RI long read: Private equity giants’ forays into impact: a sign of the market evolving or cause for concern? – Part 1

(GPs) are seeing commercial opportunities to make impact investments while trying to maximise returns.

US presidential candidate hopeful Elizabeth Warren has made private equity firms – which the Democrat calls “the poster child for financial firms that suck value out of the economy” – the first target of her proposed Stop the Wall Street Looting Act. 

At the same time, the investor giants she and many others are blaming for the collapses of and subsequent job losses at high-profile companies like Toys ‘R’ Us and Shopko, are raising billions of dollars for funds targeting social and environmental impact. 

KKR and Partners Group are raising capital for $1bn+ dollar impact funds, Blackstone launched an impact strategy in May, Apollo is rumoured to be considering an impact fund, while TPG and Bain Capital already manage dedicated impact funds. 

Perhaps unsurprisingly, mainstream private equity strategies to generate social and environmental benefits aren’t an effort to reinvent the industry or convert critics into private equity supporters (only TPG, KKR and Partners Group are signed up to the PRI). Instead, general partners (GPs) are seeing commercial opportunities to make impact investments while trying to maximise returns. 

Private equity returns vary hugely, but generally annual internal rate of return (IRR) targets are at 20% and above. 

“We’re not steering away from our private equity model – it’s important to note that the strategy we use in PE we’ll use for impact too, targeting the same returns,” says Elizabeth Seeger, director, sustainable investing, KKR. 

The firm launched its global impact strategy last year, which will comprise a dedicated impact fund reported to have raised more than $1bn so far – the final close target has not been disclosed.

We’re not steering away from our private equity model

And GPs might not have to look far from their traditional investment universe to find impact investment opportunities. Adam Heltzer, New York-based head of ESG and sustainability at Partners Group, which is fundraising for the the $1bn PG Life impact fund, says the investor had “plenty of [impact] deal flow based on our existing platform – that’s how we developed our impact strategy; we didn’t have to create a separate and ‘first-time’ sourcing effort”.

When asked why the Switzerland-headquartered private markets investor decided to launch a dedicated impact fund rather than simply continuing to make impact-aligned investments through its traditional funds, Heltzer says: “Investors asked us to create a dedicated impact strategy – but importantly they emphasised it should not come with a trade-off in returns. This was the critical balance: contribute to social and environmental impacts while upholding their fiduciary duties.”  

TPG’s Rise Fund and Bain Capital’s Double Impact Fund are the most established generalist PE impact funds, launched in 2016 and 2017, respectively. 

Bain Capital (see a snapshot of portfolio companies here on page 4), which is rumoured to be planning a second impact fund, declined to be interviewed for this article. Notably, former Massachusetts governor Deval Patrick, who has been an MD of the fund since its launch, announced in November that he had entered the race for the Democratic presidential nomination and resigned from Bain Capital. 

TPG Rise’s co-managing director Maya Chorengel tells RI that historically, TPG (see list of portfolio companies here) had made investments in companies that could be considered impact investments – for example in microfinance in Indonesia – prior to launching the Rise Fund, but starting around 2015 “there was a sense that there was a broader role that TPG could play to bring institutional capital to the impact investing market”. In addition, “the other observation was that there are larger, growth equity opportunities in impact that weren’t being served by mission aligned private capital because most impact funds were investing at the venture stage”. 

Despite the Rise Fund being rocked by the US college admission scandal – its co-founder Bill McGlashan is one of several financiers and celebrities charged with participating in the illegal scheme – TPG has managed to so far raise more than $1.7bn for its second impact fund Rise II, according to a US Securities Exchange Commission (SEC) filing on 21 October. McGlashan departed from the firm in March, and several people spoken to for this article – including rival impact-focused and traditional GPs – say the firm has handled the situation well. 

“We stuck by them throughout the McGlashan scandal,” says a director of a US pension fund allocated to TPG Rise. “Certainly it was a severe test of the integrity of the fund and their ability to regroup leadership and demonstrate accountability,” he says. “They didn’t dodge anything and really leaned into the issue across the organisation – it didn’t stop with McGlashan, they hired an independent audit to look across the organisation.” 

Regardless of TPG riding out the McGlashan situation, and it seemingly not affecting fundraising conditions significantly for PE-backed impact funds, many remain unconvinced that big traditional private equity funds are serious about impact or well placed to manage impact capital. “With some of these double impact funds you really have to squint hard to see what the impact is,” says a former director at a US private equity firm. “It’s different if the firm was set up with an aim to look at impact, then I think it’s more credible – but these impact funds […] managed by major funds, I don’t think there’s much there more than grabbing money.” 

With some of these double impact funds you really have to squint hard to see what the impact is

Concerns about big PE’s impact strategies also stem from the fact that they invest, or plan to invest, to a large extent in developed markets. 

Heltzer, who has a background working in development aid, says he “had a healthy scepticism about private equity” before joining the industry, but says there is increasing organisational buy-in at big firms to create impact, and this can be done without any financial tradeoff: “Impact investing comes in many forms and  I don't think  a hierarchy of impact is productive. We should be asking ourselves 'how can any organisation use its unique levers of influence – as an owner, as an investor, as a grantor – to optimise positive impacts and mitigate negative?'"  Heltzer adds that he sees critical social and environmental needs across all economies, both developed and developing, saying for example that there's substantial impact in backing a company addressing the US opioid crisis.

Non-impact-specialists – especially the larger firms – have “lots and lots of resources that can support their efforts” to invest for social and environmental impact, says Michele Giddens, partner at UK-based private equity investor Bridges Fund Management, an early pioneer specialising in impact and sustainability. But they do also have the challenge of “how they reconcile that impact product” with their other funds, she adds. “I’m of course hopeful that what will happen is the discipline of impact management might spread across some of the other funds in those private equity managers – that’s the positive view.”

And with impact investing originating in private markets – primarily dominated by small-scale private equity or venture capital investments in businesses or projects – it could be argued that mainstream, large private equity firms launching impact funds is a sign of impact investing maturing: “[They] are entering the part of the market that wasn’t really populated before,” says Rekha Unnithan, managing director at $2bn impact investor Nuveen. “Becoming part of the continuum.”

Rekha Unnithan, Nuveen

Indeed, generalist private equity managers entering the market has helped mainstream impact investing, Nick Moon, a partner of seasoned impact-focused private equity fund Leapfrog says. Traditional GPs do not seem to pose any threat to Leapfrog, as its latest impact fund reached a final close of $744m in May – the largest PE fund raised by a dedicated impact manager. Instead, generalist private equity managers entering the market has helped mainstream impact investing, Moon says. “You’re not seen as doing something novel anymore as an impact investor, it is becoming more and more mainstream, ultimately driven by strong demand from asset owners and managers.”

However, some institutional investors are sceptical about big private equity, he says. There are broadly two types of institutional investors looking at impact funds, he says. The first is an investor with significant experience in impact investing who sees itself as an “impact player”. These investors are asking if generalist private equity “really deliver authentic impact” Moon says.

The other group are institutional investors with broader portfolios and often a background in partnering with traditional GPs. “For them, it’s great – they’ve worked with the manager before, are happy with their track record, and now they bring them a new product not only allowing them to work with a trusted manager but to have SDG benefits as well – so you can see how compelling that is,” Moon says. 

This is exactly the view of the US pension fund director invested in TPG Rise – the institutional investor’s only impact fund allocation. A long-term investor in other TPG-managed funds, the pension fund was attracted to Rise’s dual bottom-line approach. After a “healthy debate” in the investment committee, the fact that it could buy into TPG’s attempt to put a dollar value on impact (TPG’s ‘impact multiple of money’ methodology will be discussed in more detail in part 2 of this series) decided in favour of investing in the Rise fund. The director describes the pension fund as “pretty traditional in how we look at our investments – our fiduciary duty says nothing about social and environmental factors, it’s all about maximising returns”. So far, the pension fund is happy with its Rise investment, but the director emphasises it is too early to comment on returns and long-term performance. 

It should be noted, however, that traditional GPs running impact funds hasn’t immediately triggered a flurry of pension fund interest in impact – a big part of the investor universe still consist of faith-based funds, private wealth funds and foundations, says an institutional sales director at a US asset manager: “Investing in an impact fund, even if it’s double impact, is a big leap for US pension funds [because of fiduciary duty requirements],” she says. “I’m not having conversations about impact investing with the likes of CalPERS and CalSTRS," she adds.   

Meanwhile, the emergence of larger impact funds managed by private equity giants can also create new exit opportunities for incumbent impact funds. “The underlying deals we invest in are anywhere from $5m-25m, and those usually don’t go to the public market [at an exit] but to strategic and larger funds,” says Vikram Raju, Head of Impact, at Morgan Stanley Investment Management AIP Private Markets. The fact that there are now larger impact oriented funds means new, potential buyers for such assets. “It’s a very good development to create a holistic value chain of impact,” he says.