GLOBAL INSIGHTSFROM IMPACTINVESTING
TO INVESTINGFOR IMPACT
By Jason M. Thomas and Megan Starr
The dual purpose of "impact investing" has always seemed to imply that positivesocial and environmental outcomes necessarily come at the expense of financial
performance. In this paper, we document that it is precisely the societal goals of the
impact investor – diversity and inclusion, environmental sustainability, responsible
governance – that increasingly generate the above-market returns sought by themarket as a whole. As traditional financial efficiencies have become more fully
integrated and priced in to assets, environmental and social factors provide a lens to
identify untapped value in all types of companies by driving sales, reducing costs andboosting productivity through improved governance, inclusion and diversity initiatives,
workplace investments in human capital, and investments in energy sustainability.

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FROM IMPACT INVESTING TO INVESTING FOR IMPACT
The phrase “impact investing” was coined in 2007 to describe
a new form of financial intermediation that combines socialand environmental mission-orientation with traditional asset
management.1 From the outset, the dual purpose of thestrategy seemed to suggest that positive social and environmental outcomes necessarily come at the expense of financial performance. Researchers focused on impact’s “cost” interms of foregone returns,2 often implying that traditional
strategies must involve some degree of social or environmental degradation. As initially conceived, impact investing
seemed predicated on a “damned if you do, damned if you
don’t” mindset that treats genuine impact as irreconcilable
with (risk-adjusted) return maximization.

By Jason M. Thomasand Megan Starractually impede improvements in investment performance.
By presuming that social benefits detract from returns,
traditional investors ignore the ways an impact orientation
can add (market) value. And by assuming that genuine
impact requires some degree of financial sacrifice,4 impact
investors can fail to appreciate how socially-optimal strategies manifest themselves in company income statements
and valuations.

Improved Governance & Longer-Term Orientation
Relative to listed equities, private markets are illiquid,
involve more concentrated ownership stakes, and offer
investors a much greater degree of control over the underlying portfolio companies. These features naturally cultivatea longer-term orientation and a much broader assessmentof risks and opportunities. Investors exchange liquidity for
influence, a trade-off that could only make sense if the
returns to more active governance compensate for thecosts of being “locked in” to the investment. Since these
returns typically take years to manifest themselves, private
holding periods tend to be much longer than those of thetypical stock market investor,5 and require a willingness tohold the asset for five or more years.

N.B. impact investing traditionally refers to private
investments made into companies or assets with
the intention to generate social and environmental
impact alongside a financial return. ESG integration
strategies are applicable across both public and private
markets, and typically refer to the incorporation ofenvironmental, social, and governance factors into a
traditional investment analysis across a wide range ofcompanies. Most institutional investors focus on where
ESG factors add material value through differentiatedinsights (however other types of investors use thesetools to express market views or personal priorities).

As interest rates have declined and entry multiples haverisen, it is no longer possible to generate historic rates ofreturn without investing for impact – to use the term in avery broad sense. With no tailwinds from falling financecosts, recovering economies, or rising valuations, private
markets investors can only meet return targets by consistently building better businesses. And while better businesses tend to be stronger financial performers, company
financials provide much too narrow a vantage point toassess the strength or sustainability of a business. A muchbroader lens is required, which examines every componentof the business through a total improvement orientationthat adopts aspects of the intent, actions, and theory ofchange once thought to be the exclusive province of“impact” funds.6

As markets have evolved, this stark dichotomization betweensocial and financial returns has become progressively harderto defend.3 The same companies often receive financing
from both traditional asset managers and dedicated impact
funds. The same pools of capital often commingle funds
from highly-motivated environmental, social and governance (ESG) investors with those of investors focused solely
on earning the highest possible (risk-adjusted) return.
More consequentially, as we describe in greater detailbelow, it is precisely the societal goals of the impact
investor – diversity and inclusion, environmental sustainability, responsible governance – that increasingly generate
the above-market returns sought by the market as a whole.
As traditional financial efficiencies have become more fully
integrated and priced in to assets, environmental and social
factors provide a lens to identify untapped value in all typesof companies by providing means to drive sales, reduce costs,
enhance productivity, or expand valuation multiples.

Impact investors seek to produce beneficial social outcomesthat would not occur but for their investment in an enterprise.7 While “impact” funds in their purest definition arelimited to investing in companies whose sole, or “core,”business directly addresses a defined set of environmental orsocial challenges, a total improvement orientation assesses
the potential actions to improve social and environmental
outcomes at all prospective businesses. Hence while

The assumed trade-off between social benefits and financial returns may not just be outmoded; such thinking could

4 Brest P. and K. Born (2013), “When Can Impact Investing Create Real Impact,” Stanford Social Innovation Review.
5 Morningstar estimates that the average turnover ratio for managed domestic stock funds is 63%, as ofFeb. 28, 2019.
6 Jackson, E. (2013), “Interrogating the Theory of Change: Evaluating Impact Investing Where it Matters
Most,” Journal of Sustainable Finance & Investment.
7 Brest and Born (2013).

1 Höchstädter, A. and B. Scheck. (2015), “What’s in a Name: An Analysis of Impact Investing Understandingsby Academics and Practitioners,” Journal of Business Ethics.
2 Barber, B. et al. (2019), “Impact Investing,” NBER Working Paper No. 26582.
3 Chowdhry, B. et al. (2019), “Investing for Impact,” Review of Financial Studies.

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impact investing channels capital to a narrowly defined
subset of potential investment opportunities, private
markets’ particular characteristics – concentration, control,
and a longer time horizon – provide both the opportunities
and financial incentives for investors to generate beneficial
outcomes across a much broader universe of businesses.

of the $1.7 trillion increase in private markets assets undermanagement (AUM) as delistings have waned in significance(Figure 1). With virtually no fat to cut, returns on these investments depend on investors’ ability to catalyze growth, which
typically results in substantial increases in employment.12
FIGURE 1

From Cost Containment to Top-Line Growth

Changing Nature of Private Investment Types,
1990-201813

In the early years, private markets resembled a “barbell”
with capital focused on early-stage venture and late-stage
public-to-private delistings. Most of these late-stage investments targeted public companies that had squandered
resources on dubious investments that seemed to prioritize size and maximize the resources under management’s
control (often referred to as “empire building”).8 Private
governance more closely scrutinized the cost structures,product lines, and organizational hierarchies that evaded
detection under the ownership of a broadly diffused massof public shareholders free to sell their stake at any time.9
While delivering significant increases in productivity, such
scrutiny also often resulted in payroll reductions and it is,perhaps, these experiences more than any other that havecontributed to the sense that financial returns and social
returns do not coincide in traditional private investing.10

Deal Type by Share of Investments

1990-2004

2005-2018

Private(Primary &Secondary)

Carveout

60%

Share of All Deals

50%
40%
30%
20%
10%
0%

Public-to-Private

PIPE, Add-On,
Other

Deal Type by Value Invested“It is precisely the societal goals of the
impact investor – diversity and inclusion,
environmental sustainability, responsible
governance – that increasingly generate
the above-market returns sought by themarket as a whole.”$1,400Relative to 2004 AUM

Relative to 2018 AUM

Billions of USD$1,200$1,000
$800
$600
$400
$200

While discussions about the impact of private equity still
focus on these public-to-private de-listings, these investments have declined significantly as a share of private
market activity. The success of private governance – and theevidence of gross inefficiencies it uncovered – led to botha sharp decline in the number of public companies – fromnearly 8,000 in the late-1990s to less than 3,500 today –and improvements in public company governance.11 As aresult, the market opportunity from public-to-private cost
rationalization has declined precipitously and returns havecome to depend on investors’ ability to underwrite – anddeliver – value creation from top-line growth.

$0

Public-to-Private

Private(Primary &Secondary)

Carveout

PIPE, Add-On,
Other

The alignment between financial and social returns is evident
in the data. Among all U.S. Carlyle investments completed
since 2013, every 10% increase in payrolls (excluding theeffects of mergers) has been associated with a statisticallyand economically significant 21.4% increase in cumulative
returns (likewise, every 10% decline in payrolls corresponds
to a -21.4% drop in returns).14 Among investments where
employment growth exceeded 15%, average returns were
nearly 60% higher than for investments where headcountdeclined, on average (Figure 2).

Since 2004, investments in private companies – including
secondary buyouts – have accounted for more than 60%
8 Jensen, M.C. (1986), “Agency Cost of Free Cash Flow, Corporate Finance, and Takeovers,” American
Economic Review.
9 Richardson, S. (2006), “Over-investment of Free Cash Flow,” Review of Accounting Studies.
10 Davis, S. et al. (2019), “The Economic Effects of Private Equity Buyouts,” October 7, 2019.
11 Business Roundtable, 1997 Statement on Corporate Governance, affirmed that CEO’s “paramount duty” isto the corporation’s shareholders.

12 Davis, et al. (2019). Investments in private companies are associated with a 13% increase in employment,
on average, over a two-year period. If the private company was previously owned by a private investor, theaverage employment gains are 10%, on average.
13 Josh Lerner, Harvard Business School, Global Preqin Data, June 2019, Carlyle Analysis of Portfolio Data.
14 This is based on a sample of 35 companies with at least 3 years’ worth of headcount data over the period
2015-2018, controlled for anomalous growth (e.g., apparent acquisitions/divestitures, very low headcount, etc.).

3

We do not believe such employment growth was accidental
or incidental, but stems directly from investor intervention:industry and product market expertise, and the doors opened
and strategic guidance provided by professional networks anda global footprint. While few of these portfolio companies
would meet the screen of a “pure” impact fund, the beneficial
social outcomes would not have occurred in the absence ofinvestment – here, value creation is demonstrably positively
correlated with increased social value in the form of new jobs.

suggests that workforce investments that lead to positivesocial outcomes – higher retention rates, enhanced employee
engagement, and greater sense of purpose – tend to yieldfinancial returns not evident to observers solely focused on
accounting data.
FIGURE 3

Workplace Investments in Employee Retention
Generate Outsized Returns16
Cumulative Return of an Equity Strategy Long Low TurnoverFirms and Short High Turnover Firms

FIGURE 2

Positive Relationship Between Carlyle Payroll Growthand Returns15

600%

2.50x

Return

2.30x
2.10x
1.90x
1.70x

400%

200%

1.50x
1.30x
1.10x

1.70x

1.6x
70%

1.2x

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

59%

60%

1.10x

50%

0.90x

40%

0.70x

30%

>15%

21%

17%

20%

Cumulative Headcount Growth, 2015-201810%

Human Capital and Returns

0%Arithmetically, increasing payrolls does nothing to boost
financial returns in and of itself. It is only when marginal sales
grow at a faster rate than marginal employment that firmlevel productivity increases at the rate necessary to hit returntargets. While “human capital” often refers to the managerial
talent and professional networks of people at the top of anorganization, research and experience indicate that the experiential knowledge and motivation of the broad employee baseis equally as important to company performance.

90%

Productivity

Profitability

Turnover

Percentage of Business Units with Above-Median Composite
Performance Scores, Ranked by Employee Engagement

80%
70%
60%
50%
40%
30%
20%

Firms with lower employee turnover dramatically outperformtheir high turnover counterparts (Figure 3), as the frictionalcosts of hiring and retraining more than offset any perceived
gains from “holding the line” on compensation. Moreover,survey data also make clear that employee engagement
reliably predicts productivity and profitability at the individual firm and business unit level (Figure 4). Our experience

10%
1st

5th

10th

20th

30th

40th

50th

99th

0%
60th

0-15%

70th

<0%

80th

0.50x

Median Outperformance of Top-Quartile Businesses over
Bottom-Quartile, Ranked by Employee Engagement

90th

1.10x

Businesses with High Employee Engagement
See Markedly Better Results across Several
Performance Metrics17

Average MOIC by Headcount Growth
1.9x

1.50x
1.30x

FIGURE 4

95th

1.90x

-40%
-20%
0%
20%
40%
Cumulative Headcount Growth, 2015-2018

2004

2002

0.70x
0.50x

2003

0%

0.90x

Employee Engagement Percentile

16 Fedyk, Hodson; Trading on Talent: Human Capital and Firm Performance (November 18, 2017). Harvard
Business School
17 Gallup; The Relationship Between Engagement at Work and Organizational Outcomes; 2016.

15 Carlyle Analysis of Portfolio Company Data, February 2020. Some companies lack data for 2015 or 2018, but
all companies have at a minimum 3 years’ worth of data.

4

Diversity Improves Decision-Making

Returns on Investment in Sustainability

In addition to issues of employment and job satisfaction, a
total improvement approach prioritizes additional elements ofhuman capital. For example, many impact-oriented investors
prioritize diversity and inclusion and look to channel capitalto businesses with diverse boards, founders, and leadershipteams.18 The data from our own companies support thegrowing consensus that diversity should be a priority of all
funds with governance rights and influence, not just because
it is a socially-desirable outcome, but also because diversity
improves decision-making and financial outcomes.

Of all the issues for which investors seek opportunities tomake an impact, perhaps none is as consequential as climatechange. Whether through pure-play impact, infrastructure,or dedicated clean energy funds, billions of dollars havebeen raised for investments in renewable and sustainablesource of energy, energy storage, and carbon capture technology and much more is needed. When including expectedindustry and public outlays, total investments in this spaceare expected to exceed $300 billion per year through 2040,
with more than $550 billion required annually to reach the
net zero emission goal of the Paris Agreement.21

FIGURE 5

While dedicated renewable energy funds will remain the
primary channel to address opportunities from climatechange, shifts in public consciousness have increased thereturns on broader investments in sustainability. The past
two years have witnessed a sharp rise in the use of thephrase “climate crisis” – in lieu of “climate change,”“climate risk,” or “global warming” – to describe thenature of the threat facing the planet (Figures 6 and 7).
Such usage conveys a sense of urgency that has also been
increasingly reflected in asset prices.

Average

14.0%

12.3%

12.0%

10.3%

10.0%
8.0%
6.0%
4.0%
2.0%
0.0%

0.5%
No
Diversity

DiverseNews Mentions of “Climate Crisis” by Month22
65,000Weighted Average

12.0%

55,000

9.8%

10.0%

45,000

8.2%

8.0%
6.0%

FIGURE 6
Somewhat
Diverse35,00025,0004.8%

15,000

4.0%

5,000

2.0%
0.0%

(5,000)No
Diversity

Somewhat
Diverse

Dec-08May-09Oct-10Aug-10Jan-11
Jun-11
Nov-11
Apr-12
Sep-12
Feb-13
Jul-13
Dec-13May-14Oct-14Mar-15Aug-15Jan-16Jun-16
Nov-16
Apr-17
Sep-17
Feb-18
Jul-18Dec-18May-19Oct-19Cumulative Earnings Growth
Since Acquisition, Annualized

Cumulative Earnings Growth
Since Acquisition, Annualized

Annualized Cumulative Earnings Growth Averages by
Board Diversity Rank19

DiverseBy promoting divergent viewpoints, board diversity contributes to more deliberative decision-making processes andmore effective governance.20 Over the past three full years,
the average earnings growth of Carlyle portfolio companies
with two or more diverse board members has been nearly
12% per year greater than the average of companies thatlack diversity (Figure 5). After controlling for industry, fund,and vintage year, companies with diverse boards generateearnings growth that’s five times faster, on average, witheach diverse board member associated with a 5% increasein annualized earnings growth.

FIGURE 7

Investment Research Reports Including “Climate
Crisis” by Year23
90
80
70
60
50
40
30
20
10

18 C.f. Consumer Technology Association Diversity Investment, 2019.
19 Carlyle Analysis of U.S. Portfolio Company Data, February 2020. “Diversity” refers to female, Black,
Hispanic or Asian.
20 Carter, D, Simkims, B, Simpson W. “Corporate Governance, Board Diversity and Firm Value”, The Financial
Review 2003

21 International Energy Agency, 2019 World Energy Outlook.
22 Carlyle Analysis; Google Trends.
23 Carlyle Analysis; S&P Capital IQ Database.

5

2019

2018

2017

2016

2015

2014

2013

2012

2011

0

In today’s market, consistentoutperformance requires a total
improvement mindset that is able
to both perceive and capitalize on
the financial returns generated inpursuit of societal goals.

FIGURE 9

Private Firms More Sensitive to Investment
Opportunities than their Public Counterparts25
Average Annual Change in Gross Fixed Assets

Private Firms

Public Firms

0.12
0.10
0.08

As public fears of the nearer-term consequences of climatechange have intensified, enormous disparities in energy
sector multiples have emerged. Today, the valuation
assigned to a given energy company largely depends on
where its assets sit on the clean energy spectrum (Figure8), creating compelling financial incentives to accelerate
the energy transition in advance of changes in underlying
energy consumption.

0.06
0.04
0.02
0.00

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Sensitivity to Investment Opportunity

FIGURE 8
Sensitivity to Investment Opportunities

Valuation Multiples Have Adjusted to Energy
Transition Risk in Advance of Changes inFundamentals24
Renewable
Infra/Facilities

90.00X
80.00X
70.00X

Multiple

60.00X
50.00X

EV/Battery/
Manufacturers

40.00X
30.00X
20.00X
10.00X
0.00x

0.10
0.08
0.06
0.04
0.02
0

0.05

0.1

0.15

0.2

0.25

Industry-Specific Sensitivity in Share
Prce to Changes in Earnings

FIGURE 10Wind Turbine/
Solar Tech

Adding Renewables Capacity to O&G Assets Can
Produce Significant Multiple Expansion26

Energy Transition

R² = 0.6781

20.0x

Thanks to longer holding periods and investment horizons,
companies backed by private capital tend to invest morethan their public counterparts and that investment tends
to be more sensitized to changes in relative valuations(Figure 9). These climate-related shifts in asset prices incent
private investors to reduce carbon footprints and deploy
capital into green energy and related storage technology.
Increasing renewables’ (photovoltaic solar and wind) shareof total revenue from zero to 40% could lead to a doublingof the typical energy company’s trailing Ebitda multiple(Figure 10). Ironically, investments in oil and gas companies
offer the strongest financial incentives to accelerate theglobal transition to clean energy – a fact not lost on private
market investors with a total improvement orientation.

24

Public Firms

0.12

0

Integrated
Oil and Gas
S&P Global
Utilities

Private Firms

0.14

18.0x

EV / TTM EBITDA

16.0x
14.0x
12.0x
10.0x
8.0x
6.0x
4.0x
0%

10%

20%

30%

40%

50%

60%

70%

80%

90% 100%

25 Asker, John William and Farre-Mensa, Joan and Ljungqvist, Alexander, Corporate Investment and Stock
Market Listing: A Puzzle? (October 4, 2014). Review of Financial Studies 28, no. 2 (February 2015): 342-390.
26 Carlyle Analysis of S&P Capital IQ Data, February 2020.

Carlyle Analysis; S&P Capital IQ Database.

6

Investing for Impact

Jason Thomas is a Managing Director and Head of
Global Research at The Carlyle Group, focusing on
economic and statistical analysis of Carlyle portfolio
data, asset prices and broader trends in the global
economy. He is based in Washington, DC.

Pure impact funds channel capital in pursuit of important socialand environmental goals; their potential to catalyze change inthese areas and seed new growth opportunities make theman important part of the investment ecosystem. But the bifurcation of the market into “impact” and “traditional” funds
can create a false dichotomy in the minds of observers thatassumes high returns impose social costs, or that beneficial
outcomes necessarily require some financial concession.

Mr. Thomas serves as Economic Adviser to thefirm’s corporate Private Equity, Real Estate andCredit Investment Committees. His research helps
to identify new investment opportunities, advancestrategic initiatives and corporate development, andsupport Carlyle investors.

The same societal values that motivate investors to allocate
towards impact funds have become increasingly reflectedin broader asset prices. Above-market returns often comedirectly because of – not in spite of – actions that advancethe social goals of the impact investor – as demonstrated
by the examples here highlighting the financial impacts ofgreater inclusion and diversity, environmental sustainability,
and responsible governance. In today’s market, consistentoutperformance requires a total improvement mindset
that is able to both perceive and capitalize on the financial
returns generated in pursuit of societal goals.

Prior to joining Carlyle, Mr. Thomas was Vice
President, Research at the Private Equity Council.
Prior to that, he served on the White House staff
as Special Assistant to the President and Director
for Policy Development at the National Economic
Council. In this capacity, Mr. Thomas served as
primary adviser to the President for public finance.
Mr. Thomas received a BA from Claremont McKenna
College and an MS and PhD in finance from George
Washington University, where he studied as a Bankof America Foundation, Leo and Lillian Goodwin
Foundation, and School of Business Fellow.
Mr. Thomas has earned the chartered financial analyst
designation and is a Financial Risk Manager certified
by the Global Association of Risk Professionals.

Economic and market views and forecasts reflect our judgment as ofthe date of this presentation and are subject to change without notice.
In particular, forecasts are estimated, based on assumptions, and maychange materially as economic and market conditions change. The
Carlyle Group has no obligation to provide updates or changes to these
forecasts.

Megan Starr is a Principal and Global Head of Impact
for The Carlyle Group. She is based in New York.

Certain information contained herein has been obtained from sources
prepared by other parties, which in certain cases have not been updated
through the date hereof. While such information is believed to be reliable
for the purpose used herein, The Carlyle Group and its affiliates assume
no responsibility for the accuracy, completeness or fairness of suchinformation.

Prior to joining Carlyle, Ms. Starr was a Vice President
within Goldman Sachs’ Investment Management
Division, where she helped build the Environmental,
Social and Governance (ESG) and impact investing
business. Previously, Ms. Starr was Chief of Staffof The JPB Foundation, a $3.8 billion private familyfoundation based in New York City.

References to particular portfolio companies are not intended as, andshould not be construed as, recommendations for any particular company,
investment, or security. The investments described herein were not madeby a single investment fund or other product and do not represent all of
the investments purchased or sold by any fund or product.

Ms. Starr received an MBA and a certificate inpublic management and social innovation from
Stanford University’s Graduate School of Business,where she was an Arbuckle Leadership Fellow,
and an AB in environmental science and public
policy from Harvard College, where she graduatedmagna cum laude.

This material should not be construed as an offer to sell or the solicitationof an offer to buy any security in any jurisdiction where such an offer orsolicitation would be illegal. We are not soliciting any action based on
this material. It is for the general information of clients of The Carlyle
Group. It does not constitute a personal recommendation or take into
account the particular investment objectives, financial situations, or needsof individual investors.

C O N TA C T I N F O R M AT I O NJason Thomas
Head of Global Research
jason.thomas@carlyle.com(202) 729-5420

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