Private Markets: Changes in trends and attitudes
Anthony Harrington assesses the interaction between the supply of private market impact opportunities and investor attitudes towards them
At a glance
• There is not necessarily any ‘penalty’ on financial returns from projects that have societal impact as their focus.
• Credit Suisse calculates cumulative investment of around $52bn (€49bn) in private conservation-focused funds.
• Scalability and replication of projects remains challenging.
With rapid growth in investor appetite for – and interest in – impact investing, one can expect to see a marked increase in marketing efforts to spin private market projects as ‘impactful’ when they may have, at best, only a mild impact hue about them.
Investors’ satisfaction with such projects is entirely a matter for them, and the same goes for the impact fund managers. Each has to decide where the line lies. But we can expect, at least for the next few years, to find an upsurge in investment opportunities being marketed as impact investing.
“There is a big grey area in which you could take a view either way,” says Matt Christensen, global head of responsible investment at AXA Investment Managers (Axa IM). The crunch point for him is whether or not the investment generates a real, measurable societal benefit.
So, for example, impact investing in healthcare is not just about providing the funds to build hospitals or to introduce new solutions, but having the metrics to show whether or not the project widens access to health care, increases immunisation levels, or improves child mortality and so on.
There are certainly ‘light touch’ green bond investment opportunities, such as projects that bring some reduction in CO2 emissions. “Sometimes we find a great story that truly merits being treated as a green bond,” says Christensen. “Other times we find a great financial story, but its impact credentials are slight, so our green fund won’t touch it. We are looking for projects that generate market level returns and have a good impact story that we can demonstrate robustly to clients.”
Robust assessment, scoring, and reporting metrics can help impact funds differentiate themselves. We can also expect to see investors, from family offices to high net worth individuals and pension funds, growing in sophistication as far as their ability to discriminate between funds is concerned.
One of the reasons for the growth in this area is that impact funds have been generating some very interesting returns alongside their impact credentials. According to Cambridge Associates, backing projects where the primary concern is social or environmental impact rather than profit has proved to be no barrier to generating excellent returns.
In fact according to Cambridge Associates, impact funds that raised under $100m (€94m) returned a net IRR to investors of 9.5% for the period 1998 to 2004 (long enough and far enough back in time for returns to have been realised). By comparison, similar funds in the general private investment universe returned an average of 4.5% for the same period.
The focus on funds under $100m highlights another issue with impact investment projects. Many, if not the large majority, of these projects are still struggling to scale up to the point where major pension funds and institutional players would feel comfortable taking positions. Making 9.5% on a small investment is all very well but less attractive for large institutional investors given the small ticket sizes.
In a report on conservation finance from early 2016, Credit Suisse said a number of conservation and social-impact managers with scalable projects are working with investors seeking market-like returns. But it noted that project replication and scalability remain major challenges.
Anne Ackermann, a member of Credit Suisse’s impact investment team based in Zurich, says the first thing her team does when looking at a prospective investment is to conduct comprehensive due diligence on the potential partner, and then to look at the prospective cash flow and the impact credentials of the project.
“We also decide, at this stage, if this is a project that we can present as of interest to a large number of investors, or if it is only for sophisticated, niche investors with a sound understanding of the world of impact investing,” she says.
Ackermann, along with many fund mangers in the sector, says there is no doubt that investor interest is strong and growing. “We started in micro-finance in this field back in 2002 and the transformation since then has been remarkable,” she says. “We now have all kinds of additional themes. We are looking at healthcare, for example, and marine conservation, along with the preservation of the oceans, which is one of the latest major themes to emerge. We are seeing investor appetite for all these themes and I expect this to simply go on strengthening over the next few years.”
Values-based organisations, such as the Church of Sweden, have long had an interest in ethical investing, and this has widened in recent years to embrace impact investing generally. Gunnela Hahn has been head of responsible investing at the Church of Sweden since the post was created in 2008 but for her this is all part of a continuum of values-based investing. “We were one of the founders of Oikocredit, which specialises in micro-finance, at the World Council of Churches in 1968. The investment firm was launched in 1975, so we have been in this field for more than 40 years,” she says.
One of the first things Hahn did when her position was created, which itself represented a major step forward in the organisation’s approach to values-based investing, was to move the portfolio away from coal, oil and gas-related investments, and to prioritise climate and social impact investments.
She says that for decades the Church had been donating philanthropically to support primarily Oikocredit in what would now be called impact investment projects, via grants rather than equity. The big change has come with the realisation that equity and bond-based impact investing can generate market-like returns.
Hahn says: “We now distinguish very clearly between one pool of money that is philanthropic, and another that is meant to generate investment returns. The two are complementary in that we can use the philanthropic pool to fund training for project managers, who can then deliver better outcomes on the investable projects.”
According to the Credit Suisse report, private investors have made around $52bn available for conservation finance, but the world needs around $300-400bn to clean up the damage created so far to global ecosystems and the world’s oceans. Much of this additional capital could come through impact strategies once the problems of scalability and measurable outcomes have been more fully addressed.
Results so far seem to bear this out and impact funds are themselves becoming much more visible. Impact Assets, for example, publishes an annual list of the top 50 impact funds around the world, which, between them, address a huge number of projects in both the developed and developing worlds.
One of these funds is Aqua-Spark. As Anna Novogratz, one of the founding partners notes, the fund is all about trying to transform the aquaculture industry and it targets returns that look stratospheric. “Our model is a little different,” she says. “To effect the changes that we want we need strong financial returns to make a true impact. We need to get to the point where sustainable aquaculture brings returns that are comparable to today’s traditional industry. So we have developed an ecosystem portfolio of companies all along the aquaculture blue chain that can benefit each other as they work towards a more sustainable industry. We target a return in the high twenties but tell our investors we aim for a minimum of 12%.”
The main challenges, Novogratz says, are choosing the right companies, being able to create synergies across the value chain and attracting sufficient capital to execute its strategy of initial and follow-on investments.”