Impact investment, targeting both a financial return and a positive, measurable, non-financial return, appears on track to become the second major investment theme of the 21st century after technology and digitisation.
There are trillions of dollars potentially heading towards the alternatives market, but GPs looking to seize this opportunity must move fast.
Twenty years ago, impact was low on most agendas. In recent years, the huge growth in awareness of the importance of environmental and social imperatives, and an increasing sense of shared responsibility and purpose, has finally put sustainability at the heart of business.
“In our conversations with LPs, a common concern is a sense there is insufficient supply of institutional quality impact managers able to solve for both investment track record and impact authenticity”
Within private markets, this understanding has been coupled with a growing awareness of the enormous opportunities available to those who are able to help solve sustainability challenges – resulting in an exponential growth in enthusiasm for dedicated impact investment strategies.
Why LPs are attracted to impact
There’s been a huge surge in enthusiasm from the investor community, including high-profile LPs in each category, to allocate capital to this megatrend.
There are three main drivers for LPs increasing their impact allocations. First, investors feel companies oriented towards impact can keep ahead of consumer preference and regulation and offer better downside protection.
Second, they are attracted to the upside story – the sustainability megatrend is here to stay and many products playing into it are expected to achieve strong secular growth, delivering better financial returns.
Third, investors are increasingly focused on aligning their investment activity with their institutional values, with impact and sustainability increasingly front and centre.
In our conversations with LPs, a common concern is a sense there is insufficient supply of institutional quality impact managers able to solve for both investment track record and impact authenticity.
To secure LP capital it’s vital GPs show hard evidence of their ability to generate strong financial returns (track record) and convince LPs of their dedication and systematic approach to intention and strategy for delivering non-financial returns (impact authenticity). The former can be difficult in a relatively young sector, while the latter isn’t easy in a space where firms are often criticised for a lack of credible data on sustainability. In addition, GPs must be able to articulate their purpose as well as raising the bar on ESG to keep pace with competitors.
Furthermore, GPs themselves are also increasingly considering whether LPs are sufficiently aligned in their own approach to impact and sustainability. Guiding GPs to the investors with appetite for impact, and LPs to the managers that will give them the best access to the megatrend, is an equation we’re keen to solve.
What can the impact investing industry do to accelerate momentum?
On the manager side, GPs need to focus heavily on demonstrating their ability to add real value to their investments and ensure they are providing sufficient evidence to convince LPs that they are skilled generators of strong returns.
When it comes to impact authenticity, GPs must clearly communicate their fund’s intention and how they’re helping investors; how the fund’s strategy delivers on that intention; and how they’re resourced to achieve it.
On the industry side, greater standardisation is key. Today there is no generally accepted accounting principle for impact investing. While this is not getting in the way of industry momentum to invest, it does mean there is inefficiency in the system. LPs are forced to ask bespoke questions of GPs (and in turn portfolio companies), taking up time and creating confusion around the ability to making fair comparisons between managers.
Strong, simple standardised methodology will help, and there are groups and initiatives working in this space to drive the creation of accounting principles that reflect a company’s financial, social, and environmental performance and investor and managerial decision making.
The impact investing trend appears to represent both an extraordinary investment theme and opportunity, one which seems likely to evolve the way private markets measure success. The industry has exceptional momentum. Regulators, industry associations, LPs, GPs, portfolio companies can now look to protect this momentum and accelerate it through enhanced impact data and methodology.
Jeremy Smith is head of impact at placement agent Rede Partners.