Impact investing: making a splash

Once a niche corner of the private equity landscape, impact investing has been thrust into the limelight in the past two years. Since the start of 2017, a number of big-hitters have announced vehicles dedicated to the strategy, including Bain Capital, TPG Growth, Partners Group and KKR.

Meanwhile, a number of European-domiciled private equity houses at the lower end of the market have also closed impact-dedicated vehicles, such as Palatine Private Equity, Bregal Investments and Bridges Fund Management – indeed, the latter has had an impact focus since its foundation in 2002.

A factor that has historically restricted mainstream GPs’ attraction to investments underpinned by positive social outcomes is the question of whether such strategies involve a trade-off in terms of returns. Given that, until recently, there were only a small number of players involved in the space, financial track records of impact-dedicated strategies are limited.

"It has historically been the entrenched viewpoint that impact investing involves a trade-off in terms of returns," says James Perry, a partner at UK-based impact investment firm Project Snowball. "But it is increasingly becoming the case that ignoring the wider impact of your investments – even just taking the view that it is the role of government, rather than business, to safeguard society and the environment – is, in itself, a risk. You can either approach that risk from a more reactive ESG-focused viewpoint of ensuring you do no harm, or take a more proactive approach and identify the opportunities presented."

Best of both worlds
Prominent impact investors agree there is a naturally expanding landscape of potential deals with no trade-off for investors that embrace these opportunities. According to Beth Houghton, partner and head of impact at Palatine Private Equity: "We are a returns-focused fund – targeting the same sort of returns as any other vehicle – as well as being impact-focused." Palatine held a final close for its impact fund on its hard-cap of £100m in September 2017. "We have identified areas of natural growth," she says, "such as skills and training, the circular economy, demographic changes and renewable energy. Plastics have also been a big push for us. As a firm, we are reducing the use of plastics across our portfolio and its supply chains. But plastics also present a great investment angle as identifying replacements will be key."

Bridges Fund Management was set up with an impact focus in 2002 and completed a second fundraise for its permanent capital vehicle in July 2018, reaching £50m. The GP’s CEO, Philip Newborough, says Bridges was launched in part to prove it is possible to invest purely with an impact-specific remit and concurrently deliver good returns. It is only by delivering on that thesis, he says, that the firm has been able to raise more than £900m in commitments since inception.

Unless we can find a common consensus around how we analyse and articulate impact, we run the risk of confusion and inconsistency" - Philip Newborough, Bridges Fund Management

Indeed, the GP has delivered its fair share of eyebrow-raising exits in recent years. A source told Unquote at the time of its exit from online car insurance company Halo Insurance Services in June 2017 that the investment generated a return multiple of more than 10x. Similarly, at the time of The Gym Group’s IPO in 2015, Bridges’ remaining investment in the company – which had already delivered a 3.7x money multiple and 50% IRR via a 2013 partial exit to Phoenix – was valued at 5.8x cost.

Yet Newborough also points to the firm’s involvement at the more philanthropic end of the spectrum, where investors might be prepared to accept a lower return if the investment delivers better social outcomes. "Because we manage a platform of funds that operates across the spectrum, what we are seeing is that investors are often interested in supporting a range of impact investments, with different risk/return profiles."

Grass roots
While the appetite for an increase in impact investment is perhaps most immediately manifested in the number of GPs launching dedicated vehicles, the primary catalyst appears to be LPs and the demands of their underlying customers.

"The move towards impact [funds] is probably primarily driven by LPs at the moment," says Palatine’s Houghton. "But that should, in turn, drive more GPs to move into the strategy. There is a lot of pressure from pension holders currently, who want their money to be invested ethically – from an ESG angle – but also deliver impact. There are a few funds in the market that are focusing on both returns and impact. The more we demonstrate we can deliver on that, the more LPs will be attracted and the more GPs will be prompted to see if they can raise an impact fund."

Snowball’s Perry explains LP motivation in stronger terms, though he says the increased appetite, while tangible, remains gradual. "There is little point in an insurance company making investments that are going to exacerbate climate change, increase the frequency of natural disasters and ultimately result in a surge in claims," he says. "Similarly, while pension funds’ customers want to grow the size of their pension pots, they also want the planet to be in a fit state in 20 years’ time when they do retire."

However, Perry also argues that GPs cannot simply enter the space in response to – or in the desire to capitalise on – LP demand: "GPs themselves have to want to make an impact. And if they plan to continue attracting the best talent, then embracing this conversation is paramount."

Momentum in Europe’s largest private equity market, the UK, has also recently been supported by government initiatives. In 2016, the Department for Business Energy and Industrial Strategy set up an advisory group to assess how investors could "engage with individuals to support the values and social causes they care about". And in June this year, the Department for Work and Pensions launched a consultation intended to clarify rules and make it simpler for pension funds to invest "with an environmental and social impact".

Bridges’ Newborough explains that many early-mover LPs in the impact space were foundations and family offices, who he says are "instinctively inclined to align their investments with their mission and values". Yet he says that the LP make-up of such funds has evolved in recent years. "You’re seeing the big wealth managers devote more time and resources to [impact investment], mainly because they’re responding to the demands of their clients for more exposure to it," he says. "But we’ve also been lucky enough to receive great support over the years from a number of UK institutional investors, including local authority pension funds, which have actually been among the leading pioneers in this space."

Both Newborough and Palatine’s Houghton stress that, while signs of progress are encouraging, it is still early days in the evolution of the space. And Newborough highlights that there are many challenges faced by private equity investors looking to raise impact vehicles: "Some investors are interested in having greater control and flexibility, or lower costs than a standard blind pool fund provides. Others are interested in longer hold periods for income-generating assets, particularly if they are looking for investments that align with their values and do not want to push investees into an exit that could compromise that. Then there is the challenge of different investors thinking about and reporting impact in different ways, which makes it hard for LPs to make comparisons."

Made to measure
As an increasing number of high-performing generalist GPs roam into the space, each with their own unique approach, questions are likely to arise surrounding the very definition of impact investing itself. It is a concern that Bridges’ Newborough believes is of paramount importance to the continued emergence and long-term success of the strategy. "Unless we can find a common consensus around how we analyse and articulate impact, we run the risk of confusion and inconsistency, which leads to misaligned expectations at best, and impact-washing at worst," he says. "That is definitely a potential constraint to the growth of this market."

Snowball’s Perry says there is already a range of approaches that might be defined as impact investing. He argues there is a risk practitioners stop at the minimum definition of modest ESG measures, thus limiting the scope of the practice. "Actual impact ranges from meeting more stringent ESG requirements with positive social or environmental outcomes, to investing with a more active focus on those outcomes, through to pure philanthropy," says Perry. "The way in which you measure that depends on the impact you are seeking to make and is best approached on a business-by-business basis. There are currently no catch-all metrics – such as how IRR and multiples are used to report financial performance – that can be applied across the board to measure impact itself."

Developing a consensus about methods for measuring impact performance is something the Impact Management Project is looking to address. The project is a sector-wide initiative involving around 2,000 contributing organisations that Bridges’ field-building arm, Bridges Impact+, has been heavily involved in over the course of the past two years.

Newborough says the project’s strategy begins from the premise that every business and investment has an impact on people and the planet. "Impact management is about figuring out which effects really matter, then maximising the positive and minimising the negative," he says. "For the next phase [of the project], we have been able to bring together an alliance of some of the world’s leading standard-setting organisations to try and produce a set of principles, standards and benchmarks that can potentially become generally accepted around the globe."

Ignoring the wider impact of your investments – even just taking the view that it is the role of government, rather than business, to safeguard society and the environment – is, in itself, a risk" – James Perry, Project Snowball

The alliance, or second phase, referred to by Newborough was launched at the UN General Assembly in the final week of September. But with many of the new generation of impact vehicles already in the process of being deployed, fund managers have, to date, been largely responsible for developing their own metrics for evaluating the success of their investments.

Palatine made the third deal from its impact fund in September with its investment in Estio Training – a provider of IT, digital and technology apprenticeships – and the GP has adopted a business-by-business approach. "When we invest in a business we have the returns KPIs that everyone has, but we also have impact KPIs, and some of those are naturally growth KPIs, too," says Palatine’s Houghton. "As we roll out more sites with Trade Skills 4U – which focuses on social mobility and taking people from unskilled to skilled work – we will naturally train more people. Quality, age and outcomes are other KPIs on that investment."

While there has been a visible increase in interest for impact-focused private equity, wide-scale and long-term adoption will depend on the success of the current generation of practitioners, as Houghton, Newborough and Perry all point out.

"Financial services as a whole is not keen on novelty," says Snowball’s Perry. "It is a sector that wants to see a track record, and until impact investors have 10-15 years of historical performance data to look back on, that is going to present challenges. It is a bit of a chicken and egg scenario. But the private equity industry is relatively new and nimble, compared with other asset classes. The hope is that it is well placed to take leadership on the impact investing front and can turn it into a competitive advantage should it choose to do so, which will have hard-edged benefits."

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