With the rise in impact investing – the most active direct investing segment of the ESG trend around the world – a group of 35 North American specialist private equity managers has co-published a report showing how the alpha potential is being realised in the nascent asset class.
The report published last month, ‘The Alpha in Impact – how operating with an impact objective can add financial value for investors’, was written and co-produced by Tideline, a US consulting firm which also specialises in the asset class. The 35 managers (general partners or GPs), which include one Canadian firm, formed the Impact Capital Managers (ICM) network after a meeting at the Harvard Business School in February 2017. The group represents about US$8 billion in impact-focused capital. High on the network’s ongoing agenda was to disabuse investors of the notion that what they term “market-rate impact investing” involved a trade-off with portfolio returns.
The report identifies the ways which impact objectives enhance financial performance, based on transactions in the portfolios of market-rate GPs. They call this concept “impact alpha”. Tideline’s research identified 10 unique drivers of impact alpha, which not only support the achievement of defined social and environmental outcomes but also enhance investment management and add value for investors and investees.
They organised these drivers into three core components: accessing unique and high-quality investment opportunities; creating value across the portfolio; and, strengthening outcomes through operational rigour and risk management.
The authors say that the activities which underlie the three components lead to specific sources of financial value. These include: increased dealflow and higher win rates; more attractive terms at entry; increased revenues; and, lower capital and operating costs. The 10 drivers are:
- source deals through mission-aligned networks
- uncover opportunities through deep market expertise
- build the alignment of values with investee
- leverage impact expertise to develop more effective businesses
- enhance branding and story telling
- attract and retain manager and investee talent
- unlock public and philanthropic capital
- Promote discipline and efficiency in operations through impact accountability
- establish credibility with impact-driven stakeholders, and
- optimise social, environmental and reputational risk management.
Tideline has a strong Australasian connection. One of the three authors and a co-founder of the firm is New Zealand-born Ben Thornley, who was raised and educated in Australia. He now resides in Portland, Oregon, with his American-born wife and two daughters. Thornley started his career in 1996 in Sydney as an investment journalist in Australia, working for publications owned by a former listed small company, InvestorInfo Ltd. These included Investor Weekly, Investor Daily, IFA magazine and InvestorSupermarket.com. His role included a stint as New York correspondent for Investor Daily. The titles are now owned by Momentum Media. He later worked for the Australian Consulate General in New York.
Tideline was launched in 2014, with offices in San Francisco and New York. The other two co-founders are Christina Leijonhufrud and Kim Wright-Violich. The other two authors of the alpha impact report are Amy Bell and John Griffiths.
A key part of the report is real-life experiences and case studies based on interviews with 13 of the ICM members, which represents about $US 4 billion. It also includes results of other studies, such as the 2018 survey conducted by the Global Impact Investment Network (GIIN), which had 228 respondents with assets total US$228 billion, and a 2017 study by Cambridge Associates.
Two-thirds of the GIIN survey respondents said they sought market returns for their impact investments. The Cambridge Associates study found that between 1998 and 2014, impact private equity and venture funds generated an average annual return of 5.8 per cent, with about a quarter generating double-digit annual returns.
The Tideline authors say that while the evidence for impact alpha is compelling, more research is required to: a) test, validate and update the drivers of impact alpha based on analyses of portfolio-level data; b) quantify the additional financial and impact value achieved through each driver; and, c) provide further resources and tools for impact venture capital and private equity managers.