Capital may have increasingly concentrated among big name mega-funds over the past few years, but that doesn’t mean LPs haven’t been committing to some of the less well trodden paths as well. The news last June that New York State Common Retirement Fund had invested a further $350 million to two investment funds through its in-state private equity investment programme, to bring its total local commitments to $2.1 billion, illustrates a trend among some LPs to support local economies as well as target global opportunities.
In-state programmes are far from new – many US state pension plans have been running these for well over a decade or more. Florida State Board of Administration has been investing in growth-related Florida businesses since 2009, for example, while New Mexico State Investment Council has been investing locally since the 1990s. However, there is a new impetus behind the idea of investing locally, says David Helgerson, co-head of impact investing at Hamilton Lane, which manages the two funds that NYS Common committed to last year.
“We’ve been directly involved in state-focused programmes for 20 years,” says Helgerson. “Yet more recently, we’ve noticed the growth of local and impact investing has accelerated. That’s due to a confluence of factors – private markets have become an accepted asset class and source of capital, LPs are increasingly looking for investments that align with their values, and access to information has improved significantly, including the capacity to track impact outcomes.”
It’s not just state pension plans that are looking to invest locally to deliver impact alongside a financial return. “Large-scale in-state programmes tend to be the preserve of state pension plans,” says Helgerson. “But there are also smaller initiatives, and these tend to be established by trusts, endowments, high-net-worth individuals and family offices. And here we are seeing the evolution of more sub-asset class strategies, such as seed funding, venture capital, and private credit, all with a place-based focus.”
It’s a trend also noted by Natalie Walker, a partner at StepStone. “The US public pension plans tend to be the most forward-thinking in local investment,” she says. “They have tended to back local managers through their small and emerging manager programmes. But we have seen some other types of LP follow suit, such as endowments, foundations and, in some cases, corporate pension plans.”
Demand for local investing is only one side of the equation. There also needs to be sufficient investment opportunities to choose from on the supply side, says Helgerson. “There needs to be enough capital focused on local areas to make an in-state or local programme work. It’s harder to generate an attractive financial return on smaller economic areas. That’s why in-state programmes have worked well in some US states and regions – they tend to be the ones with scale.”
There have been movements on the supply side around fund formation, according to Walker, which could help scale up local investment opportunities in the US. “Competition in private equity has become fiercer over the past few years and one way some GPs are looking to differentiate themselves is by looking to underpenetrated markets, such as tier-two cities, where there is more limited competition for deals,” she says. “These funds also tend to be more social impact-driven and focus on underserved and disadvantaged communities.”
As with so many trends playing out today, the pandemic has had a hand in dispersing potential investment options beyond the biggest US cities. “We’ve also seen quite a few regional funds set up over recent times, such as those focused on the Pacific Northwest or the Midwest areas,” adds Walker. “Some of this is happening as a consequence of the pandemic as GPs moved out of metro cities and realised that some of these regions are underpenetrated and offer a better buying opportunity and the potential for more upside.”
The pandemic may have highlighted inequalities and raised awareness of the importance of local communities, but the increased focus on local business was already apparent before covid struck as businesses and investors began to question the economics and impact of globalisation.
“There was a stretch of time in the 1990s to early 2000s when everything and everyone seemed to have a global bias, as businesses and policy-makers looked to globalisation for supply chain improvement and lower costs,” says Helgerson. “Today, there is a shift back towards local economies.
“We are seeing people reassess the environmental impact of, for example, shipping goods across the world, and businesses are reassessing whether they actually get value from global supply chains. This is leading to a re-evaluation of local economies. Investors increasingly see value in local relationships and proximity, as they can help influence outcomes and avoid the risk of global events interrupting supplies. There are a lot of advantages to being local.”
This seems to be true beyond the US, with the UK in particular seeing increased interest in place-based investing. “The idea of local investing started in the US with in-state local investing plans that have been designed to encourage economic growth locally and we are now seeing some momentum for similar in the UK,” says Rhonda Ryan, a partner and head of European private equity at Mercer.
A 2021 report by The Good Economy, the Impact Investing Institute and Pensions for Purpose found the UK’s local government pension schemes were investing just 1 percent of their portfolio in ways that could directly support local economic development. The paper argued the case for scaling this to 5 percent and creating a market that would attract not just local authority pension funds, but also mobilise other types of investor as well.
There is a sense that this is starting to pick up steam. “We’ve definitely seen interest in place-based investing among other investors besides local authority pension funds,” says Sarah Teacher, interim joint chief executive of the Impact Investing Institute. “These tend to be investors that are rooted in a particular place, such as charitable foundations, or wealthy families that come from a certain area. They are looking to drive outcomes in a particular location and are using geography as part of their impact lens.”
In the UK, some of the opportunities are being framed around the government’s levelling up agenda that targets so-called “left behind” regions, towns and cities. The development of impact frameworks and a greater recognition of the interplay between different parts of a region’s infrastructure and local economies should create more diverse investment options and stand a better chance of success than previous attempts. A 2020 KPMG report that set out a framework for developing the UK regions, for example, referenced the need for a holistic approach. “Earlier interventions,” it says, “have often failed because only some of what is required to reignite regional growth were addressed in isolation.”
As Ryan notes: “When this works, it can be win-win – if there is a good opportunity set, it can generate good returns and investors can act as anchors for the local area and help mobilise other LP capital. However, there is the potential that it could be lose-lose if investors can’t generate sufficient return for their stakeholders and other investors do not crowd in.”
This is why the Impact Investing Institute sees many of these place-based programmes investing alongside government initiatives – at least initially. “There is only so much government can do on its own,” says Teacher. “There is a clear role for private capital to partner with national and local government to generate outcomes. The development of impact measurement and reporting means that investors are holding themselves accountable to their impact intentions; this differentiates them from past attempts to mobilise private sector capital for public policy outcomes.”
Private equity emerges
The first wave of local investing in the UK has generally focused on infrastructure and building homes. “Real assets tend to be the common opening play in place-based investing,” explains Teacher, but she adds that locally focused private equity funds are on the rise – albeit from a low base.
“We’ve moved on pretty quickly,” says Teacher. “People now understand the basic mechanics of how we can achieve high-quality place-based investing and the conversation has shifted from why to how.
“The UK impact investing market is now worth at least £58 billion ($72 billion; €66 billion) and we’ve seen an uptick of mainstream finance getting with the impact agenda and internalising it with rigour and intensity. This is not a flash in the pan.”
Further, she adds, the move to decarbonisation is making place-based investment more of an imperative. “Climate change is real and we need to see a just transition – a fair and inclusive transition to a net-zero economy – that is rooted in places,” says Teacher. “Decarbonising the Aberdeen economy, for example, doesn’t work if you don’t consider how the 90,000 or so workers in the oil and gas industry there will find a new role in a new economy. Creating green jobs in [the UK city of] Hull makes no difference to the people of Aberdeen because they don’t live there.”
The UK and US are just two markets witnessing a trend towards local investing. Canadian investors are also building local programmes; Caisse de dépôt et placement du Québec, for example, has provided C$90 million ($66 million; €61 million) to Teralys Capital for investment in local start-up funds. Yet we are likely to see the creation of many more similar movements – as long as the right opportunity sets with sufficient scale are available, says Hamilton Lane’s Helgerson. “We are seeing significant interest among investors all around the globe – across Asia, parts of Europe and North America especially – to try and figure out how to run local investment programmes.”
It’s worth noting that not everyone is headed in the same direction; in April, for example, affiliate title Buyouts reported that Alaska Permanent Fund will stop making new commitments to its in-state private equity programme due to concerns about potential governance and reputational risks.
The main issue currently facing local investing, though, is whether LPs will be willing to hold the course against today’s difficult backdrop when it can be tempting to commit to well-known names with long track records. Walker, for one, is trying to ensure the movement continues. “There is momentum in local investment programmes, typically as part of LPs’ small and emerging manager programmes,” she says. “We are encouraging clients not to pull back from these now – these are often the programmes that suffer in more challenging economic times because they are sometimes viewed as discretionary spend – because these can offer investors good returns.”