR.

Could you explain how KKR thinks about impact investing, as distinct from ESG management?

At KKR, we think impact investing is ‘where’ you invest, whereas ESG is ‘how’. By thoughtfully approaching both, we believe we become better investors.

Ken Mehlman, Co-head of Global Impact strategy, KKR

We define an impact investment as a company that is, through its core business model, addressing a global structural challenge that aligns with the UN Sustainable Development Goals. We believe ESG management is important for us to consider across our investment strategies and asset classes, and we integrate ESG considerations into the investment process, including due diligence, decision-making and management practices, as appropriate. However, not every investment is an impact investment: as part of our Global Impact strategy, we seek to invest in companies that measurably contribute to a proven commercial solution to locally relevant UN SDGs across certain thematic areas.  

The first is climate action, which includes investing both in the energy transition and in companies that are helping communities adapt to and mitigate the impacts of climate change through efforts that support clean water, green infrastructure, or resilient development. 

The second is sustainable living, which seeks to invest in solutions that reduce resource use, energy consumption and waste generation in the ways we live and work. For example, sustainable-living companies might enable more sustainable product packaging or power the future of mobility, providing environmental, social and often financial benefits. 

Our third theme is lifelong learning, which focuses on advancing equitable access to quality education and aligning skills development to employer demand. This theme includes workforce development through vocational training, and companies that provide labour market data and analytics to help businesses upskill and train workforces for the jobs of the future. Another example is investing in educational technology that personalises and digitises education to help students learn more effectively.

The fourth is inclusive growth, which promotes broad-based financial and digital inclusion, societal participation and safety. For example, inclusive growth investments help underserved individuals and communities access the capital and resources they need to benefit from global economic growth.

How do you think about driving performance in your impact portfolio? Do investors still need to sacrifice returns for impact?

The playbook we use for our impact investing platform is the same playbook we have used for 46 years in private equity. In both cases, we are looking to invest in what we believe are macro themes or trends with important tailwinds, and proven business models. 

We then focus on active governance, either buying a majority stake or taking a minority stake with a focus on real influence. Next, we roll up our sleeves and get involved. We take the full suite of tools that KKR has developed and engage with management teams to support our portfolio companies’ growth.

We do not believe impact investors need to sacrifice returns. We’re not interested in concessionary returns. We are focused on businesses with an inextricable link between impact and financial performance, so revenues and impact scale in tandem. Moreover, the trends I set out earlier are some of the most important trends in the world today, and if you blend that opportunity with a playbook that has helped investors produce great returns for decades, we believe that investing in those companies is a good way to do well financially by addressing critical global challenges. 

How do you approach value creation within your impact investments?

At KKR Global Impact, we use a similar toolkit to the one used across KKR. One aspect we really focus on is operational improvement, leveraging the KKR Capstone team of full-time operating professionals to address everything from human capital management to procurement.

We also support our portfolio companies’ M&A activities at a strategic level, and our colleagues at KKR Capital Markets help them make acquisitions and address financing and capital structure improvements. Geopolitics are very important for any company operating in and around these themes, and the KKR Global Institute is invaluable in that regard.

We look both at how these companies are doing today and where they can go in the future. Core to that is value creation and the differentiated capabilities we can bring to the table as investors.

How are current macro challenges impacting the opportunity set for impact?

Recent macro challenges have further expanded the opportunity set. The lack of available trained workers is a significant concern for many industries, and we have invested heavily in platforms that provide vocational training, opportunities for employees to improve their own skills, and edtech to address the significant learning loss that resulted from school disruptions due to covid.

Every day, you see stories in your news feed about the challenges posed by Europe’s reliance on Russian energy. In my view, the economic, security, and environmental solution to that is the energy transition. That includes having an increased focus on renewable assets that are critical components of climate action. From an environmental and geopolitical perspective in the case of the war in Ukraine, a decarbonised world with less reliance on traditional energy sources, that delivers localised and decentralised energy, reduces vulnerability to oil and gas manipulation. 

These themes are also, in many cases, uncorrelated to other market factors, which is attractive to many investors. These investors are driven by demographics (ageing of the workforce), technology and the environment. None of these themes change based on how the Dow Jones performs or whether inflation increases, for example. LPs also appreciate that many of these impact themes are, in essence, non-discretionary: we need to clean up after a terrible storm, we cannot delay improvements to water quality, and we need workers to fly our planes, care for our elderly and ensure our cybersecurity.

How does that opportunity set vary across geographies?

Many of these opportunities are present around the world but the nature of the opportunity changes in different markets. For example, workforce development is a theme around the world, and an example of a company we have invested in within that space is MasterD in Spain. In 2021, Spain had the second-largest unemployment rate in the European Union with 15.5 percent of its total workforce unemployed, according to the OECD, and the largest youth unemployment rate in the EU with roughly a third unemployed in November 2021, per Eurostat data. MasterD provides over 280 courses to more than 96,000 learners annually to address that specific challenge in Spain and Portugal. 

Energy transition is also a global challenge, but different opportunities are relevant in different markets. Responsibly managing waste is a good example. In India, most waste is not responsibly collected, so we have invested in a company focused on waste management and treatment to address this. In the UK, waste is collected but it generally goes to landfills or is exported, so our investment there is focused on managing waste in a different way by turning waste into energy.

If you look at where we have invested so far, our portfolio is approximately one-third North America, one-third Europe, and one-third Asia. We see significant opportunities in all markets. Geographical diversification is another advantage of our global strategy.

Which sectors and themes currently offer the most compelling opportunities for impact investors?

Climate action is a huge opportunity set involving energy transition solutions, as well as platforms and companies addressing issues such as water quality, land resiliency and disaster recovery. Sustainable living is also exciting – think about the circular economy, for example. We invested in a company in Italy called CMC that provides packaging solutions designed to be the exact size of an e-commerce product to reduce the amount of cardboard, void filler and empty space used in packaging. This solution not only reduces packaging waste, but can also help increase the efficiency of transport in planes and trucks and lead to the reduction of fuel usage and carbon emissions. 

I’ve also mentioned that workforce development is an area facing significant challenges. The idea of inclusive growth covers a wide range of compelling themes and sectors, including supporting financial inclusion products and platforms, as well as cybersecurity around the world.

How is the role of data evolving when it comes to measuring impact in the portfolio?

What you measure is what you manage and, from the early stages of KKR Global Impact’s Investment Committee’s consideration of an investment, we work to identify potential impact KPIs against which we are going to measure. We focus on measuring each company’s contribution towards one or more of the UN SDGs, sourcing indicators from recognised, third-party reporting frameworks where appropriate. We also seek to integrate impact and ESG performance into our governance and portfolio management processes, including measuring our companies’ progress against our goals.

The role of data in impact measurement has always been critical, and in recent years we have seen even more of an emphasis on data quality and consistency in measurement methodologies. We are part of industry efforts that promote harmonisation and an understanding of best practices in impact measurement approaches. That is a significant work in progress, and we try hard to root what we do in third-party frameworks that have been developed with input from a variety of stakeholders and experts where appropriate. 

What should LPs focus on when assessing impact funds?

I think LPs should first make sure impact managers are focused on sensible macro themes and that they have a thesis for how they are going to deliver the returns LPs expect. Secondly, they should assess the authenticity of the manager’s commitment to impact, their approach to measurement and the efficacy of their contributions.

Third, they should look at the fund’s data and KPIs. Are they rigorous in how they measure and report impact? We are proud to deliver a detailed impact report to our LPs each year that provides significant detail on how we are seeking to advance relevant UN SDGs, taking SASB Standards into account, and working to measure and optimise climate emissions and board diversity performance, among other material variables. These metrics are important for taking action to deliver positive impact. These data points should be accessible and will be key for LPs looking to assess impact strategies.

How has the impact investing landscape changed over recent years?

In almost every category, we find that capital investment follows opportunity, and opportunity is driven by the most critical challenges in need of solutions. For example, today many businesses and industries cannot find workers equipped with the right skills, so we have platforms in a number of countries providing solutions to this challenge. Likewise, weather events like those that recently occurred in Florida, Puerto Rico and South Carolina force us to recognise the importance of resilient development. 

Over the last three years, first with covid and then with Russia’s war in Ukraine, we’ve seen an acceleration of the trends KKR Global Impact is focused on, and there is a recognition that an energy transition is needed for both environmental and geopolitical reasons.

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