Is impact the
new black?
Performance with purpose: Impact investing
rises to prominence

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This paper was first published in Evercore, “State of the Market”, 2019.
Samantha Steele, Head of Private Market Strategies, Private Markets
Leigh Hazelton, Research Analyst, Private Markets
Adam Rizvi, Intern, Private Markets

Impact investing is an investment strategy that has grown dramatically since its infancy. In
essence, its objective is to make a positive difference and target progress on environmental,social, and governance (ESG) matters. Whilst still in the initial stages of development, impact
investing continues to grow and mature. In this regard, it should be front and centre in
investors’ minds that this industry is at a turning point. An increasing awareness of criticalglobal issues such as climate change, food production, and healthcare has made it clear thatinvestors — both institutional and retail — should start considering how to integrate ESG
practices actively into their investment portfolio.
As a concept, socially responsible investing at the institutional level took off in the 1970s, led
by social pressure on university endowments. The growth rate of the impact industry has
ratcheted up following the publication of the United Nations’ 17 Sustainable Development
Goals (SDGs) in 2016, which aim to address a collection of global societal challenges to be
met by 2030. Shortly following the release of the SDGs, a small group of investors took the
initiative to review their existing portfolio and their investment allocation approach, todetermine how they could do more to achieve the SDGs. This socially conscious approach toinvesting — also known as impact investing — is rapidly becoming an established part of theasset management industry. Nowhere is this more evident than when considering that the
total assets under management (AUM) of signatories to the United Nations-backed Principles
for Responsible Investment is now USD$82 trillion (according to the Annual Impact Investor
Survey, 2018).
The inclusion of an impact mandate to a wider portfolio can add several new and useful risks.
These risks can be useful both from a performance and diversification perspective. Therefore,
they can make the impact strategy a useful building block when constructing and maintaining
a private markets mandate. Having said that, as the industry evolves there are challenges.
Take, for instance, the lack of harmonisation around reporting and measurement as well as
the shallow market of experienced managers. Both challenges highlight the need for
dedicated expertise in order to harness the investment strategy’s true potential.

The evolution of impact investing
There are several ways for investors to incorporate ESG
concepts and methods into active investment portfolios thatoffer the potential to enhance diversification and accessnew return drivers over the long term. Many investors prefer
the incorporation of ESG into their portfolio via the exclusionof certain securities or industries. However, now there is a
growing contingent of global investors who are seeking to
make a direct impact on the world by means of impact
investing — a strategy employed by those who aredetermined to generate both a positive societal andenvironment impact whilst generating financial returns.
From an evolutionary perspective, impact investing
represents the third generation of ESG. The first focussed

Russell Investments / Is impact the new black?

on exclusionary screening, while the second saw investors
employ a thematic approach to gain access to ESG themes.
The natural evolution from these two preceding approaches
was for investors to seek greater influence over their ESG
portfolio. Then, impact as an investment strategy was born.
As a strategy, impact investing is growing rapidly. The
Global Impact Investing Network’s most recent estimate isthat the impact market doubled in size to USD$228 billion in
AUM from USD$114 billion between 2016 and 2017.1
Investors ranging from public pensions to private equity
firms are increasingly including impact investments as partof their asset mix. Some of these impact investors
are ‘impact first’ and are willing to accept a lower financial
return (compared to a conventional financial product) in lieu
of a greater impact. The other group of impact investors are‘finance first’ and believe that return on investment is the/1higher priority. Neither strategy is better than the other, andwe believe that for the sector to function properly both
impact first and finance first investors are required.

Whilst the opportunity set is broad (and loosely based on
the 17 SDGs), some common asset classes utilised todesign an impact strategy are renewable energy,
healthcare, and education-oriented private equity. From anunlisted investment perspective, these strategies arecommonly accessed via a commingled, closed-end fund in
the private equity, private real estate, private debt, andinfrastructure sectors. Out of the four main strategies, thelevel of impact and explicit link with impact contribution canvary. For example, private debt can be viewed as an
attractive investment strategy for investors seeking tocapture a yield premium. However, we believe the limited
management influence may dilute the true ‘impact’ of thistype of investment. As a result, we believe the use of private
debt in an impact portfolio may best be limited toopportunities directly linked to the SDGs. Furthermore, theaforementioned linkage should be tangible and be clearly
underwritten by the end investor.
Previously, impact investing was largely concentrated in
private foundations (e.g. the Gates Foundation),government bodies (e.g. the European Investment Bank)and the largest, most sophisticated institutional investors.
This is changing as impact investing is now becoming more
recognised as a credible investment strategy by the broader
investment market. The industry is also receiving significant
attention from sub-national governments at the regional andlocal level, who are stepping in to fill some of the void left
behind by sovereign governments. Take for instance, theOverseas Private Investment Corporation (OPIC), which isa US government agency that helps businesses invest
abroad and is a well-known financial participant in many
segments of the industry. In fact, certain sovereign
governments are increasingly targeting tax incentives
towards investments with a clear impact potential.

Can impact investing add value to adiversified private markets
portfolio?
Interest in impact investing has grown significantly as thestrategy has challenged the preconceived notion that socialand environmental benefits could only be achieved throughphilanthropic donations. Instead, impact investing provides
an opportunity for investors to commit their capital with aneye towards advancing social and environmental solutions,whilst generating financial returns.
An argument can be made that returns from impact
strategies should match those produced in the traditional
alternative asset classes, in light of the complexity andtechnical knowledge often required to create value.
Complexity is generally due to the esoteric nature of theunderlying assets, for example: financial inclusion private
equity, charitable social enterprises providing early years
education, or anaerobic digestion power plants.
Prior to, and during, the ownership period of an asset, a
deep understanding of how the asset is affected by factors
such as current and future legislation and technologicaldevelopments is necessary to achieve consistent riskadjusted success. This additional layer of complexity alongwith the knowledge barrier has helped maintain lower
pricing. In contrast, more traditional private market
strategies which sit outside the impact sphere haveexperienced a dramatic increase in valuations over the pastten years, driven up across the spectrum by the hugeamount of cash inflows. This concept is becoming more
accepted by global investors as showcased in the 2018
GIIN Annual Survey, where 82% of respondents indicatedthat their impact investments have met their expectations
both from an impact and performance perspective.2

Exhibit 1: The evolution of ESG

Source: Russell Investments, for illustrative purposes only

Russell Investments / Is impact the new black?

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The impact sector should also benefit as the private market
industry continues to expand and raise new capital, whichshould provide greater stability and certainty to performance
via the solidification of a robust and consistent exit market.
Take for instance, the core infrastructure fund market, which
has already raised roughly USD$60 billion year-to-date in2018, a figure which already surpasses the entirety of
2017.3 For the renewable energy segment of the impact
strategy, this is bolstering the creation of a healthy exit
market which fund managers can profitably tap into oncethe operational and technical complexity has been worked
through for their assets. This phenomenon is not limited
solely to renewable energy and is therefore likely to benefit
the entire impact strategy in the form of greater exit
potential in the future.

What do investors need to consider
prior to making an allocation to
impact?
The potential for additional risk-adjusted return has notgone unnoticed by the institutional investment market. As
the asset cycle ages, a surge of new investor capital into
the general private markets industry has begun to slowly
drip into the impact space. Yet it is important to note that the
impact sector is still a small part of the overall market.
Amounting to only USD$228 billion4 out of USD$7.8 trillion,5
the relatively small size of the market is helping to maintaina perceived yield premium for investors with the right levelof sophistication to access the opportunity.
This increase in investor appetite is expected to bebeneficial for the strategy as it provides vital feedstock for it
to grow. However, as with private markets more generally(and any new industry) there are clear considerations thatinvestors must factor into the decision-making process.

Risks
Impact investing is not without risk; however, we believethat impact investing is a useful building block whenconstructing a private markets portfolio. The introduction of
new risks — such as country risk due to the potential
inclusion of new countries, asset risk (a combination of firstmover risk and technical knowledge risk), and new macrorisks which may be more demographic in nature thanmarket-linked — can help further diversify an existingmandate.
By no means are any of these risks insurmountable orunrewarded. Instead, their addition to an existing portfolio
places an even greater value on due diligence. Investors
with the capability to underwrite new asset classes in newmarkets, or who are able to achieve this via the support oftheir adviser, should be able to understand the risks toensure that a suitable return is being earned.

ReportingInstitutional investors and managers alike increasingly wantto assess the impact of their investments on society.
However, measuring a firm’s societal impacts is not easy.
Accounting standards for measuring impact do not yet exist
and the measures in use are still evolving. Greater clarity on
measurement is slowly emerging with academic
researchers studying impact assessment, and organisations
such as the Global Impact Investing Network, GIIRs, andPrinciples for Responsible Investment seeking to develop
standards for the industry.
The growing involvement of large-scale and mainstream
firms also presents a surmountable risk, namely the risk of‘impact washing’ — i.e. when actors adopt the label without
meaningful loyalty to investors’ societal goals.
Encouragingly, impact investors are aware of this risk andare beginning to emphasise the importance of greatertransparency around impact investing when underwriting acommitment.

Exhibit 2: Examples of impact investing

Source: Russell Investments, for illustrative purposes only

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Other emerging ideas include third-party certification andthe development of shared principles. Indeed, the GIIN has
committed to developing a set of principles (to be launchedlater this year) to strengthen the identity of impact investingin order to drive growth and protect the integrity of themarket.

Whilst this evolution of the reporting process is positive,
multiple frameworks and definitions — even whenthoughtfully developed — can create confusion. Therefore,
this remains an area to monitor closely in the future. There
are several players in the impact industry who are taking thebull by the horns, with the objective of pushing the industry
up the maturation curve at a quicker pace. As the industry
grows and institutionalises, this feature is expected to
improve, and the anticipation is that it will advance to asimilar level as the rest of the private markets.

Investment opportunities
Even considering the entrance of the large diversified fundmanagers, the credible manager pool can be quite shallow
within the impact sector. The pool gets incrementally
shallower as investors delve into more esoteric investment
strategies where often even the most experienced andtalented managers are fundraising. Unlike more common
private markets (where there can be a dozen managers
available at any point in time) this shallow pool puts evengreater emphasis on the ability to underwrite a manager, as
well as the investment opportunity. To achieve long-term
success, experienced hands will be vital to navigating theselection process.

An important consideration for institutional investors looking
at including impact investing into their wider portfolio is thatthe strategy may be client-focused — rather than productoriented. This is because the areas of impact tend to vary
based on the client’s wants and preferences. For example,
investors could be focussing on specific SDGs, or might
have select locations in mind. Therefore, the ‘one size fits
all’ approach may not be the best access point for many
investors.

As the market matures and investor demand strengthens,
the universe of product offerings continues to expand. In
2017, fund managers collectively raised USD$18.7 billion
with a median capital raise in 2017 of USD$32.5 million.6
Overall, fund managers in this space are expecting to raise
USD$22.5 billion in 2018,7 a 20% year-on-year increase,highlighting the extent to which impact investing is gaining
momentum.

appetite. This is because the underlying investment
opportunities often benefit from direct links to long-term
demographic factors. Impact is an area of focus for younger
generations who are more likely to have made orconsidered an impact investment. This comes as no
surprise given that these generations are more likely to be
more socially and environmentally conscious. For example,
the Millennial generation is four times more likely than Baby
Boomers to invest their money for positive social andenvironmental impact.8 Therefore, for the industry tomaintain growth, it is important for managers to continue todevelop impact products and services that meet the wants
and needs of multiple generations of investors.

Where do we go from here?
We believe strongly that as the impact industry expands
and matures with more capital allocated to this strategy, it
will eventually evolve to become a familiar slice of a private
markets portfolio — similarly to the gradual inclusion ofprivate debt. However, it is important to consider that thesector is currently in its adolescence, growing and maturing
at the same time, which lends it several rough edges andpotential pitfalls. Given the clear and growing number ofinvestors seeking to take an active approach to achieve
their ESG and impact goals, we are fully confident that
impact investing is not a passing fad.

From a risk and return perspective, the inclusion of an
impact strategy in an existing private markets mandate will
potentially have a positive effect on the overall risk/return
characteristics. Impact investments are not by definition
riskier than traditional investments, but specific risks can be
identified, especially because of the dual objective at play.
These risks, however, will be highly dependent on the typeof investment. Therefore, it is important for investors to
conduct thorough due diligence prior to making an initial
impact investment, as well as throughout the lifecycle of themandate (and where possible, with the assistance of those
who have specific expertise). This review ensures that the
new risks being incorporated into the portfolio are better
understood, underwritten, and are being adequately
rewarded.

As an industry that is growing and maturing at the sametime, impact investing understandably has some roughedges to be polished, and we expect they will be in time.
These rough edges point to the necessity for an
experienced manager who can guide investors on theirjourney in the impact industry.

Looking to the future
Out of all the key private market investment strategies,
impact is the most likely to gain from multi-generational
1

6

2

7

Global Impact Investing Network, Annual Impact Investor Survey 2018.
Global Impact Investing Network, Annual Impact Investor Survey 2018.
3
Infrastructure Investor, ‘Welcome to the golden age of infrastructure
fundraising’, 18 October 2018.
4
Global Impact Investing Network, Annual Impact Investor Survey 2018.
5
Preqin, ‘Alternative Assets Performance Monitor’ —2016
figure.

Russell Investments / Is impact the new black?

Global Impact Investing Network, Annual Impact Investor Survey 2018.
Global Impact Investing Network, Annual Impact Investor Survey 2018.
8
Barclays, ‘Investor motivations for impact: A behaviouralexamination?’, 18 July 2018.

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Impact investing and private equity: The perfect marriage?
Based on its history, private equity would seem an unlikely partner for impact investing.
However, with a greater emphasis now on ‘profit with purpose’, many private equity firms areembracing impact investment as a new opportunity to raise capital. The private equity sector’s
early impact investing approach has been led by the traditional, financially motivatedinvestors. However, it is now evolving to encompass a broad suite of operational andstrategic capabilities. Part of that operational expertise necessarily involves setting goals for
portfolio companies and actively monitoring performance against these goals — whether they
are sales growth, gross margin enhancement, or customer satisfaction.
Many private equity managers across asset classes now recognise that a strong focus on
ESG and impact (as part of the business decision-making process) can add value at thebottom line of the underlying portfolio companies, and thus does not necessarily need to beviewed as a trade-off. Some managers go even further to use their impact programs to unlock
new investment opportunity sets. For them, impact is a lens that can help them:
1. Spot under-served markets where other investors are not looking;
2. Work with mission-driven management teams, who would otherwise be wary of private
equity; and3. Build economic value by thinking deeply about, and measuring clearly, the social orenvironmental returns that move in lockstep with earnings growth.
In light of this, several major private equity firms are now building out their capabilities in
impact investment as it is no longer simply viewed as the latest investment fad. We believe
this changing approach reflects a market realisation that impact investment themes havepermanence and may be less susceptible to cyclical factors than once thought — in both
operations and liquidity.
Despite the growing interest of private market fund managers there remains a potential
misalignment between the fee structures of the private equity industry, which rely on the ‘2
and 20’ model and the underlying impact investment ethos. As more capital flows into thesector, the expectation is that greater competitive pressure during the fundraising process will
adjust fee structures to a level that is more palatable to investors, and encourage different
business models where the fee structure allows for efficient resource allocation.
A transition to lower fees will present challenges, as the operation of an impact strategy tends
to be asset management intensive. Impact investing may require a broader geographicalmarket and due to the specialist skills required, may require a pay premium to attract the besttalent. Investors must therefore evaluate whether fees are justified by the manager’s strategy
and the non-financial goals of the fund, whilst also appreciating that unprofitable management
fees could act as a constraint on performance and business focus.

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