Financial return

Once the preserve of philanthropic efforts, deploying capital for impact has moved squarely into the realm of investors seeking financial returns, as well as positive social and environmental outcomes.

In fact, the definition of impact investing set out by the Global Impact Investing Network explicitly includes the objective of financial returns. Although impact investing covers a range of financial return targets, the proportion of impact investors seeking market-rate returns has been growing steadily and now stands at around two-thirds, GIIN research suggests. In addition, the vast majority of respondents to the organisation’s annual survey (91 percent) report financial returns either in line with or exceeding their expectations (even more – 98 percent – said their impact expectations had been met or exceeded). Far from being uncomfortable bedfellows – as some sceptics might believe – these figures suggest that impact objectives and financial returns can easily go hand in hand.

“There is a place in impact investing for a broad spectrum of financial objectives, from concessionary to market rate and everything in between,” says Adam Heltzer, head of ESG and sustainability at Partners Group. “However, if you are to mobilise significant capital and create catalytic change, investors need to generate a financial return.”

There is scope for investors with different objectives to join forces to achieve greater impact as well as improve financial returns. “There is a lot to be gained from impact investors from all parts of the spectrum working together,” adds Heltzer. “In the past there was some scepticism among the more concessionary investors targeting the parts of the world with the greatest need for capital about the motives of financial return investors. But we’re now seeing a sharing of ideas that improves practice across the board. Those focused exclusively on impact objectives are now more able to see how to create more sustainable businesses, and investors with financial and impact objectives have a greater understanding of what can genuinely create impact.”

The GIIN’s ambition is for social and environmental factors to be “integrated into investment decisions simply by default, as the ‘normal’ way of doing things”. We may be a little way off this yet, but there are already some experienced hands that can demonstrate the commercial imperative of impact investing.

“If you manage social and environmental issues effectively,” says Shami Nissan, head of responsible investment at Actis, “you are not only de-risking the business and ensuring business continuity, but you’re also more able to identify positive actions you take. If you then layer community projects on top of that, you are earning a licence to operate in what can be sensitive environments. We may not take the shortest route from A to B, but by addressing these issues, we’re creating significant value in the companies we back.”

Global vision

Impact investing may have originated from small investments targeted at improving the lives of local communities, but the growth of the industry and the increased urgency of finding solutions to issues such as global warming have led to much greater ambitions.

Some say the creation of the UN’s Sustainable Development Goals in 2015 has been a game-changer in this respect, in particular as all countries agreed to adopt them.
“We live in a very big, messy world,” says Adam Heltzer, head of ESG and sustainability at Partners Group. “You need enormous will and resources to address the complex issues it faces – that requires a global vision.

“The SDGs have been a huge success story because of their wide adoption. They are the closest thing we have to a global strategy for improving people’s lives and managing the environment and our resources sustainably. They create a framework through which all actors can focus their efforts and build coalitions and collaboration across countries, governments, businesses and people.”

Healthcare

The third Sustainable Development Goal, good health and wellbeing, fits squarely within one of the key sectors for impact investors.

Indeed, in the Global Impact Investing Network’s 2019 survey of impact investors, healthcare sits in the top three target areas, behind energy and food and agriculture. Yet while healthcare may seem obvious as an impact sector, there can be significant risk, and investors need to look carefully at the type of sub-sector they support.

“In theory, all healthcare investments can have a positive impact,” says Taylor Jordan, managing director at Goldman Sachs Asset Management.

“But the risk of unintended consequences can be high – look at the opioid crisis. We therefore focus on healthcare solutions that materially reduce cost and improve care in areas such as services and technology.”

Inclusive finance

The sector aims to establish start-ups, help people out of poverty and assist them with gaining more control over their lives.

It can cover a range of issues, from providing financial services such as credit, pensions, insurance and savings products through to offering education on household budgets and business management.

“If people lack access to finance or face high cost of capital, it is very difficult to improve their lives or grow their businesses,” says Taylor Jordan, managing director at Goldman Sachs Asset Management. “If you can provide appropriately structured financial services to underserved populations at the right price, you open up opportunities and develop local economies.”

The financial services landscape in emerging markets has been transformed, but inclusive finance is also relevant in developed markets. “In the US, for example, you have millions of people living in poverty without a strong social safety net,” adds Jordan. “Many rely on payday lenders to cover financial shortfalls which can lead to a vicious cycle of debt. We see a growing set of investments that leverage technology and market innovations to bring down costs and effectively serve underserved populations.”

Job creation

Job creation has long been one of the metrics through which the private equity industry has sought to convince the wider world that it has a positive impact on the communities its investment touches.

This does not make private equity automatically an impact investment. The job creation figures publicised by individual firms and industry associations are, by and large, incidental, and employment creation has historically been a by-product of investing to expand a business.

Yet for some investors, there is a clear intention to create jobs as a means to develop economies and improve people’s lives. CDC, the UK’s development finance institution, is one example of this. “Job creation is our primary mission because we believe it leads to economic empowerment and there is a strong alignment with financial returns,” says Clarisa De Franco, managing director, funds and capital partnerships at CDC.

Job creation is particularly powerful as an objective because it has the potential to help economies meet a number of the UN Sustainable Development Goals, including no poverty, zero hunger, gender equality, decent work, economic growth and reducing inequality.

However, this is far from a simple addition game. “It’s not enough just to look at the absolute numbers of added employees in a business or the wider community,” says De Franco. “You really have to assess whether you are creating high-quality jobs. Better and higher-skilled jobs improve company prospects and do more to help lift people out of poverty. With higher wages, you’re also boosting local economies more broadly.”

Taylor Jordan, managing director at Goldman Sachs Asset Management, agrees. “One of our main focuses is on financial inclusion to create jobs in underserved communities,” he explains. “But if private equity firms are intentionally targeting job creation as an impact goal, there needs to be a focus on job quality, with income levels and benefits that genuinely make a difference in employees’ lives.”

For CDC, there is also a multiplier effect, given that it focuses on investing in areas where capital is needed most. “Many of the firms we’ve backed over the years can now attract more capital from LPs,” says De Franco. “That means they can now also target larger businesses. That has a trickle-down effect on employment quality as, with capital, these companies can invest in training. That allows better-paid employees to improve housing and spend on education and healthcare for their families.”