Warren Valdmanis, Two Sigma

Two Sigma has closed its first impact fund on more than $600 million, pitching a buyout strategy that “creates good jobs”.

This puts Two Sigma Impact I among the largest social-only impact funds in private equity. Its strategy is an unusual one: rather than investing in companies that trade in providing products or services to solve problems, as most impact funds do, Two Sigma Impact is “buying great employers and making them even better employers”, partner Warren Valdmanis, who leads the strategy, told New Private Markets.

The fund has closed below target, having initially targeted $750 million, the Wall Street Journal reported in 2021. Two Sigma launched the impact business in 2020 and reached a first close for the fund on $425 million in April 2021. It now stands at $602 million, with a further $75 million in co-investments.

Fundraising has been challenging; Two Sigma launched the fund during the pandemic – “which is obviously a hard time to be marketing a first-time strategy. You’ve got to develop relationships over Zoom,” said Valdmanis. The firm then wrapped up the fundraise amid the macroeconomic headwinds of recent months. “But we’re thrilled with the support that we’ve got. To have raised a first-time fund of this size is a good endorsement of the strategy that we’re pursuing.”

Social impact strategy

“We buy great employers and make them into even better employers,” said Valdmanis. “The primary output of that work is [creating] good jobs.” The fund has deployed $370 million so far. The firm did not comment on the financial returns it epects to generate, but, according to a source with knowledge of the fund, it is targeting gross returns of more than 20 percent and 2.5x money.

Two Sigma focuses on companies in four sectors: consumer, healthcare, business services and education and training, chosen because these sectors face critical labour challenges, said Valdmanis. Companies in these sectors “don’t have enough motivated, trained people to grow. Employee turnovers are near all-time highs. Companies struggle to retain their best people. They struggle to maintain institutional memory inside their companies.”

How can private equity help? “Great employers” in these sectors are surely already well-versed on these challenges and have developed and implemented mitigation endeavours. New Private Markets asked Valdmanis what Two Sigma can bring to the table – besides capital – for such companies.

“The problem that most companies face is that, even if they have that insight, they don’t really have good metrics or tools to measure workforce-related issues,” said Valdmanis. “We at Two Sigma have data science expertise in building diagnostic and business intelligence tools… that we can use to hold management accountable and to inform an action plan.”

While Two Sigma labels this as an ‘impact’ strategy, Valdmanis’s comments can be a helpful case study for any control investor seeking to create value by implementing ESG improvements at the portfolio level.

For example, for portfolio company Circle of Care, which provides therapy for children with autism, Two Sigma built a therapist-matching algorithm that has led to “happier, more productive workers and a more efficient company”, said Valdmanis. Two Sigma also “selected a [new] CEO” for the company last year whom “we knew was the right kind of leader to implement a good jobs strategy”.

Private equity’s negative reputation among many founders for appropriating and disrupting companies, rather than helping resolve their challenges, has proved a hurdle to Two Sigma’s deployment, Valdmanis acknowledged. But opening with the ‘impact’ label and the ‘good jobs’ strategy has helped win them over.

Keeping score

“There is not really a commonly accepted definition of a good job,” said Valdmanis, so the firm created a scoring tool to measure job quality and its own impact at portfolio companies.

To develop the Good Jobs Score, Two Sigma Impact distilled academic research to identify four factors of job quality: fairness (described by Valdmanis as “how you’re paid and your benefits”); growth and progression opportunities; leadership (“do you have a supportive environment where you get feedback and can give feedback and feel psychologically safe?”); and purpose (“where you feel like your work has some intrinsic value”). The tool produces a score for each of these four factors and an overall score between 1 and 5.

Two Sigma has implemented performance- and productivity-linked pay for some of its portfolio companies, including Circle of Care and supply chain labour provider Eclipse Advantage, to address the ‘fairness’ factor in good jobs. Does this create income insecurity for workers who may need to take medical or personal leave, or anyone who may have an ‘off’ day? Valdmanis doesn’t think so: “It’s important that workers have a good, solid baseline pay, but we also think it’s important that if workers outperform, they will get rewarded for that.”

Two Sigma is not tying its own carried interest or incentive schemes to impact performance or increased good job scores in portfolio companies.