“So far, we’ve seen impact fund managers raise predominately smaller vehicles focused on emerging markets investments, with some larger funds targeting sustainability sectors in the US and Europe,” said Joelle Sostheim, PitchBook analyst. “It is difficult to forecast what future fundraising will look like, but with commitments from notable LPs like the Ford Foundation, in addition to a piqued interest from industry leaders like TPG, Bain, and KKR, we expect to see increased fund sizes and activity.”
The PitchBook Platform currently tracks data on more than 390 VC and PE impact funds that are managed by both impact-focused firms and mainstream firms overseeing discrete, dedicated impact funds. This analyst series starts with a holistic overview of impact investing that answers the following questions:
- What Constitutes an “Impactful” Investment? Unlike socially responsible investing, which is predominately used with public market securities, impact investing is a private market investment strategy that targets investment in social enterprises or impact funds. Social enterprises are companies that are both financially stable and create positive externalities through the goods and services they offer, the populations they serve, the jobs they create, or a combination of these factors. Because of the subjectivity of “impact,” investors actively track outcomes with unique metrics that correspond to their specific goals, and often require their portfolio companies to do the same.
- What Strategies Are Employed by Impact Funds? The ecosystem consists of two dominant strategies: those targeting market-rate returns, and those who accept concessionary returns. Impact funds are typically structured as closed-end VC or PE funds with traditional LP agreements and fixed investment periods. The investment instruments utilized by market-rate impact fund managers include equity stakes, leverage, and hybrid instruments, such as revenue-based financing or convertible notes. Conversely, impact fund managers who accept concessionary returns predominantly use fixed income instruments to achieve returns, focusing on debt investments in riskier but highly impactful businesses.
- What Differentiates PE and VC Impact Investment Funds? Impact funds are usually smaller vehicles than generalist PE or VC funds – 59% and 86% of PE and VC funds, respectively, are smaller than $100 million. Additionally, many of these vehicles target companies in emerging markets. Our data finds that PE fund managers concentrate on investments in Africa, while VCs focus more on South Asian countries.
- Which LPs Are Contributing to This Alternative Asset Strategy? – Sources of capital for impact funds are a mix of for-profit and not-for-profit LPs, including DFIs, foundations, HNWIs, family offices, and pensions and insurance companies. DFIs are uniquely positioned to commit capital to impact funds, and are the greatest contributors, because of their long-term financial positions and social/environmental development goals. They show the strongest aggregate commitment, as nearly 9% of all their VC and PE fund commitments since 2002 have gone to impact funds.
- What’s Next for Impact Investing? – At a base level, impact investing is an innovation on philanthropic capital that socially-oriented investors can utilize to scale the reach of their allocation, while still enjoying financial returns. As this investment strategy matures, the performance of pioneering impact funds will be crucial for establishing credibility, solidifying best practices, and setting the stage for future managers. While the entrance of mainstream firms will help attract a larger base of capital, uniformity around impact metrics is crucial so that investors can compare and benchmark investment opportunities.
Download the latest installment here.
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