Private equity impact managers outperform non-PE peers – report

PE-focused impact investments saw higher average returns and greater variation than did private debt investments, according to findings from the Global Impact Investing Network.

Private equity-focused impact managers are generating higher average returns than private debt and real assets-focused impact managers, a report has found.

Disclosed data on average gross realised returns since inception in the Global Impact Investing Network’s report show private equity investments had higher average returns and greater variation than private debt investments (18 percent versus 11 percent in emerging markets; 16 percent versus 8 percent in developed markets),

The top 10 percent of emerging market private equity investments earned the highest realised returns, all generating returns in excess of 29 percent; while the top 10 percent of emerging market private debt investments reported realised returns greater than 14 percent.

The data is presented in Impact Investing Decision-Making: Insights on Financial Performance.

In general, PE-focused investors “tend to outperform their peers and with greater variation in their returns”, Dean Hand, research director at the GIIN, told Private Equity International. Hand did not provide specific details on the reasons behind this. She pointed out, however, that the financial performance of impact investments varies significantly based on asset class and investment objectives, and that risk-adjusted market-rate returns are achievable contingent on manager selection and investment strategy.

For return expectations of impact managers overall, GIIN found that nearly one-fifth of impact investors reported outperforming their financial expectations and impact expectations. Almost three-quarters of respondents reported performing in-line with their financial expectations, and eight in 10 respondents indicated performing in-line with impact expectations.

Of private equity-focused impact investors, 16 percent reported outperforming their financial expectations and 18 percent reported outperforming their impact expectations. Private debt-focused impact investors reported 26 percent and 24 percent on financial and impact expectations, respectively.

Hand noted that portfolio risk including liquidity and exit risk as well as business model execution and management risk could be factors linked to weaker fund performance.

The report revealed that private equity-focused impact investors have a higher perception of risk when it comes to liquidity and exits than private-debt focused managers – 28 percent versus 7 percent.

“Exits are more challenging in this asset class [private equity], whereas the nature of private debt is that exits are naturally facilitated. The extent to which this risk plays out relative to private debt [four times greater] suggests that private equity investments are under greater pressure,” Hand said.

Smaller impact funds – below or equal to $100 million – also tend to outperform market and investor expectations, according to the report. Smaller impact funds in emerging markets generated higher returns than their larger peers (20 percent versus 17 percent). This is similar to Cambridge Associates’ benchmark which reported that smaller impact funds exceeded the financial performance of larger funds (8.6 percent versus 3 percent).

Performance relative to expectations also varied by regional focus, according to the report. Just under one-third of investors focused on sub-Saharan Africa outperformed relative to their financial expectations, compared to 19 percent of investors focused on the US and Canada. However, 21 percent of investors focused on sub-Saharan Africa reported underperforming relative to their expectations, compared with 5 percent of investors focused on the US and Canada.

The report also noted that impact investors are increasing becoming more sophisticated in how they manage performance and make capital allocation decisions. In addition to financial return and impact objectives, financial risk tolerance, impact risk tolerance, resource capacity and liquidity constraints are also taken into account.

When assessing, measuring and managing several types of portfolio risk, impact managers are also considering factors including liquidity and exit risk as well as currency risk, and market demand and competition risk.

GIIN’s report draws on data from six of the industry’s existing financial performance studies published between 2018 and 2020 including Cambridge Associates’ Private Equity and Venture Capital Impact Investing Benchmark, IFC’s Long-Run Returns to Impact Investing in Emerging Markets and Developing Economies, Symbiotics’ Private Asset Impact Fund Report 2020, as well as analysis based on GIIN’s 2020 Annual Impact Investor Survey. It explores private debt, private equity and real assets, the most used asset classes in the impact investing industry.