An impact fund is managed to create a positive social and environmental impact alongside (not instead of) a financial return. As societies and governments globally move to more sustainable models, impact investing is becoming increasingly popular, providing capital to critical sectors such as renewable energy and agriculture, as well as basic services like education and health.
It’s important to stress that the positive change achieved by private equity impact funds comes in addition to returns, which are generally above public markets and on par with the private equity market¹.
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Almost all modern private equity firms build ESG (Environmental, Social and Governance) considerations into how they do business as a way of avoiding negative impact. Impact funds look at the same considerations but use them to build strategy that has a positive impact.
The asset class is not defined by a target sector but by the impact of the product or service provided by target companies within a range of sectors, meaning that impact funds are often diversified across sectors and regions. For example, a fund might invest in companies involved in renewable energy, microfinance and sustainable agriculture across multiple continents.
Since impact funds aim for more than just financial return, they do not target the same level of return as other private equity categories. Though impact funds are a relatively new addition to private markets, there is evidence that companies that operate in environmentally and socially responsible sectors can outperform companies that do not.
The impact fund market is growing steadily as we edge closer to the 2030 “deadline” of the UN’s Sustainable Development Goals (SDGs). Laid out in 2015, the SDGs take on categories like reducing poverty, creating sustainable cities and providing access to clean, affordable energy. Since every goal requires financial investment, there is a gap that needs to be filled. The UN estimates this gap to be $2.5 trillion in developing countries alone, so impact funds play a role in bridging the gap, backed by an increasingly attractive regulatory environment.
Market-rate returns. This is essential to point out. As stated above, the return profile of impact funds - higher even in many cases. These results are consistent with Morgan Stanley research on public equity and with Preqin research on private equity, which found that sustainable fund returns were in line with comparable “traditional” funds in both asset classes.
Stabilising a portfolio. The research as above also found that social impact funds had a lower volatility than non-impact funds. In particular, sustainable public equity funds experienced a 20% drop in downside deviation to “traditional” funds, while private equity impact funds showed lower variance - a key measurement of risk.
Long-term value. As economies around the world shift focus to the future of our societies and our planet, companies with a positive impact are preferred by governments, customers and investors alike. Looking ahead, this means that the long-term future of impact investments is very likely to improve at an accelerating rate.
Investing in what matters. Plenty of experienced investors will tell you that investing is about more than a pure financial return. So, considering that impact funds can achieve market rate returns - at a lower volatility while diversifying a portfolio - the added bonus of knowing an investment is making an impact can be attractive to many investors.
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