Impact investing, which aims to generate social and environmental impact alongside financial returns, is gaining more traction among private equity firms. With the right approach, impact investing can align well with private equity’s active ownership model and leverage PE firms’ expertise in value creation. Though some perceive an inherent trade-off between impact and returns, many successful private equity impact funds have delivered market-rate or above returns. The key is diligent vetting of impact metrics, thoughtful portfolio construction, and active management of the impact and financial performance. When executed properly, private equity can be a powerful tool to direct more capital towards solving social and environmental challenges while also earning solid returns.
Global momentum behind impact investing in private equity is driven by investor demand
In recent years, major private equity firms like TPG, Bain Capital, and KKR have launched impact investing strategies. This shift reflects rising LP interest in strategies that target both financial returns and positive impact. Drivers include growing LP focus on ESG factors, younger inheritors prioritizing social impact, and tightened government regulations. However, firms getting into impact must have true impact credentials and institutional-quality diligence, measurement, and reporting capabilities. Those without will struggle with reputational risks.
Leading private equity impact funds use the UN SDGs as impact benchmarks
Many private equity impact funds orient around the UN Sustainable Development Goals (SDGs), which provide a credible, globally relevant framework. For example, Partners Group’s PG LIFE fund targets areas like education, healthcare access, and financial inclusion. SDG alignment helps funds select investments, define material impact KPIs, and report progress to LPs. However, each fund must still carefully evaluate an investment’s context-specific impact potential during diligence using both quantitative and qualitative factors.
Strong impact governance separates leading impact investors
Top-tier private equity impact investors have rigorous impact governance structures. This includes dedicated impact committees and processes to ensure impact is evaluated independently from financials. Partners Group’s PG LIFE fund requires approval from both its Global Investment Committee and Impact Committee for every deal. The two committees conduct parallel diligence on financial returns and impact. Leading PE impact funds also continually refine their impact management systems based on experience and adopt field-building standards like the IFC Operating Principles for Impact Management.
Returns need not be sacrificed for impact with proper portfolio construction
Many assume impact investing necessitates financial tradeoffs, but empirical evidence shows strong risk-adjusted returns are attainable. A Cambridge Associates benchmark found impact PE/VC funds launched 2005-2016 had returns in line with conventional funds. However, thoughtful portfolio construction, diversification, risk calibration, and active management of synergies between impact and financial drivers are essential to optimize for both. Hands-on management of ESG factors also enables value creation. With diligence and experience, top-tier impact PE firms have delivered market-rate returns.
In summary, the recent momentum behind impact investing strategies in private equity reflects rising LP interest. With rigorous measurement, reporting, governance, and portfolio construction, PE impact funds can optimize both impact and market-rate returns. Leading PE firms are leveraging their active management capabilities to direct more capital towards impact and build the field.