Ford Foundation: PE-style funds don’t fit snugly with human capital investment

Private markets impact funds must be structured to prioritise people and society the same as returns, according to Ford Foundation’s Roy Swan.

Swan, who leads the foundation’s impact group Mission Investments, told New Private Markets that the traditional private funds structure that impact strategies typically replicate doesn’t allow for “patient capital” to finance sustainable investments. The result, he said, is that firms are still incentivised by the pursuit of short-term returns at the expense of portfolio company employees.

While the perfect structure is not yet clear, Swan said the overall goal should be for managers to provide longer-term solutions for problems impact capital seeks to solve.

How does Mission Investments approach impact investing in private markets?

Roy Swan: Everything we do is about building a more inclusive form of capitalism – stakeholder capitalism – which we believe is a more sustainable investment approach for helping societies and preserving the planet.

We believe there could be private markets strategies that utilise superior structures for operational and human capital investments in a way that generates attractive financial returns. That’s a strategy that doesn’t fully exist, frankly.

Why is it important for impact strategies to focus on human capital?

RS: The traditional private markets fund structure – a three-to-five-year investment period and 10-year limited lifespan – incentivises short-term behaviour that’s counterproductive and can generate negative consequences.

For example, when a firm lays off workers or transitions employees from full time to part time, which reduces family and healthcare costs, that increases costs for taxpayers. This contributes to a society that’s subsidising the returns of certain types of operational and human capital investment strategies.

To grow a business sustainably, patient capital is an advantage that can facilitate long-term planning and lead to the investments that are required to nurture effective business models.

Why is it difficult to invest in human capital using short-term strategies?

RS: If the goal is to maximise compensation, it’s rational to quickly generate higher value from investments. But this makes addressing human capital and quality of jobs not an easy fix.

Over the long term, employee attrition costs can be significant. If a firm wants attrition levels down to as low as can be, that requires a lot of changes in how a business is managed. But in the short term, it may actually reduce a company’s earnings because of the investments that are required to implement changes. So, it’s complicated.

Are there existing private markets fund structures that can help address this issue?

RS: I think it’s going to take some experimentation.

For many long-term asset owners, return of capital is less important than cash flow, which makes longer term fund structures an attractive option. But there also needs to be an ability to redeem capital, which means evergreen funds and holding companies, for example, are not a perfect fit. Continuation funds could be a reasonable way to achieve a longer holding period, but those structures still include incentives that do not necessarily encourage human capital investments.

What does Mission Investments seek in a private markets impact manager?

RS: We are very interested in managers that don’t have a cognitive bias saying you can’t treat employees well while also making a lot of money. At the end of the day, whether its engagement or innovation, all profitable companies start with the employee. As private markets investors, the results we get are those that we design.