LPs debate the usefulness of impact-linked carry

Impact-linked carry continues to divide LPs. “It’s the gold standard,” said an institutional investor at PEI Group’s Responsible Investment Forum in New York last week. “But the devil’s in the details in terms of how it’s actually implemented in the context of the investment strategy,” they continued.

A growing number of impact fund managers are introducing mechanisms by which their performance fees are tied to non-financial performance. EQT’s Future fund, Apax, L Catterton and Generation IM offshoot Just Climate are some of the most prominent examples. In most cases, the mechanism involves the GP forfeiting a percentage of their carried interest if the fund’s assets miss certain pre-determined impact goals or KPIs.

“About half of the European [impact] funds we’ve seen in the past six months are doing it in some form,” another institutional investor said. The conference was held under Chatham House Rule, so speakers can be quoted but not identified.

For one investor, impact-linked carry is a useful indicator of intentionality, but “it doesn’t mean the buck stops there. We have to understand how it really works. It’s just one of the tools we have in our toolkit” to ensure a GP delivers on the impact intentions it pitched.

“It takes up too much internal bandwidth,” another investor said, such as setting targets, measuring and auditing performance and weighting different KPIs. “There are so many third parties involved if you do it on a deal-by-deal basis… I worry that we’re focusing on the wrong thing. [Impact fund managers] should focus on investment selection. Impact should be tied to the investment thesis.”