When private equity’s big players, such as TPG, KKR and Bain Capital, launch funds targeting impact investments, it’s certain that this once small and unassuming part of the market has become a major trend. TPG, having raised its first TPG Rise fund in 2017, garnering a not insignificant $2 billion, already has plans to raise a second with a target of $3 billion, demonstrating the firm is keen to continue pursuing impact strategies far into the future. Let’s also not forget BlackRock chief executive Larry Fink’s letter to CEOs of public companies sent in January 2018. It laid out, in no uncertain terms, their responsibility not only to generate profits but also to “make a positive contribution to society”.

Yet while the idea of making an impact through investment is clearly having a moment, there remains a lot of confusion around what impact investing really is. That’s not helped by the raft of acronyms, such as SDGs, ESG and IRIS, that investors need to get their heads around to understand what proponents are talking about. There is, as yet, no commonly accepted definition of impact investing and there is even debate among the market’s participants as to whether there should be one – on the one hand, some believe it would be helpful to set strict criteria to protect the integrity of this sub-set of investment; on the other, people say this would be too restrictive.

A lack  of definition makes quantifying the size of the market a difficult task. But everything points to expansion. The 225 respondents to the 2018 survey of impact investors by the Global Impact Investing Network invested $35.5 billion into 11,136 deals during 2017. Respondents planned to increase the amount of capital they invest by 8 percent and the number of deals by 5 percent during 2018.

Given the apparent popularity of impact investing, we set out to answer some of the questions investors may have about this growing part of the market.

What’s the difference between responsible and impact investing?

With no set definition, it can be hard to determine the difference between, for example, responsible investment and impact, although many are willing to offer their view. “The distinction relates to one’s level of engagement,” says Audrey Selian, director of the Artha Initiative, an online impact investment platform associated with family office investor Rianta Capital. “There’s a lot of nuance here, but I’d see responsible investment as more linked to public company investment where environmental, social and governance filters are applied to determine the effectiveness of a company’s stewardship. Impact investing is more a variant of private equity or private debt where investors are actively engaged in the business to drive societal benefit.”

It’s a view reflected by, but not precisely mirrored by, the opinion of Amit Bouri, chief executive of the Global Impact Investing Network. “Responsible investment derives from the movement 50 years ago to screen out investments connected to Apartheid in South Africa,” he explains. “It has therefore largely been about avoidance of harm to society – not investing in tobacco, fire arms or companies that contribute to climate change, for example. As ESG has become increasingly integrated into investment practices as a means of avoiding risk, we’ve seen it evolve into incentivising companies to become more responsible in their behaviours. Impact investment, by contrast, is not just about avoiding companies or managing risk, it’s about being intentional in generative positive impact.”

Overall, the message is that intentionality matters. A fund has to set out to make an impact in defined areas – and measure its progress in doing so – to be considered as an impact investment.

How can I measure impact when there are no standardised tools to do so?

This is clearly a work in progress. There are several initiatives that aim to help LPs gauge the impact a fund is having or purports it will have. One of these is the IRIS catalogue of metrics provided by the GIIN. “These are the generally accepted metrics in the industry and we’ve made them publicly available,” explains Bouri. “It doesn’t give any recommendations, but it does help investors find tools that match their specific objectives and that are backed up by credible research. It’s an exciting time for private equity impact because there is a growing base of experience and data. As this develops further, the metrics available will become more effective at measuring impact.”

Meanwhile the International Finance Corporation is set to launch a new set of guidelines under its Operating Principles for Impact Management in early 2019. While not intended to be a detailed set of measurement tools, they will provide a broad framework within which impact considerations can be integrated into investment decisions, from defining impact objectives in an investment programme through the lifecycle to exit.

LPs also need to consider themselves what they are trying to achieve. “Investors need to work out what they care about,” says Selian. “That’s the starting point for understanding what metrics they should be using when evaluating a fund manager’s impact and measuring their own performance in this area. Yet it’s worth remembering that fund managers are relying on metrics reported to them by company management teams – there’s a lot of margin there. While we’re starting to see some attempts at third-party verification of impact assessments, there is not yet the means to do this across all investments.”

Patience may therefore be required – standardised tools may take some time to emerge. “The current state of affairs around measurement is not satisfactory,” says Adam Heltzer, head of ESG and sustainability at Partners Group. “It’s very hard for LPs to get their heads around myriad frameworks and methodologies. GPs will have polished answers at the ready, but LPs really need to challenge what’s being said to ensure there’s substance behind the messaging.”

LPs have to recognise that successful impact investment will require critical thinking, adds Heltzer. “It would be a shame if all we generated was a warehouse of feel-good stories,” he says.

“The reality of every business is much more messy. Investing in renewables sounds like a great impact story, but you also have to measure aspects such as use of water, loss of biodiversity and so on. LPs really need to engage to understand and think about the negative impacts of the investment as well as the positive and examine how the GP is using its levers of influence to manage and mitigate.”

I have a fiduciary duty to my stakeholders, so why should I sacrifice returns?

There are types of impact investment that target positive outcomes ahead of financial returns. In her book, Catalyzing Wealth for Change, Julia Balandina Jaquier splits outs two types of impact investment – finance first and impact first – where the latter often targets below-market returns in order to achieve greater impact or address tougher problems. These, she suggests, are often most suited to institutions such as foundations, development finance institutions and individual philanthropists, which have flexible pools of capital. Indeed, among respondents to its annual survey, GIIN finds that 16 percent are seeking below market-rate returns that are close to capital preservation and a further 20 percent seek below but close to market-rate returns. Balandina further explains that impact investing is distinct from, for example, venture philanthropy, which tends to support specifically social purpose organisations and where financial trade-off is implicit.

There are many impact opportunities that can also generate market-rate returns. These tend to be areas where, according to Balandina, there is a “focus on social/environmental problems and needs, creating a compelling business opportunity”.

The GIIN survey also shows that there is a remaining 64 percent of respondents that are seeking risk-adjusted, market-rate returns. “You don’t need to sacrifice returns when investing for impact,” says Heltzer.

He points to Partners Group’s new PG Life strategy, which aims to build a portfolio of investments that contribute to achieving the UN Sustainable Development Goals while also generating attractive risk-adjusted returns. “We had to test whether this would generate high enough returns,” he says. “We analysed all investments made over the last 10 years that would have met SDG-related impact criteria and compared them with a control group. This subset neither outperformed nor underperformed.”

I have a large allocation to private equity so how can I possibly deploy it in impact funds when they tend to be so small?

This was certainly the case until a few years ago. It’s also true that impact strategies often focus on emerging markets, which often necessitate smaller investments. Nearly half of GIIN survey respondents (45 percent) say they invest primarily in emerging markets. But more mainstream options are entering the market, with much larger ticket sizes. The $3 billion fund to be launched by TPG on top of its existing $2 billion fund, plus KKR’s $1 billion impact strategy, Bain Capital’s $390 million offering and Partners Group’s $1 billion PG Life alone add up to significant amounts, and more large funds will enter the market.

This, say proponents, has the potential to generate large-scale change. “Traditionally, impact has tended to be small scale and many people have put it in the philanthropy bucket,” says Heltzer. “But some impact investing is becoming larger and more mainstream. One of our investments, for example, is in a renewable energy platform in Australia, where 70 percent of power is generated by coal-fired plants. This investment will contribute just under 2 percent of the country’s renewable energy target. We’ve also invested in a smart meter business in Europe that already reaches 11 million apartments and helps reduce energy and water consumption. Under our ownership, we will increase its impact by expanding the business to new regions and countries. As lead investors in large businesses, we can drive the board agenda, change the way the company thinks about impact – that means we can begin driving change on a systemic scale.”

OK, so more mainstream investors are getting involved. Aren’t they just greenwashing their investment strategies?

“There is clearly a move by many private equity firms towards raising impact funds and there are new ones emerging,” says a managing director at a secondaries investor. “I’m quite uncomfortable about that because there is a lot of scope for firms to apply a marketing varnish over what they’re doing without any real substance behind their claims.” This is a genuine concern for many. “The impact investing brand is definitely appealing right now,” says Bouri. “And it is tempting for fund managers to do a pretty paint job around this.”

The answer, says Bouri, is for prospective investors to do their homework. “LPs really need to get under the hood,” he says. “If the firm and its processes are built around impact, then we know the firm is serious about achieving the outcomes it claims to be targeting. This could mean having separate investment committees whose purpose is to identify impact objectives in an investment and/or building manager incentive structures around impact.”

There is no substitute, it seems, for hard, investigative work when it comes to assessing the real story behind the marketing claims. And while this is also true of private equity strategies in general, the task is made that much harder by the lack of standardisation when it comes to impact measurement.