The new wave of US ESG investing: as some impact funds hit market returns, corporates and tech family offices move in

Fund-of-funds, equity stakes in impact GPs or revenue sharing agreements are thriving

Impact investing has bifurcated from a lower rate of return being acceptable to some investments that are now making upper quartile returns. 

Kristian Nammack, Founder of impact investment adviser, Nordic Reach, calls the latter ‘investor-grade’ impact investing.

He says it is different from ‘philanthropic grade’ impact, but adds: “not that there’s anything wrong with that.” 

As he notes, most early funders of impact were foundations, such as the Ford Foundation: “Because they are in the business to do social good,” he says, “it meant they could accept investments that produced a slightly lower rate of returns in exchange for an impact. And there’s something called a mission-related investment (MRI) that is a tax loophole. Foundations must give away 5% of their assets every year to be in compliance with their tax-exempt status, which could take the form of an investment in a ‘good cause’ that did not provide very good, if any, returns."

This, he says, painted a picture of impact investing as a lower rate of return for better social outcomes.

Then, he says, certain ‘impact’ investments started making premium returns, and some investors realised that you could solve social and environmental problems and make good money.

One such performer is New Markets Venture Partners, an impact manager that has achieved top quartile performance across each of its last three funds, according to benchmarks from Cambridge Associates based on other venture capital fund performance.

Traditionally, funding for these impact funds has come from foundations, family offices and high net worth individuals. 

But Marieke Spence, Executive Director of Impact Capital Managers (ICM), a network of investment grade impact investors says that new funders, notably corporates, are coming into the space.

ICM has just had its first corporate venture join it: the Salesforce Impact Fund, [established by sales software company]. She says this is unusual because typically ICM members are private equity GPs [general partners] with varied investor clients. 

Increasingly, she says corporates are co-investing in companies alongside ICM members, while also making investments into funds themselves, and joining it to their own sustainability endeavours: “For example, Microsoft put a $30m investment into Closed Loop Partners and set very ambitious targets for themselves on zero waste by 2030. They recognize that to meet those targets they need the kind of expertise that Closed Loop has.”

Insurance companies, she says, pointing to Prudential as a leading example, have also been at the forefront of backing impact: “They have been in the impact space for a long time,” she says. “There are a few early leaders who drove this, such as Tony Berkley at Prudential. He joined from the W.K. Kellogg Foundation, so you could say he has impact in his bones.”

Interestingly, Spence has some concerns about foundation involvement in impact. 

“Foundations have been keen to build the necessary infrastructure for impact investing, but on the whole they’ve been frustratingly slow to invest in impact funds themselves. Some of this is an educational curve with a first generation of ‘gatekeepers’ and RIAs [registered investment advisers] just not being savvy to impact; understandably they don’t want to feign expertise with clients. So it is up to us and our peer institutions to make a clear, evidenced-based argument for impact, and the case as to how impact can drive returns and result in a competitive business advantage.”

“The other thing we have seen is the rise of impact fund-of-funds and other intermediaries who are taking equity stakes in impact GPs or building revenue sharing agreements,” adds Spence: “These new vehicles are filling a gap in the market. For example, many of our GPs cannot accept a larger cheque from an institutional allocator, but that’s a missed opportunity for the GP and for the larger investor, because it stops them from being able to invest in this range of really exciting smaller funds. So a fund-of-funds – with the right expertise – can provide the mechanism for smaller funds to participate in capital from larger investors. And it allows larger investors to access expertise that may not be available within their own organisation.”

Mark Grovic, General Partner at New Markets Venture Partners, says different industry sectors have different motivations to do impact: “Banks have the Community Investment Act [1977, which requires the Federal Reserve to encourage banks to help meet the credit needs of the communities in which they do business, including low- and moderate-income neighbourhoods], and insurance companies were worried that they were going to be regulated like the banks so they self-regulated and put together pools of impact capital. At Prudential, they have a billion dollar impact fund and they have done very well for themselves and didn’t have to deal with it being concessionary, except maybe at the very beginning. It also makes them good citizens.”

“Then there’s the new philanthropy,” he adds, “which is much more a business model along the lines of market returns and sustainability – investments rather than grants. And there’s a lot of family offices for the new technology billionaires who think more dynamically about how they are investing their money which is a big new pot of money in the impact space from that second generation of family offices that cares about impact and returns. Two different spaces [new philanthropy and new family offices] that have come to the same conclusion.”