Short track records, problematic KPIs and differing expectations make managers in the budding private equity impact space “far from straightforward to assess”, according to a new paper from investment consultancy bfinance.
The paper describes a growing private equity impact investing market, in which the arrival of funds of funds and dedicated secondaries vehicles marks an expanding and “increasingly diverse” fund universe.
Takeaway number one: in an immature asset class such as this, where a lot of managers are raising Fund I, “idealised impact investing ‘best practice’ does not yet translate into real life”, the report notes.
“Actual track records are short; KPIs are problematic; managers are often unable to demonstrate intentionality, additionality or a clear theory of change to the extent that one may wish,” the authors write. “The investor must find a way of navigating a highly imperfect world.”
The report lists what it sees as red flags in assessing managers, funds and deals. Here is a list of red flags at the firm level that bfinance says “may suggest a weaker approach within the current manager peer group.” The list is not comprehensive.
Policies and commitments
- Vague/superficial policies lack practicality.
- Annual sustainability reports lack transparency and/or tangible evidence of outcomes achieved by the firm to support commitments.
- Firm-level affiliations do not reflect specific types of impact targeted in strategies, eg, a climate strategy, but no firm-level involvement with climate or net zero initiatives. Considerations may vary by region (US vs Europe) due to lower pace of adoption.
Resource & governance
- Non-ESG/impact investment team members unable to communicate on or lack conviction on ESG/impact matters.
- Slow/limited development of ESG/impact resources; staff may be inexperienced (rapid move from analyst to director level due to high demand for talent).
- ESG/impact individuals spread thinly across strategies/asset classes, with low time commitment to a specific strategy.
- Lack of diversity at firm level and specifically in the investment teams.
Impact product development
- Firms entering this sector with an ‘asset aggregator’ mindset; product development chiefly driven by financial considerations.
- Misrepresentation of strategies using ‘impact’ product labels.
- Lack of discussion or willingness to consider (over time) developing KPIs that are linked to impact particularly as impact outcomes are a measurable objective of the strategy.
Around two-thirds of the impact funds bfinance has assessed have been launched by managers for whom impact is not their main strategy: a typical example would be a multi-strategy firm that launches an impact fund. One doesn’t have to stick with impact-only managers to find “high quality” strategies, bfinance says, but “many firms do have an ‘asset aggregator’ mindset when launching impact strategies. Look carefully at indicators of commitment and culture.”