Skip to main content
The fundamental premise of impact investing is that it can deliver a double bottom line: a positive social and/or environmental change and a market-rate financial return. Yet it can be difficult to parse through a sea of information (and frequently marketing spin) to select funds that actively deliver on these twin goals.

Environmental, social, and governance (ESG) frameworks are laudable and have had a positive influence for those concerned about investing with ESG goals in mind. ESG- compliant funds, however, are not required to make a measurable impact. True impact investing, on the other hand, should intrinsically meet ESG criteria.
 
The reputational risk of failing to meet impact goals or ESG requirements has become an increasingly significant concern for companies.1 Regulations, such as the Sustainable Finance Disclosure Regulation (SFDR) in Europe, go some way toward ensuring transparency and accountability for public market sustainable investments, but there is no precise legal equivalent for private markets. This is a challenge for investors because effectively assessing the processes implemented by funds to guarantee that their underlying holdings will meet impact goals is crucial to achieving the sought-after double bottom line.
 

THE FIRST BOTTOM LINE: HAVING A POSITIVE SOCIAL AND/OR ENVIRONMENTAL IMPACT

How should investors approach identifying funds that are likely to provide genuine impact? In short, we think they should seek out funds that:
• Demonstrate intentionality around their impact
• Employ a robust framework for measuring effectiveness
• Actively track and regularly report on impact-related key performance indicators (KPIs)

Intentionality

While some strategies are inherently impactful—for example, a renewable energy fund that invests in solar and wind energy—it is more important to seek out fund managers who clearly state their intention to contribute to positive social and/or environmental change. While this may seem obvious, fund managers that place this goal front and center—rather than as a marketing- led afterthought—are more likely to have thoughtfully constructed a robust approach to generating and measuring impact.2

Measuring impact

When selecting a fund, the primary goal for investors looking for impact should be ensuring that the fund applies a robust framework to its portfolio companies. For example, some firms map their portfolio companies to the United Nations Sustainable Development Goals (SDGs) (See “UN Sustainable Development Goals: Mapping Impact” in the Appendix). These SDGs are, however, relatively high-level, abstract concepts. It is therefore preferable to seek out funds that go a step further by explicitly analyzing how those SDGs (or other impact goals) are being met.

There are frameworks that help fund managers do this. One such common framework is the five dimensions of impact laid out by the Impact Management Project— namely what, who, how much, contribution, and risk.3 As our hypothetical case study in Exhibit 1 shows, this framework breaks down the expected impact of a portfolio company into practical, easy-to-digest factors that help funds understand the expected depth and breadth of an impact outcome, and parse who and what it would directly affect (See Exhibit 1).

Monitoring and reporting impact

It is vital to determine whether an investment is likely to have a positive impact, but it is not sufficient. It is equally important that a fund manager has a robust system by which to track impact throughout its ownership of a portfolio company.

One common and useful approach involves selecting one or more KPIs for each holding, alongside typical financial measurements, such as net profit margin and interest coverage. There are several sources—including the Global Impact Investing Network (GIIN) IRIS+ catalog— that offer metric sets that aim to foster consistency across investments, although in many cases impact KPIs should be tailored to the specific company and/or sector. Examples include greenhouse gas emissions avoided or reduced and number of children developmentally on track.

These results must be included in regular reports to investors, whether quarterly (alongside financial performance) or annually. In recent years, a few pioneering managers have even held themselves accountable by tying a portion of their own carried interest (profits) to reaching certain impact-oriented goals.4

This clearly signals a firm commitment to impact, as well as aligning managers’ interest with investors.

Exhibit 1: IMP’s five dimensions of impactTHE SECOND BOTTOM LINE: DELIVERING A MARKET-RATE RETURN

Impact investments may generate a strong or top-quartile return, but there is insufficient data available to ensure an apples-to-apples comparison with other investments, due, in part, to the difficulty in separating out the historical performance of impact and non-impact investments in funds that may have featured both. Further, we are likely still several years from the emergence of a high-quality equivalent impact fund benchmark, unlike more established private market asset classes in which there are multiple major data providers that allow investors to benchmark funds against their peers.

Performance analysis must, therefore, focus on absolute or market-rate returns. In other words, each investor should use their own asset class return expectations to determine what appropriate performance would be for their impact investments. For example, investors may target a mid-teens return within their equity bucket, or a high single-digit yield within their credit allocation. They can then apply these benchmarks to impact investments they are considering. In other words, rather than seeking top-quartile outperformance, investors should target the double bottom line we mentioned at the start of this paper: a positive social or environmental impact and a market-rate return as determined by their own investment goals.

In our view, a market-rate return is more than adequate compensation, given the ability to also do good and drive positive change.

Appendix: United Nations Sustainable Development Goals-Mapping Impact

Was this article helpful?
YesNo

ENDNOTES

1. Source: PwC, “The economic realities of ESG,” October 28, 2021.
2. Source: GIIN, “Core Characteristics of Impact Investing,” April 2019.
3. Source: Impact Management Project, “Impact management norms.”
4. Source: New Private Markets, “Linking carried interest to impact: The ‘who?’ and the ‘why?’,” September 27, 2021.
5. Source: United Nations.


IMPORTANT INFORMATION

The material herein has been provided to you for informational purposes only by Institutional Capital Network, Inc. (“iCapital Network”) or one of its affiliates (iCapital Network together with its affiliates, “iCapital”). This material is the property of iCapital and may not be shared without the written permission of iCapital. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of iCapital.

This material is provided for informational purposes only and is not intended as, and may not be relied on in any manner as, legal, tax or investment advice, a recommendation, or as an offer or solicitation to buy or sell any security, financial product or instrument, or otherwise to participate in any particular trading strategy. This material does not intend to address the financial objectives, situation, or specific needs of any individual investor. You should consult your personal accounting, tax and legal advisors to understand the implications of any investment specific to your personal financial situation.

ALTERNATIVE INVESTMENTS ARE CONSIDERED COMPLEX PRODUCTS AND MAY NOT BE SUITABLE FOR ALL INVESTORS. Prospective investors should be aware that an investment in an alternative investment is speculative and involves a high degree of risk. Alternative Investments often engage in leveraging and other speculative investment practices that may increase the risk of investment loss; can be highly illiquid; may not be required to provide periodic pricing or valuation information to investors; may involve complex tax structures and delays in distributing important tax information; are not subject to the same regulatory requirements as mutual funds; and often charge high fees. There is no guarantee that an alternative investment will implement its investment strategy and/or achieve its objectives, generate profits, or avoid loss. An investment should only be considered by sophisticated investors who can afford to lose all or a substantial amount of their investment.

iCapital Markets LLC operates a platform that makes available financial products to financial professionals. In operating this platform, iCapital Markets LLC generally earns revenue based on the volume of transactions that take place in these products and would benefit by an increase in sales for these products.

The information contained herein is an opinion only, as of the date indicated, and should not be relied upon as the only important information available. Any prediction, projection or forecast on the economy, stock market, bond market or the economic trends of the markets is not necessarily indicative of the future or likely performance. The information contained herein is subject to change, incomplete, and may include information and/or data obtained from third party sources that iCapital believes, but does not guarantee, to be accurate. iCapital considers this third-party data reliable, but does not represent that it is accurate, complete and/or up to date, and it should not be relied on as such. iCapital makes no representation as to the accuracy or completeness of this material and accepts no liability for losses arising from the use of the material presented. No representation or warranty is made by iCapital as to the reasonableness or completeness of such forward-looking statements or to any other financial information contained herein.

Securities products and services are offered by iCapital Markets, an SEC-registered broker-dealer, member FINRA and SIPC, and an affiliate of iCapital, Inc. and Institutional Capital Network, Inc. These registrations and memberships in no way imply that the SEC, FINRA, or SIPC have endorsed any of the entities, products, or services discussed herein. Annuities and insurance services are provided by iCapital Annuities and Insurance Services LLC, an affiliate of iCapital, Inc. “iCapital” and “iCapital Network” are registered trademarks of Institutional Capital Network, Inc. Additional information is available upon request.

©2024 Institutional Capital Network, Inc. All Rights Reserved. | 2024.01

Back to Private Equity
Kunal Shah

Kunal Shah

Kunal is Managing Director and Head of Private Asset Research & Model Portfolios, focused on the identification, selection, and due diligence of private market funds. Previously, Kunal was a Principal in the private markets group at Meketa Investment Group, a leading global investment consultant serving pensions funds, endowments and foundations, and family offices. He received a BS in Business Administration with a concentration in Finance from Drexel University. See Full Bio.