Vintage 2010-2017 impact funds – and private capital funds managed by GPs committed to ESG – offer returns on par with funds that aren’t managed by ESG-committed GPs, and with less variance
Vintage 2010-2017 impact funds – and private capital funds managed by GPs committed to ESG – offer returns on par with funds that aren’t managed by ESG-committed GPs, and with less variance
A key question for LPs considering environmental, social, and governance (ESG) and impact investment opportunities is whether they can do well by doing good. Some LPs worry that by focusing on ESG and impact investing, the range of deals available to them is narrower. As a result, there may be missed opportunities to generate the returns they might otherwise enjoy. But as the ESG and impact investing universe continues to expand, how valid is this concern? Should investors expect a trade-off between values and performance?
Clearly, that’s a big question to try to answer, but let’s start by looking at the data. As a jumping-off point, we examined Preqin Pro performance data on 1,100 private capital funds that were either classified as impact funds¹ or as funds managed by GPs with a commitment to ESG. We chose to also focus our dataset on post-Global Financial Crisis funds providing IRRs of between three and 10 years. These funds hold about $1.5tn in assets under management (AUM), and span vintage years 2010-2017.
To compare performance, we analyzed the variance in returns across three fund groups. The three groups are: impact funds, funds managed by GPs committed to ESG, and funds classified neither as impact funds nor as funds managed by ESG-committed GPs. Here’s what we discovered.
Fund Growth and Investor Interest
Fig. 1 shows the dispersion of returns and average IRR across all three fund groups, with each bubble representing a specific vintage year. A data point that stands out is vintage 2016 impact funds. IRRs since inception for vintage 2016 impact funds outperformed the other two types of funds. They exceeded the returns of funds managed by ESG-committed GPs by an average of about 2.8 percentage points. They also outperformed the third fund group – those classified neither as impact funds nor as funds managed by ESG-committed GPs – by an average of about 1.6 percentage points.
What if we look at longer-term IRRs? Preqin data shows that vintage 2011 funds managed by ESG-committed GPs outperformed the third fund group – those classified neither as impact funds nor as funds managed by ESG-committed GPs – by an average of about 2.4 percentage points.
Another important metric to consider is the dispersion of fund returns, which offers a glimpse into the portfolio benefits of impact funds and those managed by GPs committed to ESG. The two fund groups, particularly the impact group, have a lower dispersion rate than funds classified neither as impact funds nor as funds managed by ESG-committed GPs. Indeed, impact funds’ IRRs showed a standard deviation of about 12%. This is slightly below the standard deviation for funds managed by ESG-committed GPs (13%) and significantly below that of the third group of funds in our dataset (21%).
What is the benefit of a lower dispersion rate for investors? Lower variance tells LPs that there is less risk in the manager selection process, even when they are selecting from a smaller pool of funds. It also tells them that when investors do commit to an impact fund, or a fund managed by a GP committed to ESG, they can have higher confidence in its performance.
Private Equity’s Leading Edge
Given private equity’s dominant role in the private capital industry, we examined this segment of the dataset closely. Isolating private equity from the rest of the data reveals several key findings.
First, there is a wider divide between the three fund groups – impact funds, funds managed by ESG-committed GPs, and the rest (Fig. 2) – compared with private capital as a whole. Second, impact funds – particularly those of younger vintages – generated higher returns with less variability.
As highlighted in Fig. 2, there is higher variability in fund performance across all three fund groups for funds of vintages 2016 and 2017. This higher variability reflects significant growth in the size of the alternatives industry during this period: after all, a larger pool of assets is more likely to show greater variance. That said, it’s still early days for funds of these vintages. As they age, some reversion to the mean can be expected, which means the higher variability may not persist.
What is noteworthy is that impact funds show a lower variability in fund performance compared with the other two fund groups, while still – on average – outperforming. This outperformance has helped to boost investor demand. For example, impact funds of 2016 and 2017 vintages have a combined $87bn in total AUM – nearing the $102bn of the previous five years combined.
If GPs can show that a commitment to ESG is no barrier to generating the returns investors expect, the ESG and impact universe is likely to continue to expand. Below we highlight some of the larger funds from Preqin Pro with available performance data.
Fund Focus:
Vital Capital Fund
Strategy: Growth Capital
Vintage Year, Size: 2011, $350mn
IRR: 20.0% (Dec-18)
Vital Capital Fund was closed in 2013 after raising capital aimed at improving the lives of low- and middle-income communities in sub-Saharan Africa. Its investment process aims to find profitable portfolio companies that can positively impact the region’s infrastructure and public health with a focus on long-term sustainability.
The growth-capital fund has invested much of its capital in clean water, renewable energy, and healthcare to support the region’s population. Reducing poverty and hunger in the area are among its top-stated goals along with public health and wellbeing. Progress toward these goals is measured through internal KPIs and third-party rating systems from the Global Impact Investing Rating System (GIIRS).
Additionally, as a GP, Vital Capital has co-invested $49mn of its own capital in the fund.
Bridges Property Alternatives Fund III
Strategy: Real Estate
Vintage Year, Size: 2014, $333mn
IRR: 7.8% (Jun-19)
This fund invests in commercial, residential, healthcare, and educational properties with goals centered around improving communities and environmental sustainability through SMEs. Since its 2014 closure, the fund has invested in office and industrial spaces, to support job creation and rejuvenation of the surrounding areas, and several environmentally focused residential projects in the UK.
Despite the fund’s impact focus, management emphasizes a goal to invest responsibly in the community while still maintaining a portfolio of profitable companies that will reward investors.
DBL Equity Fund – BAEF II
Strategy: Venture Capital
Vintage Year, Size: 2009, $150.8mn
IRR: 7.0% (Jun-19)
DBL Equity Fund is a venture capital fund with the stated goal of promoting innovation with a dual emphasis on portfolio companies’ social impact and profitability. Fund sponsor DBL Partners was founded on this principle of a double bottom line (DBL), believing that both profitability and sustainability could co-exist, a core tenet of modern ESG investing.
The fund invests in consumer goods and services, healthcare, information technology, and clean energy, primarily in the Northwest US. The fund is the second of four funds raised or being raised by the DBL.
In addition to the firm’s emphasis on its DBL impact investment strategy, it also works with its employees and portfolio companies to encourage local hiring and education and waste reduction, among other initiatives.
¹ Preqin defines impact funds as funds in which the firm invests with positive impact as its primary goal. This is defined as having an impact investing policy, or being a member of GIIN and/or IFC OPIM.
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