Impact investing is trending, spawning a rapidly growing industry powered by investors who want to generate social and environmental impact as well as cross-asset financial returns. Furthermore, it is expected to play a key role in directing private capital into companies that could address key social and environmental challenges.
Private markets are ideal for impact investing. By putting capital in, investors create incremental activity. And private equity firms’ attitude and approach has matured in how they value ESG performance and investment decisions.
Private equity as an asset class has shown resilience in the past two years. The size of the private equity market has tripled in the past decade from nearly $2tn in 2010 to over $6tn in November 2021, according to Preqin.
‘Investors are limited in mainly two ways: theyrarely have a majority vote on how a business should be run and investors’interests often compete with those of others.’
Additionally, the GIIN Annual Impact Investing Survey reports that 16% of impact investments are in private equity.
Private market investors are entering early-growth areas. Companies operating in the private markets space are offering solutions that could change the way issues such as climate change and social housing are addressed. The pandemic created a buzz for megatrends that are already actively affecting society, creating an investment opportunity.
Sam Steele, director of private markets at Russell Investments, said: ‘Impact investing is important in the listed space. However, investors are limited in mainly two ways: they rarely have a majority vote on how a business should be run and investors’ interests often compete with those of others. There are therefore barriers for the discerning impact investor within the listed space.’
On the other hand, the ‘impact’ of an investor in the private markets space is much greater with private equity buyouts offering the largest opportunity set.
‘The buyout investor takes a majority ownership of a company and is therefore in the driving seat for change. Within buyouts, one of the major value generators is increasing EBITDA, requiring higher efficiencies across the board.
‘An impact investor, passionate for change, will have several years to embed a full spectrum of impact targets in companies from actual processes to who will run the company. This will hopefully enhance value by increasing EBIDTA and by the company being a more sustainable, conscious enterprise,’ said Steele.
Challenges identified
Despite the huge appetite for private markets and the pivotal role they could play, investors are facing great challenges that prevent them from allocating to impact investing.
According to Steele, there are two notable challenges. The first is that investors need to fully commit both to the cause and the allocation of capital for longer durations to slowly see the changes they desire.
The other is understanding the complexities of implementing impactful changes – in particular, sectors and sub-sectors such as in the capital-intensive mining world. This means that private equity firms will need to commit more resources and develop enhanced impact strategies to not exclude companies from impact portfolios.
‘Of course, private markets are not the cure-all and should be considered alongside listed investments as a way of generating wider impact. However, there are not many investable universes where an investor can be in an actual driving seat to implement the real changes required to make a lasting difference,’ said Steele.
From early-stage funding to deal-sourcing to public offering, the role of sustainability is ever-increasing. Government supervision and legislation push us to use ESG metrics in our investment analysis.
Investing in private markets is giving investors the ability to track the impact their money is creating. After all, this is just good private markets investing and we are heading in the right direction.