Rise of the impact ethos

As the impact mindset gains momentum, Private Equity International asks if private equity and impact investing will ever fully converge.

Sir Ronald Cohen, a pioneer of the impact movement, has called for a new economic model that displaces the tyranny of profit. Covid-19 has exposed a dysfunctional economic system, with unsustainable levels of inequality, he explains in his recently published book, Impact: Reshaping Capitalism to Drive Real Change. We need to hit re-set.

Covid will help demonstrate the importance of a business’s social and environmental impact. It is time, Cohen claims, for companies to publish impact-weighted accounts that reflect both financial and impact performance.

We are not there yet, but with the prospect of a new form of compassionate capitalism on the horizon, private equity cannot afford to be left behind. We have seen a spate of mega-managers launching impact arms over the past few years, eager to capture the escalating impact appetite of their investor base and to take their first tentative steps towards what may become the new norm.

Firms to have recently raised impact funds include TPG, Bain Capital, KKR, Blackstone, Apollo, Morgan Stanley and Hamilton Lane. Tania Carnegie, global lead, private equity and asset management at KPMG IMPACT, believes it is an important strategy for firms of all sizes.

It is not only relentless asset gathering that is luring mainstream sponsors into the impact space. PE invests behind the global mega-trends that dictate the future of demand. Many of those mega-trends – from the energy transition to technological breakthroughs – are inherently impactful.

Rekha Unnithan, co-head of impact investing at Nuveen, says the firm is increasingly coming up against mainstream PE investors in processes, pointing, for example, to assets buoyed by tailwinds in environmental practices: “Environmental services companies; companies looking to produce alternative sources of protein; sustainable packaging companies – private equity firms will inevitably look to invest in sectors that are well positioned from a macro standpoint.”

Marc Becker, senior partner and co-lead of Apollo Impact, says: “Private equity’s interest in impact is driven not just by the recognition that private capital can play an important role in solving some of society’s most pressing problems, but also that these companies tend to be beneficiaries of strong secular tailwinds and the mindfulness of consumers that want to do business with responsible operators.”

Indeed, as Bridges Fund Management partner Maggie Loo tells Private Equity International, everyone wants to invest in areas with strong underlying demand. “By investing to solve societal challenges, we are by definition, targeting areas where that demand is unmet,” she says.

And what is good for our planet, it seems, is increasingly aligned with what makes good business sense. “The United Nations Sustainable Development Goals articulate the staggering needs across the world and, in many ways, run in parallel with the big mega-trends from a commercial perspective,” says Michael Etzel, partner at the Bridgespan Group.

A licence to operate

Simply catering to investor whims and pursuing underlying demand trends is not enough to officially constitute impact investment. The definition of impact promulgated by the Global Impact Investment Network is clear: it must be measured and intentional.

But there is another definition – espoused by Cohen – which considers the impact of investment more broadly. There are also signs PE firms recognise that the articulation of impact beyond financial performance is critical to maintaining a licence to operate, and that it is beginning to play a more central role in decision-making.

Stakeholders want to know that a business and its investors are leaving the world a better place, and so no PE firm can afford to be lackadaisical about its externalities. “Less than half of the value of a company can actually be seen on its balance sheet,” says Loo. “A lot of the intangible value is being driven by what sort of corporate citizen
you are.”

Being a good corporate citizen encapsulates everything from diversity and inclusion to ethical supply chains, or, as we have seen recently, how you behave amid a global crisis.

“The extraordinary events of the last calendar year, including the social justice movement and the devastation of a global pandemic, have magnified the importance of sustainable, socially responsible business practices,” says Steve Ellis, co-managing partner at The Rise Fund, the impact investing platform managed by TPG.

Responsible business practices can largely be equated with ESG, something purists want to differentiate from impact. “When managers start to blend ESG and impact investing, you get what some refer to as impact washing,” says Becker, citing a tobacco company that could have a strong diversity and inclusion programme and be mindful of its greenhouse gas emissions, but still have a negative primary output.

“Impact investing is highly focused on the externalities of the companies you own, and increasingly we are seeing investors across all strategies pay close attention to this in an effort to increase the positive and decrease the negative externalities of their investments”

Joanna Reiss
Apollo Impact

Yet equally, scrutinising externalities is intrinsic to impact. Here again we are starting to see a convergence of investment ethos. “Impact investing is highly focused on the externalities of the companies you own, and increasingly we are seeing investors across all strategies pay close attention to this in an effort to increase the positive and decrease the negative externalities of their investments,” says Joanna Reiss, partner and co-lead of Apollo Impact.

Of course, there will always be businesses that serve a purpose that do not have quantifiable, intentional, positive externalities. And so, it seems likely that a raft of dedicated impact investors, specifically targeting those that do, will always have an important role.

Yet as the world wakes up to a more expansive understanding of business performance in the wake of the covid crisis, it is also likely PE firms will be judged on their impact, in the widest sense, and not just financial returns.

“The world is facing unprecedented challenges and there is a new class of entrepreneurs focused on creating solutions, while still building successful businesses. At the same time, corporations and investment firms alike are realising the long-term sustainability risks communities and the planet are facing – and this is likely to increase in the aftermath of the pandemic,” says Maya Chorengel, co-managing partner at The Rise Fund.

“These two groups – entrepreneurs and investors – will increasingly join together to drive successful impact solutions. And as the sheer volume of impact solutions increases, we anticipate that impact investing principles will continue to be integrated into a classic investing approach.”

“We are seeing a clear convergence between mainstream private equity and impact,” adds KPMG’s Carnegie. And indeed, Etzel believes, that as dedicated impact vehicles become more prevalent among mainstream managers, that impact mentality is only going to spread.

“The big private equity houses are taking baby steps with these new impact strategies. They are learning a new language, learning how to work with a new set of data and how to answer a new set of questions,” says Etzel. “They do so in the understanding that one day that language, that data and those questions are going to be relevant to everything that they do.”