Impact investing is a growing movement capturing the attention of investors across the world. But too much capital is still sitting on the sidelines, which results in part from suspicions around financial performance. Throughout the industry's development, investors have questioned the ability of impact investments to generate financial returns similar to traditional investments.
When considering impact investing on behalf of clients, financial advisers may find recent research, GIIN Perspectives: Evidence on the Financial Performance of Impact Investments, useful. In reviewing the financial performance of funds in the three largest asset classes in impact investing: private equity, private debt, and real assets, as well as individual investor portfolios allocated across asset classes, we see signs of real credibility for the market.
First, market-rate returns are achievable in impact investing. A private equity benchmark produced by Cambridge Associates and the Global Impact Investing Network (GIIN) found top quartile returns net of fees and expenses of 9.7% or higher and mean returns of 5.8% among market-rate seeking investments. A study of 170 private equity transactions by the Wharton Business School found an average gross IRR of 9.2%, and a McKinsey & Company study of 48 private equity impact investing exits in India found an average gross IRR of 11%.
These numbers are comparable to returns over the past decade in conventional private equity and venture capital. This is not to say that all investments that seek market-competitive returns will achieve them. Just as in conventional private investing, choosing the right fund manager is critical.
It is also important to note that not all impact investments seek to achieve market rates of return; some impact investors intentionally target below-market-rate returns in order to achieve a specific type of impact, create a bridge between philanthropy and conventional investing, or catalyze other capital and therefore foster market growth.
Preliminary research into the performance of below-market-rate-seeking impact investing funds in the U.K. shows that near-capital-preservation returns were possible among high-risk investees previously reliant on grant capital.
Second, small funds do not necessarily underperform relative to their larger peers. In private equity, venture capital, and real assets, smaller funds performed at least as well as large funds across various strategies, thus disproving conventional wisdom that fund size and performance are positively correlated.
At the same time, the continued success of established fund managers and their demonstrated ability to raise ever larger amounts of capital shows a growing landscape of attractive impact investment opportunities for large institutional players.
Third, the impact investing market includes opportunities for investors with varied risk appetites and investment strategies. While most third-party research has focused on the private equity, private debt, and real assets asset classes, several individual impact investors have taken a portfolio approach to building an impact investment strategy across multiple asset classes (including public markets) in order to meet their overall risk/return preferences.
Of course, financial performance is important, but it is just one side of the equation. Impact investors are defined by their intent to generate a positive social and/or environmental impact alongside a financial return. Some investors have become increasingly transparent with the release of impact reports, yet there remains a critical need for aggregate research on the impact of impact investments.
This is challenging, not least because investors measure and report their impact using very diverse methods, together comprising a robust and multifaceted impact investing industry. However, we believe active impact investors, as well as researchers and other entities, can do more to embrace their field-building responsibilities by openly sharing data on the financial and impact performance of their investments, either directly to the public or by contributing to aggregated, third-party research.
Increased transparency around financial and impact performance will enable financial advisers to make more informed portfolio allocation decisions for clients, allow new players to more confidently develop market entry strategies, and allow both to set well-informed performance expectations and more accurately evaluate performance.
By confirming the industry's potential, we hope to see greater flows of capital funding sustainable solutions to our most critical social and environmental challenges.
Abhilash Mudaliar is Research Director at the Global Impact Investing Network.