The nature of private markets supports companies aiming to solve social and environmental challenges while delivering a financial return.

The past decade has seen significant growth in the number of private companies seeking to address social and environmental challenges across diverse areas such as renewable energy, waste processing, education technology, financial services, and healthcare, among many others. At the same time, investor interest in global sustainability has climbed sharply: According to industry research, 80% of global investors say they are more focused on sustainability today than five years ago1 and 95% of Millennials are interested in sustainable investing strategies.2

This combination of an attractive opportunity set and interest from institutional and high net worth investors has helped attract private equity attention and fueled the growth of impact investing, a segment within the sustainable investing universe that seeks to generate a measurable social and environmental impact alongside a market-rate investment return. As it has matured, this once-niche market has entered the mainstream and become a vibrant option for high-net-worth investors seeking to align their portfolios with their values.

In this first entry in our Impact Investing series, we examine why the private markets provide an ideal home for impact-focused companies.

Public markets may offer limited potential for direct impact

Compared with sustainable investment strategies offered in the public markets, we believe the private markets are better positioned to deliver positive impact while achieving market-rate financial returns. There are a few reasons for this. First, investors in public market companies typically own a small percentage of shares and, as a result, have limited ability to influence the impact potential of these companies. Rather than actively drive impact, sustainable public market strategies often take a more passive approach by screening out undesirable industries (for example, fossil fuel or firearms) and/or investing in companies that perform well on environmental, social, and governance (ESG) measures.

chart - flows into sustainable funds grew dramatically in 2019

One of the more common ESG-related approaches, known as ESG integration, is often marketed as “socially responsible,” but a look under the hood of some of these funds reveals a larger focus on risk management related to corporate governance than on achieving positive environmental or social impact. Amid a dramatic rise in ESG assets under management, the SEC is beginning to scrutinize funds’ socially responsible claims to determine whether they are legitimate or amount to marketing spin, a phenomenon known as “greenwashing.”3

Leveraging resources helps private equity firms institutionalize ESG across a portfolio
Through the private equity model, managers maintain significant influence over portfolio companies, enabling them to drive improved impact and financial outcomes. The PE model creates efficiencies by leveraging management, technical expertise, and resources across a portfolio of companies. As PE firms become more focused on impact, they are employing this model to deploy, manage, and measure the success of ESG programs and specific impact initiatives systematically across companies.

Untested ideas and technologies can thrive in private markets
Another reason private markets can better foster impact is that the public markets tend to be less hospitable to smaller companies developing untested approaches or that have longer time horizons. Many impact-focused companies are innovative and technology-oriented and need time to prove out their ideas. The vast majority of these companies are located in the private markets. The long-term nature of private equity better enables these companies to thrive: Unencumbered by quarterly reporting requirements, impact-focused private companies and their investors can be flexible and patient in building and following through with longer-term solutions to intractable social and environmental challenges. Public companies seeking to make an impact, meanwhile, must weigh the benefits of such long-term projects against critical near-term financial targets.

Impact investing has reached a tipping point
In the early days of impact investing, most strategies focused on environmental issues and invested in companies that often relied on government subsidies or forward-thinking pioneer investors, such as the World Bank, for survival. These strategies could be risky and often delivered disappointing performance. Today, impact investing has entered a more mature, institutionalized sphere that has achieved scale and offers investors opportunities to participate at lower risk levels, with better return potential. As more high-quality, impact-focused private market strategies become accessible at lower investment minimums, we expect to see higher adoption rates among individual investors.

In the next entry in our Impact Investing series, we’ll examine how early impact investing strategies paved the way for today’s more mature, diversified impact approaches.

Was this article helpful?
YesNo

1) Bain & Company, Private Equity Investors Embrace Impact Investing, April 2019.

2) Morgan Stanley Institute for Sustainable Investing, Sustainable Signals: Individual Investor Interest Driven by Impact, Conviction and Choice, September 2019.

3) The Wall Street Journal, ESG Funds Draw SEC Scrutiny, December 2019.

IMPORTANT INFORMATION
This material is provided for informational purposes only and is not intended as, and may not be relied on in any manner as legal, tax or investment advice, a recommendation, or as an offer to sell, a solicitation of an offer to purchase or a recommendation of any interest in any fund or security offered by Institutional Capital Network, Inc. or its affiliates (together “iCapital Network”). Past performance is not indicative of future results. Alternative investments are complex, speculative investment vehicles and are not suitable for all investors. An investment in an alternative investment entails a high degree of risk and no assurance can be given that any alternative investment fund’s investment objectives will be achieved or that investors will receive a return of their capital. The information contained herein is subject to change and is also incomplete. This industry information and its importance is an opinion only and should not be relied upon as the only important information available. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed, and iCapital Network assumes no liability for the information provided.

Products offered by iCapital Network are typically private placements that are sold only to qualified clients of iCapital Network through transactions that are exempt from registration under the Securities Act of 1933 pursuant to Rule 506(b) of Regulation D promulgated thereunder (“Private Placements”). An investment in any product issued pursuant to a Private Placement, such as the funds described, entails a high degree of risk and no assurance can be given that any alternative investment fund’s investment objectives will be achieved or that investors will receive a return of their capital. Further, such investments are not subject to the same levels of regulatory scrutiny as publicly listed investments, and as a result, investors may have access to significantly less information than they can access with respect to publicly listed investments. Prospective investors should also note that investments in the products described involve long lock-ups and do not provide investors with liquidity.

Securities may be offered through iCapital Securities, LLC, a registered broker dealer, member of FINRA and SIPC and subsidiary of Institutional Capital Network, Inc. (d/b/a iCapital Network). These registrations and memberships in no way imply that the SEC, FINRA or SIPC have endorsed the entities, products or services discussed herein. iCapital and iCapital Network are registered trademarks of Institutional Capital Network, Inc. Additional information is available upon request.

© 2020 Institutional Capital Network, Inc. All Rights Reserved.

Kunal Shah

Kunal Shah

Kunal is Managing Director and Head of Private Equity Solutions at iCapital, focused on the identification, selection and due diligence of private equity funds to be offered on the Flagship Platform. Previously, Kunal was a Principal in the private markets group at Meketa Investment Group, a leading global investment consultant serving pensions funds, endowments and foundations, and family offices. He received a BS in Business Administration with a concentration in Finance from Drexel University. See Full Bio.

Tatiana Esipovich

Tatiana Esipovich

Tatiana Esipovich is part of the Research & Due Diligence team. Prior to joining iCapital in 2017, Tatiana worked at DB Private Equity (part of Deutsche Asset Management) in New York. Tatiana started her career at Deutsche Bank in London. Ms. Esipovich received an MA in Modern Languages from Oxford University.