And its place in DC portfolios
Tom BairdSenior Vice PresidentManager Research
Private Equity Impact is exactly what it says on the tin: private equity investing (i.e., buying a share of a privately owned business) which aims to have a positive real-world impact – by investing in companies whose products or services are helping the world.
It’s one of a number of ‘impact’ asset classes we research. Impact assets have a dual target whereby they aim to generate both attractive investment returns and positive environmental or social impact. This is an important distinction that sets it apart from other strategies – including those that define themselves as ‘ESG integrated’ or ‘sustainable’ – that are solely focused on investment returns.
Private Equity Impact strategies use a screening process to remove strategies that fail to meet their impact investment criteria.
Where an investment opportunity satisfies the initial criteria of positive impact, further due diligence from both a financial and impact perspective are undertaken.
When seeking to identify best-in-class Private Equity Impact strategies for our clients, we focus on those that consider the importance of these two factors to be equal. This ensures that financial returns remain a primary driver of their investments.
The diagram below shows how this works in practice.
What is ‘impact’?Impact investments are investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return. The characteristics we expect to see from impact investments are:
Intentionality: Intention of an investor to generate a positive and measurable social and environmental impact.
Additionality: Investment provides benefits that, without the investment, wouldn’t have happened.
Measurability: Ability to account for the financial, social and environmental performance of investments in a transparent way.
What are the benefits? It’s clear that the world’s economy needs to transition to one that’s more sustainable. There’s been a wave of innovation with new companies, products and services all created to help enable and speed up this transition – but this requires capital.
We believe that there’s a clear funding gap between the amount of money that needs to be invested to achieve this and the amount being provided at current investment levels. The OECD estimates that, to achieve the UN’s 2030 Agenda for Sustainable Development, this gap is as large as $3.7 trillion!
Private capital will be a key component of bridging this funding gap, which creates a place for Private Equity investors with impact expertise to really add value – by sourcing these ideas and helping them to develop.
We expect to see more funds launch in the coming years as this opportunity develops and are continuing our research in this area.
What does this mean for DC members?One of the key barriers to allocating to ‘impact’ funds within DC arrangements is the potential risk that there could be returns left on the table. This is why being clear on the dual target in this asset class is extremely important.
The $3.7trn funding gap highlights that there won’t be a lack of investment opportunities in this space. Given the typical minimum investment size in this asset class, it’s most likely that we’ll see allocations via default strategies as opposed to self-select options. However, whilst there’s been an industry push to reduce asset management fees, there are still some challenges to overcome before Private Equity starts to play a more meaningful role in DC investment strategies.
Despite this, we believe it’s beneficial for DC arrangements to consider allocating to Private Equity Impact for two reasons:
1. Private Equity helps to increase potential investment returns for DC members. For younger members, even a modest allocation to private equity can have a meaningful impact on retirement outcomes due to the compounding effect of ongoing contributions and their relatively long investment horizon.
Members will benefit from this increase in expected return regardless of whether their private equity investment has an impact target.
2. There’s an increasing argument that investing in more tangible assets/related causes can help to improve member engagement.
A number of studies have suggested positive member feedback in DC arrangements where defaults have been updated to improve ESG risk management and/or where sustainability-focused funds have been added to self-select ranges.
If members know that the monthly contributions they’re making are going some way to bring about a more sustainable economy, they could become more interested in their pensions more broadly.
Clearly, some barriers remain to making sizeable allocations to Private Equity within DC arrangements – particularly fees. However, when researched and selected carefully, Private Equity Impact strategies could provide the dual advantage of higher expected returns and a means to boosting member engagement.
If you’d like to discuss Private Equity Impact in greater detail, please get in touch.
