By Colin Leopold – The billion-dollar impact fund is now a reality for mainstream private equity houses. Can they stay true to the roots of impact investing and meet the expectations of LPs?
By Colin Leopold – The billion-dollar impact fund is now a reality for mainstream private equity houses. Can they stay true to the roots of impact investing and meet the expectations of LPs?
There has been an explosion in impact strategies following the launch of one of the first and largest mainstream funds, TPG Rise, in 2016.
A record 132 impact funds were launched last year, according to Preqin, with USD20 billion amassed since 2015, according to Bloomberg data.
In a survey of more than 60 private equity professionals by Private Equity Wire during February, around two thirds of respondents said they either have, or planned to have, an impact fund in the next 12 months.
Their fundraising targets are getting larger and strategies more specialised, say placement agents and advisers, on the back of a surge in more specific LP impact allocations and European regulations encouraging sustainable investment.
In January Nordic-based Summa Equity closed its third impact fund, and Europe’s largest yet, at EUR2.3 billion. It marked Summa’s entry into the ‘billion-dollar impact club’ – a group which includes or will soon include KKR, Bain, Apollo and Apax.
Others including JP Morgan Asset Management and Allianz Global Investors are launching or building out teams within the space too.
“It’s just the tip of the iceberg, albeit a very large tip,” says Stephanie Kater, co-head of impact investing at Bridgespan, which advises funds on their impact strategies. “[Impact] is becoming mainstream and even firms that weren’t necessarily planning to think about an impact product or a responsible investing product are being pushed to do it by their investors.”
Spinning out
Once the preserve of philanthropists and government-backed development agencies, impact investing will soon become the norm across private markets, said Nils Rode, chief investment officer at Schroders Capital during an online presentation by the investment manager in February.
A Barclays Private Bank survey of over 300 respondents, on average managing USD833 million in assets, expects the share of impact investing within portfolios to reach 54 per cent by 2027, from 41 per cent this year.
Europe is currently home to a 15 per cent higher concentration of impact and sustainable investment funds in relation to traditional private equity funds, while North America has an equal percentage of both overall, according to data from Bloomberg’s Private Equity Database, showing the potential for growth in the US specifically.
Although specialist managers have been active in the space for decades, much of the current growth is coming from spin-out fund products that complement existing buyout strategies says Zac Williams, managing director at fund advisory Monument Group.
These impact extensions can offer mainstream private equity funds a ‘halo effect’, which can help initiate or develop relationships with investors while also addressing any criticism of private equity’s deepening role in society.
“We’re seeing mainstream general Impact funds launched by partners leading discussions with stories around their impact,” says Paul Yett, director of ESG and sustainability at asset manager Hamilton Lane. “So, [the conversation might be] ‘in addition to this being an investment that generated great returns, here’s some of the benefits you should be aware of around environment or social or what have you’. Investors want to hear this.”
But as larger players enter the space, how they measure their ‘impact’ is also receiving more attention from these investors.
Impact funds typically use the World Bank- owned IFC’s operating principals for impact and the UN’s Sustainable Development Goals but questions from LPs may still include ‘what outcomes in a more rigorous way. The result – known as the ‘impact multiple of money’ – suggests a minimum social return on investment of USD2.50 for every USD1 invested and can be used to monetise outcomes, ranging from lower greenhouse gas emissions to higher educational attainment to better health.
Social outcomes
The first impact funds tended to focus on social outcomes in impoverished communities – often much harder to measure – rather than environmental goals, but this has changed as new actors have entered the space and the energy transition has become a mainstream focus.
“The impact category is becoming harder to define but we have to be a little careful not to become fixated with labels,” says James Magor, director, sustainability at investor Actis, “because, yes, climate change is an environmental problem but it’s an environmental problem with profound social consequences too. By addressing a climate issue, arguably, you will be addressing some social problems as well.”
Indeed, climate-based impact investment strategies are currently among the most sought- after among European LPs, with US and Canada-based investors catching up quickly, say fundraising sources.
Last year, two of the world’s largest private equity funds – TPG and Bridgespan announced first closes of USD5.4 billion and USD7 billion respectively on climate-focused impact funds. Brookfield’s Global Transition Fund has a hard cap of USD12.5 billion.
A third manager, General Atlantic, has a USD4 billion target for its upcoming climate fund.
Given their size, climate-based impact funds are focusing less on building wind farms or solar plants and more on decarbonising entire industries.
Established France-based private equity fund Eurazeo last year launched a ‘sustainable maritime fund’ with a target size of EUR350 million to invest in advanced ship technology, innovative harbour equipment, and offshore renewable energy.
According to the firm’s head of ESG, Sophie Flak, the fund will use carbon accounting, and performance fees
for the general partners will be based on non-financial, as well as financial targets.
She believes impact funds will become much more thematic in the years to come.
“If you are a private equity fund looking at impact and ESG you’re going to go very strongly on health, you’re going to go very strongly on life science. There is an appetite from LPs for thematic products.”
Fundraising sources spoken to for this article say LPs are pushing their GPs for specific impact strategies in healthcare, the water sector and of more than 20 per cent for its first food and agriculture. Renewable energy, which generally falls within an infrastructure fund strategy, is now often perceived as a more crowded space with less opportunities its to achieve ‘impact’ goal s or double-digit return outcomes in developed markets.
There may also be a geographic bias among some of the new and larger impact funds which breaks with the philanthropic roots of the older specialists.
Frontier economics
Asia’s favourable demographics may provide more of an opportunity for impact funds seeking traditional returns than the more impoverished parts of Africa, for example.
“There was a period of time where there was quite a lot of excitement [among impact funds] about frontier geographies – that has really dropped off,” says a placement agent. “And partly, it’s because of really excellent performance in the US and Europe and in many cases, very poor performance in particular in Africa, and India. The truth is that it’s been really hard to make money off things like a chain of coffee shops in Namibia. Whereas climate, people believe that it has real performance potential.”
Apollo’s first impact fund is targeting 25 per cent IRR, linking 2 per cent of profits to impact goals and 18 per cent to financial performance, according to reports. TPG Rise achieved a net IRR of more than 20 per cent for its first impact fund as of end of September last year according to recent filings. TPG’s healthcare impact fund, Evercare, which took over the hospitals and clinics previously managed by a fund of scandal-hit Abraaj in 2019 posted a lower IRR of 3 per cent.
According to a source at one of the largest private equity funds globally, when it looked at the opportunity to launch an impact fund above USD1 billion in size several years ago, it found that it could maximise either the size of the impact fund, or financial returns, while still having meaningful impact, but not both.
Some GPs maintain that integrating ESG across all their investments is a sounder long-term strategy.
It may be early days still, says Marc Lino, senior partner at Bain & Company, which is encouraging clients to “experiment, test and learn” in the impact space but the paths to success will be found in four places: gaining market share early; lowering capex and opex through greater efficiency; securing a lower cost of capital through green loans; and winning the war for talent as a more impact-aligned firm.
Read the rest of the Private Equity Wire Insight Report: Creating Values: Behind the ESG Revolution in Private Equity
