Taking a look at the data to determine if the recent surge in impact funds is an anomaly or a sign of changing times
Recent years have seen an explosion in the market for impact funds and ESG, with investors hungry for opportunities to earn solid returns while putting their money to good use. But how significant is this trend? How many funds are actually forming, and how much capital is flowing through the industry?
To find out, let’s take a look at data from the last few years to help us decide if impact investing is the future of private equity or merely a buzzword for marketers and prognosticators. If you’re interested in learning more about what your fund can do to adapt to the growing demand for ESG, watch our webinar.
What is impact investing?
The term “impact investing” was first coined by the Rockefeller Foundation in 2008 and generally refers to investments “intended to generate valuable, quantifiable impact on the environment and the society in addition to financial returns.”
In 2020, the market size of impact investing was $715 billion, increasing from $502 billion in 2018. Those numbers are promising, but understanding what is included in those figures will help us understand what’s missing from them. There is another key term we have to define, and that’s ESG.
ESG, or environmental, social, and governance concerns, refers to the strategies employed by firms to take into account the effect they have on society, and covers things like carbon footprint, job creation, and executive pay.
Funds that aren’t considered to be impact funds may still incorporate ESG strategies aimed at creating impact. This is how the role of conscious investing might actually be underestimated: beyond tabulating the size of the impact market, it’s also important to understand that its success is changing practices throughout the industry.
Think of it this way: ESG is a strategy for ensuring a fund is doing right by people and the planet, while impact investing involves selecting assets specifically designed to improve the world. While impact investing will always be a specific sector of the private equity landscape, ESG may become a necessary part of any fund’s process, which is why even those who don’t specialize in impact investments need to understand the effect they’re having.
The rise in ESG and impact funds
In 2020, funds with an ESG focus gained $51.1 billion of net new money from investors, up from roughly $21 billion in 2019. This was the fifth consecutive year in which that number reached a new annual record. Between 2018 and 2020, ESG-related assets grew by 42%, reaching a total of $17 trillion, and representing 33% of total U.S. assets under management.
The mistake is to think of conscious investing as a feel-good write-off, or that investors are satisfied with lower returns because they’re contributing to society. They don’t have to settle for lower returns, because business is booming.
Funds with ESG strategies have often outperformed their non-ESG counterparts. Based on MSCI trends data, companies in the top third of ESG ratings have outperformed the bottom third by 2.56% per year between 2013 and 2020. It’s clear that impact investing and ESG are showing promise not just from a public relations or compliance standpoint, but in generating solid returns as well.
COVID-19 and Impact – is this growth temporary?
The pandemic has caused a realignment of priorities for many investors, and at the same time, a new generation of socially-conscious investors is coming of age, resulting in greater demand for impact. The question is whether this trend will reverse if and when life returns to normal, and if the conscious investor is really here to stay.
Let’s take a look at an example of social impact investments and just how popular they’ve become. According to the Wharton Social Impact Initiative, in 2019, a total of 138 private equity and venture capital firms raised a cumulative $4.8 billion in funds that invested in gender-diverse teams to generate a positive impact on women.
While some of that investment may be based on gold-rush attempts to take advantage of sudden social concern, the results will speak for themselves, as people see not only the returns these investments create but the benefit of addressing gender inequality during the recovery from the pandemic. There’s far more money being invested in social impact than many realize, and from more varied sources, showing how impact investments have already entered the mainstream.
Issues like climate change and gender equality won’t be going away, and are increasingly important to young investors, who will make up more of the investor base as they age. The one thing that could remove some investors from the marketplace is an inability to understand which assets are really making an impact.
What can harm this trend?
One of the biggest concerns for the industry is the practice of “greenwashing,” token initiatives created for public relations purposes that have no actual effect. Companies may try to set up in-name-only ESG initiatives meant to do the bare minimum, which is why a proper regulatory framework is necessary to force asset managers to disclose evidence for their ESG claims.
A report from the SEC’s Division of Examinations shows how malfeasance affects the industry, with some portfolio managers’ practices differing wildly from their claims. Bad actors can muddy the waters so much that investors have trouble sorting fact from fiction, which is why a set of industry best practices is crucial.
Investing in impact is growing steadily, but it can be challenging to understand and measure true impact. JTC is committed to using solid data and methods to quantify and compare impact across investments with varying goals. Funds with a clear ESG framework and the ability to prove that they’re actually having the impact they claim will have a leg up with conscious investors, because impact investing is here to stay.
