KPMG: Impact is a big opportunity for GPs

GP pursuit of investments promising positive environmental and social impact is growing. The leader of KPMG’s Impact Ventures practice Tania Carnegie explains how LPs are driving its expansion.

Tania Carnegie

This article is sponsored by KPMG. 

Assets under management targeted at impact investments will reach $468 billion by 2020, forecasts KPMG’s The Impact of Impact Investments report, marking a 74 percent increase on AUM in 2017 of $268 billion. Looking forward, healthcare, clean energy and climate change are expected to dominate the impact investment space, currently equivalent to 1 percent of capital allocated globally.

Furthermore, the number of people benefiting from impact investment will double to one billion by 2020, according to the report, which notes “these are some of the most deprived communities in the world, many having been greatly affected by poverty and climate change.”

Impact investing is reaching critical mass. We asked Tania Carnegie, the founder and chief catalyst of the Impact Ventures practice at KPMG, to describe its evolution.

Q What’s fuelling the rise of impact investing?

Certainly GPs are hearing a great deal of interest from their investors and are incorporating that feedback. Bigger players with larger funds are getting involved. Overall, GPs see it as a significant opportunity to put a differentiated lens on the way they look for and evaluate investment opportunities and that can give them a competitive advantage when assessing a company.

When you look at a company from an impact perspective, you’re looking at factors that wouldn’t typically be included in the due diligence process, for example the way a company’s products and services impact people or help to create a better consumer outcome and how that is contributing to social cohesion or economic prosperity at macro and micro levels. There are a lot of commercial investment opportunities that are high growth and represent an opportunity to contribute to solving some of the big challenges facing society. There’s an incredible role that private capital in particular has in addressing some of these problems.

Q How is impact investing different from responsible investment, corporate social responsibility or good ESG?

It’s an investment approach that looks to generate measurable social and environmental impact alongside financial returns. It’s applicable to all asset classes. The distinguishing features are the intention and the measurement of impact. ESG typically focuses on environmental, social and governance risks and opportunities related to a company’s operations, whereas impact investing is concerned with how a company earns its revenue through products or services and its environmental and social implications.

It’s common that terms are used interchangeably and different groups might interpret them differently. Another point of confusion is around socially responsible investing or negative screening, when a GP excludes investment opportunities based on beliefs or values. To add to the confusion, an investor may choose to integrate all of these different approaches into their overall investment approach.

Q What kind of impacts can an investment have?

A common way investors think about impact is in terms of the UN’s Sustainable Development Goals, a comprehensive framework of 17 goals, 169 targets, and 232 indicators covering priority areas including gender equality, the elimination of poverty and climate action. Investors can focus on specific impacts based on experience and the type of business they run. For example, an investor may focus on companies that are helping communities to be more climate resilient. Other impact investors might be a little broader in their approach, or impact agnostic but it’s important to see that the intentionality, measurement and analysis are there.

Alignment of values

What are you seeing in overall trends in impact investing?

Beyond a focus on disclosure and transparency, another noticeable theme is impact funds seeking best in class ESG integration, as well as developing a robust impact methodology. The two go hand in hand. We’re starting to hear more about the importance and unique role of trust in impact investing, and the potential for impact investing to build broader trust in investment overall.

Trust comes alongside the alignment of values. People want to be doing business with people who share the same values. However this extends beyond the GP-LP relationship. Both companies and funds view putting impact at the heart of the equation as a differentiator. If you have a social entrepreneur or mission-driven chief executive looking for a potential investor, they want to see value alignment. We have a public company client with a CEO who is passionate about the impact of their company has on its customer base and the wider community. They wanted to make sure their broader stakeholder group understood that about their approach. It’s a huge point of pride and sets them apart in the market and the way they do business.

Q Talk us through an example of the components of an impact approach.

Generally this approach is focused on investment in companies that have both high growth and impact potential.  A GP will establish an impact thesis and measurement framework upfront that will be used to help evaluate potential companies for investment, alongside more traditional financial due diligence, and will guide the monitoring and management of impact during ownership.  This impact framework may leverage existing methodologies or tools, or be entirely bespoke.  Investment may focus on particular industries, geographies, or social and environmental outcomes.  Key considerations to developing an impact approach include establishing the right level of rigour, granularity, and complexity, and a mindset of continuous improvement as practices and investor expectations around impact evolve.

Q What’s your role in assisting funds active in this space?

Our approach is to work with our clients to help them enhance their impact. We help them to articulate their strategy and to develop a robust impact measurement and management methodology, as well as support its execution, for instance in impact due diligence and monitoring. We assist them to develop reporting to their investors or other stakeholders. It’s a suite of advisory services that span the investment lifecycle.

One of the newer services we’ve been offering is impact assurance, which is similar to the assurance we provide on financial statements except it applies to the impact reported for a particular portfolio company or fund.  Clients are asking us to provide independent attestation, which, while not a guarantee, offers a third party perspective.  We provide this service to clients including TPG’s Rise Fund.

Q What’s driving the demand for verification?

It’s GPs’ desire to demonstrate how seriously they are taking impact investing that’s driving impact assurance. Some GPs are looking to go the extra mile to demonstrate the authenticity of their approach. That is one of their bigger concerns: how to make people understand that they are genuine about this.

From the LP side, some are asking questions and placing additional scrutiny on funds and opportunities to ensure information on impact is on a par with financial disclosure. The way we measure financial performance is well established with a language that investors all over the world speak. But when it comes to impact, it’s a newer space and there is a lack of generally accepted standards around how to measure and report impact.

Q How are LPs involved in the expansion of impact investing?

As the space evolves, a growing number of LPs are interested in enhanced disclosure and transparency around the impact thesis, how that’s going to be measured, managed and disclosed.  Moreover, how impact data is being leveraged as part of value creation.

LPs who are impact investors are really passionate about it. They believe in the opportunity, and they want to be doing business with managers that are equally as passionate and committed. We’ve certainly seen that with the clients we’ve worked with. Often their first questions to us will be about KPMG’s commitment to impact investing and how long have we been involved and what are some of the things that we’ve done to contribute to the impact investing community. They want to know that we care and are committed beyond helping clients and that we’re connecting on the same belief in the opportunity.

Q Given the impact on communities, is public demand for additional disclosure and transparency growing?

The broader public interest in the role of business in society overall has been rapidly evolving. A growing number of GPs see a correlation between companies that have a positive social or environmental impact and enhanced financial performance. Others don’t know what to make of it and aren’t convinced it’s viable yet. There’s a broader education opportunity. Part of this can be accomplished by GPs sharing their experience to demonstrate that no trade-off on financial return is required.  This requires a different level of disclosure and discourse found in traditional private equity.

Q What is the relationship between impact and financial returns?

Incorporating impact enables the assessment of potential investment opportunities through a differentiated lens. It gives investors a different perspective on the customer base, the market need and the growth potential. It also often requires being really focused in core areas, which prompts the development of new impact-related expertise. The other way it creates value is by attracting a robust team of top talent who are committed and passionate about what they do. That breeds success.

There are a growing number of existing investment professionals, as well as graduates, that are seeking to work in this space. A number of firms are thinking about recruitment and how one of the benefits of this approach is attracting top talent.

Q Can you be an impact investor and not have an explicit agenda? Say an emerging market fund?

There is a great deal of impact investment opportunity in emerging markets, but not exclusively. What distinguishes a great emerging market investment and a great impact investment in an emerging market is that intentionality around creating impact and explicit measurement, monitoring, and analysis, and how that information is being used to drive enhanced outcomes.

Q How are GPs moving into this space? Does it require a strategy overhaul or simply an expansion of investment horizons?

LPs and GPs are responding to their stakeholders, as well as looking more broadly at the opportunity set. A number are taking a step back and looking at their current portfolio through an impact lens to assess investments they have already made without any impact intent, and asking how much of this could be considered impactful. Surprisingly they are finding more in there than they would have thought. This demonstrates that impact investing is not that far off from their current investment style and there might be additional opportunities and benefits if they were to adopt a more intentional approach.