The billion-dollar funds that have changed impact investing

What does the broader impact market think of large private equity giants' positive impact claims, Michael Hurley asks

In recent years, heavyweight US private equity investors including Apollo, KKR, Bain and TPG have entered the field of impact investing with funds targeting positive social and environmental impact, as Environmental Finance explored in a recent series of articles.

The private equity giants and their large impact funds – each with $1 billion or more in assets – bring scale, global reach and big networks of investment professionals to the impact market.

However, many smaller investors with a longer history of making impact investments remain sceptical of the impact credentials of the newcomers. In particular, they question whether some of their investments really bring substantial positive change.

Environmental Finance asked impact veterans to provide their opinion on the relative newcomers.

The head of a Europe-based impact investment firm which claims to have made its first impact investment more than 20 years ago, who asked not to be identified, said: "We certainly look very positively at the entry of new, large actors, because we think that it is crucial that the asset class should be mainstream.

"Some of these large actors are signatories to the Operating Principles for Impact Management. It is crucial that they are not reinventing the wheel or departing from the industry standards.

"I can't speak for all of them, but I think, in general, their processes are really strong. They have the resources and the expertise to put together all these systems and analytics to make sure that they are investing in the right companies"

"If we have new entrants that also are potentially not coming necessarily from impact investing but from mainstream investing and they can relate to the standards, and can apply the standards, this meets the objective of these impact principles."

However, the relatively new entrants must be cautious not to overstate the impact intent of their investments, the source added: "What we want to avoid is 'impact washing', for example if the fund manager says: 'I'm investing to benefit the poorest of the poor', when in fact the target group is a middle-income community."

One source with knowledge of KKR Global Impact's processes told Environmental Finance: "I can't speak for all of them, but I think, in general, their processes are really strong. They have the resources and the expertise to put together all these systems and analytics to make sure that they are investing in the right companies and helping those companies succeed. That's what these private equity firms are good at, that's how they've accumulated billions of dollars.

"Some of them are signatories to the Operating Principles for Impact Management. I think that's a pretty good proxy for credibility."

The funds also bring high levels of financial investment expertise and rigour which can help give investors the confidence to allocate capital to the space.

"The involvement of these big players shows that impact has mainstream appeal," added the source. "Billion-dollar funds is what you need to crowd-in institutional capital, from the likes of pension funds. You need to be writing $100 million checks. These impact funds make that possible.

"It's like a long ramp for a lot of these big institutional investors to get comfortable with impact investing by allocating to an organisation that they know already [from previous, non-impact funds]."

The advent of the private equity giants has therefore changed the impact investing market by introducing more capital to the space.

Having more capital earmarked for positive impact investments is expected to transform the capital markets by helping connect investors with companies that have a positive impact, potentially reducing the cost of capital for these companies, and sending a signal to the market there is demand for impact investments, which could help encourage more impact businesses to be created.

"The advent of the private equity giants has changed the impact investing market by introducing more capital to the space".

The bigger funds are also cutting bigger deals. For example, a $510 million investment by KKR Global Impact in recycling firm Ramky Enviro Engineers in 2019, and a €365 million ($425 million) investment by Apollo Impact in recycled cartonboard manufacturer RDM in July this year.

The smaller impact specialists that previously dominated the market had less funds at their disposal and made smaller deals as a result.

Another market observer told Environmental Finance that this presents a challenge for the impact giants, as it would be impractical for them to disburse billions of dollars by making small investments, and there are limited large impact investments available. However, he questioned whether there was enough deal pipeline for them to be able to disburse all of the funds to credible impact investments.

One challenge for the private equity giants is that, unlike the impact investing specialists, other funds may be investing in activities that run contrary to the beliefs of the impact funds. This can create scepticism about the motives of the private equity giants, particularly as private equity does not always have the best reputation when it comes to creating environmental and social goods.

For example, there is room for improvement in the way these private equity giants incentivise staff and whether this leads them to prioritise positive impact and not just financial returns, said the unidentified source.

"I think Bain does have an incentive system for their impact funds," he said. "I don't know as much about the others but in general that's not something that's commonplace in the private equity industry.

"The other big one is political spending and lobbying and it's like a basic hypothetical: if you are a private equity firm that invests in global energy companies and your organisation or your founders are lobbying to prevent progressive policies like a carbon tax, then you're kind of talking out of both sides of your mouth."

Asked whether he thinks managers like KKR are primarily motivated by financial or impact concerns, the source says: "People saw it as a way to launch a new fund and get some more investors, it's the name to put a halo around the brand.

"[Nonetheless,] I think the hope is that will kind of act as the tip of the spear moment where these managers get comfortable making impact investments, not just through separate billion-dollar funds, but they one day take those lessons and apply them to all their books."

He says impact funds from the large private equity players do not provide 'additionality', as judged by whether the investments they make would not have happened otherwise: "I don't think it meets that bar, because I think they're first and foremost [looking to] make money off their market-rate investments.

"One challenge for the private equity giants is that, unlike the impact investing specialists, other funds may be investing in activities that run contrary to the beliefs of the impact funds".

"Where it does help move the needle is being able to bring in greater institutional capital. I think that's an example of additionality."

KKR, Apollo and TPG's Rise Fund are signatories to the Operating Principles for Impact Management, while Bain Capital is not yet listed among signatories on the initiative's website. The Principles were launched in 2019 "to bring greater transparency, credibility, and discipline to the impact investing market, [and to] address concerns about 'impact-washing'".

Diane Damskey, head of the secretariat of the Operating Principles for Impact Management, said in written comments: "The primary role of the secretariat is to oversee, administer and manage the promotion, development and adoption of the Impact Principles. The secretariat does not provide critiques about individual signatories or comparisons between signatories.

"Among the signatories, there is a wide variety of type and size of impact investor, and the need for capital dedicated to impact continues to grow. By adopting the Impact Principles, impact investors can better demonstrate the rigour of their impact management strategies—which helps bring greater transparency, discipline and credibility to the market.

"While early impact investors were primarily development finance institutions and speciality impact managers, the entry of larger impact managers that have also become signatories, publishing disclosure statements and independent verification reports, is a sign that the market is maturing.

"As the market develops and grows, we expect to have greater consensus and consistency around impact measurement, impact assessment and reporting. This will make it easier for the public to assess differences and compare across investors and investments. The market is still in the early stages here.

"Only signatories publicly disclose how their impact management systems and processes align with the Impact Principles, which is key to the increased discipline and transparency that we have seen in the market."

"The entry of larger impact managers that have also become signatories, publishing disclosure statements and independent verification reports, is a sign that the market is maturing" Diane Damskey, Operating Principles for Impact Management

Delilah Rothenberg, co-founder and executive director of the Predistribution Initiative, which was launched in 2019 with the aim to promote workers and communities in investment structures, tells Environmental Finance that in her previous work in private markets fund management she noticed that "a lot of the mega fund managers had practices that were undermining their stated ESG and impact goals".

"I was looking at how we could help workers in our portfolio companies build wealth: can we pay them a living wage, can we give the workers a stake in the equity of the portfolio company that they work for?

"Relative wealth really matters and when you think about the SDGs and you go to these responsible investment conferences and see these general partners talk about embracing the SDGs, SDG 10 is focused on addressing inequality."

She said top executives at large private equity companies could earn upwards of $100 million per year. Private equity in general – and impact investors in particular – should better link executive remuneration with the financial success of portfolio company employees, she said.

"I think it's great that these big fund managers are coming up with impact strategies and ESG management systems, but they're not really addressing many of the issues that we see come up with a systemic or in a systematic way.

"When I worked in the industry, I thought we were doing great work. And I think that is probably the case for most people who work in the industry in these [impact] roles. These firms are well intentioned.

"However, most of these private equity firms are focused on portfolio company operations. There are some issues at fund manager level that are starting to get a lot of attention in the impact investing space, like diversity, equity and inclusion at the fund manager level... but I would say that for the most part, there's a lack of understanding of how investment structure can support or inhibit portfolio companies from operating responsibly.

"There is a lack of stakeholder voice that informs the governance and operations of portfolio companies and most fund managers are still missing grievance mechanisms at fund manager level as well as the portfolio company level. A lot of them are not too enthusiastic about collective bargaining and freedom of association among the workers in portfolio companies.

"It's really hard to have a responsible investment strategy when you're coming up with that definition of responsibility yourself and not consulting with other stakeholders. The stakeholder engagement component is very much missing."