The landmark report issued by the Global Impact Investor Network (GIIN) and Cambridge Associates provides one of the first methodical analyses of financial performance for impact-driven private equity funds. The study’s authors deserve praise for setting a precise bar for ‘impact’ along with the fortitude to exclude managers from the study who could not meet that bar. To be included in the study, the manager needed both an explicit impact thesis and credible evidence of incorporating that thesis into fund strategy. This variable differentiates private market impact investing from its public market cousins. Studies that fail to sort managers on this basis are unable to say much about the performance of impact-oriented funds.
At Prudential, we read the report from the perspective of an institution with more than 40 years of experience investing for impact. As members of a team managing a $500 million portfolio of impact investments, we welcome the study as a compelling independent verification of our own investing history and observations. We specifically want to comment on three aspects of the report that strike us as particularly interesting.
Mythical Benchmarks. One of the study’s strengths is its clear-eyed description of what mainstream private equity fund performance actually looks like. Regardless of how one slices the data, typical mainstream fund performance is nowhere near the 20 percent (net) internal rate of return (IRR) many fund managers tout in their prospectuses. The real performance of the majority of mainstream funds is generally in the single digits or low teens as measured by Cambridge and others. Before this study, impact investors tended to compare their results to these aspirational returns, rather than to the real world performance of the asset class.
Basis points. The report’s conclusions about impact fund performance are necessarily limited by its relatively modest sample size and the broad variety of funds examined. Therefore, it is premature to definitively conclude that impact fund returns are generally consistent with mainstream market returns. Nevertheless, the data is sufficiently robust to firmly reject the presumption that impact funds dramatically lag the performance of mainstream funds. This should shift conversation away from concerns about wholesale loss of principal, as some detractors claim, to conservative estimates of the opportunity cost measured in a reasonably modest number of basis points.
Leveraging Talent. The third thing that strikes us from the report is the strong performance of smaller impact funds and first-time fund managers. These funds outperformed larger impact and non-impact funds and significantly out-performed small non-impact funds in some vintage years. We believe that this reflects a surge of talent into the impact investing industry and the emergence of compelling investment opportunities. It is a crucial piece of empirical data supporting the growth of the sector and overcoming some typical investor fears. Most advisers have a bias against first time managers, but the reality is that first time managers comprise the bulk of impact investing fund managers.
The report joins the growing body of literature on the performance of public market ESG (environment, social, and governance) funds that debunk the myth that such investing creates a drag on investor returns. By reducing the perceived opportunity cost and rejecting misplaced heuristics about first time managers, these studies should help steadily increase the demand for impact investments. A more realistic view of returns also suggests a compelling role for debt products in impact investing, which are also attractive and market-competitive on a risk and volatility adjusted basis.
Nevertheless, it is important to understand that not all impact investment opportunities are market neutral. Knowing when and how to accept a financial penalty for an impact investment is part of the art of the field; the result of investor choices and manager acumen. In this regard, we think the progress at the GIIN and B-Lab in establishing better impact measurement standards for financial and social performance is crucial, as is a better appreciation for when investments play a catalytic role versus playing a more passive role in well-functioning capital markets.