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Commentary: How institutional is impact investing? - Pensions & Investments

The impact investing market is gaining steam, as evidenced by nearly daily announcements of new products and entrants, not least of which is Temasek's $500 million investment in LeapFrog Investments in March.

Notwithstanding Temasek's catalytic move, however, there remains a major challenge to moving the market into the mainstream: the limited participation by other large institutional investors.

A June 2020 report from International Finance Corp. estimates that the total size of the private fund impact investing market was $415 billion in 2019, or a fraction of the $8.3 trillion managed by conventional private funds.

Why aren't more institutional dollars flowing into impact investing? There are many potential reasons for the slow trickle of capital to date. For instance, large institutional investment programs are generally managed according to well-defined policies, structured with considerable oversight and embedded with existing managers.

What's becoming increasingly clear, however, is that dynamics are changing. Just as we have seen traditional asset managers ramping up development of products incorporating impact strategies, we are now seeing similar momentum with institutional investors.

To evaluate the private impact market's level of institutional readiness, we came up with a grading system featuring five dimensions:

  • Proof of concept. Are there established impact managers and funds?
  • Depth. Is there a wide enough range of impact products?
  • Data. Can impact performance numbers be classified, scrutinized and benchmarked?
  • Connectivity. Is there a multilayered landscape of intermediaries to help design, provide due diligence and place funds?
  • Awareness. How aware and knowledgeable are institutional investors when it comes to impact investing?

We have rated each of these market dimensions as "ready," "almost ready" or "getting ready" for institutional investors.

Institutional investors want established managers and track records. This requirement typically means a follow-on fund or a first-time fund that can demonstrate it builds on a prior strategy and track record. A strong sign of proof of concept in impact investing is the emergence of well-known successor funds, like TPG Capital's Rise Fund II and Bain Capital's Double Impact Fund II, both of which target measurable social and environmental impacts in a variety of sectors.

Trends to watch: In addition to growth in follow-on funds, increased proof of concept will come from more robust realized track records, as the recent crop of impact funds harvest their investments. We also anticipate more manager specialization, with established strategies becoming more focused through spin-offs and platform extensions, such as TPG Rise Climate, which will make investments to combat climate change.

An institutional market requires a large opportunity set, which is necessary for investors to build diversified portfolios. Impact products are increasingly being launched across asset classes, including in private equity (Apollo Global Management LLC, KKR & Co.), fixed income (Avenue Capital Group) and real assets (Brookfield Asset Management, Franklin Templeton Investments). However, the overall market remains small and, with a median AUM of $89 million for impact investors in 2019, many impact funds are subscale for large investors that typically look to commit $100 million or more to a single fund.

Trends to watch: Growth in total volume and a step up in average fund size are both key to a deeper market. A key metric of institutional readiness is the number of funds over $500 million. We also anticipate more co-investments, a common institutional investor expectation that requires a commensurately larger investible market.

A significant gap remains between the quality and quantity of information on impact and financial performance. Studies from groups such as Cambridge Associates LLC and the Global Impact Investing Network, provide insights into financial performance. However, the market lacks robust information that investors really need, such as years of historical returns by vintage, strategy, size and geography. In addition, though tools are improving to measure impact, consistent data to compare social and environmental outcomes across investments and managers does not yet exist.

Trends to watch: The gap in data will be addressed over time as asset owners and managers compile their own information and share it with partners. On the impact front, in particular, more robust methodologies are needed. In addition to work by the GIIN, Impact Management Project and others, one initiative we're watching is the Harvard Business School's Impact-Weighted Accounts Project, which aims to create "financial accounts that reflect a company's financial, social and environmental performance."

Advisers are critical to support and connect asset owners and managers. Sell-side expertise continues to grow — from mainstream placement agents and large investment banks with sustainability client groups, to specialized firms with impact investment expertise. On the buy-side, some investment advisers and consultants (which count many large institutional investors as clients) have developed capabilities to source, underwrite and monitor impact products.

Trends to watch: We'll be looking for more widespread impact activity among the investment consultant community, including the implementation of systems and tools developed specifically for impact and managed by dedicated experts.

A successful market requires investors that understand the ins and outs of impact investing. A growing cadre of specialist and mainstream service providers, media platforms and other organizations are helping to educate the market. In addition, asset managers working to build demand for their products have played a critical role in raising awareness.

Trends to watch: We anticipate growing penetration of impact within conventional private markets forums — from coverage in mainstream publications to meaningful presence at mainstream conferences. Similarly, we also expect to see more institutional investors participating in specialist events and forums.

Combining each of these requirements, we see the impact market overall today as "almost ready" for large scale institutional investor participation. Although the timeframe to achieve a bona fide institutional market will depend on developments such as growth in investment opportunities, improved measurement and reporting capabilities and increased intermediary focus, as well as the state of the broader economy, momentum is growing and we believe the tipping point could come soon.

Demand from individuals, foundations and other mission-oriented investors has largely fueled the impact investing market's rise to date. The biggest asset owners appear poised to come off the sidelines of impact investing, creating an opportunity for attractive financial, social and environmental returns for themselves and their beneficiaries, as well as the impact investing firms that are ready to manage institutional capital.

Jane Bieneman is a senior adviser at Tideline Advisors LLC, an impact investing consultant. She is based in New York. This content represents the views of the author. It was submitted and edited under Pensions & Investments guidelines but is not a product of P&I's editorial team.

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