INSEAD: Impact Investing Comes Into Its Own

05-05

By Claudia Zeisberger, INSEAD Senior Affiliate Professor of

Decision Sciences and Entrepreneurship and Family Enterprise | April 25,

2018

A discussion with Kevin Lu, Chairman for Asia at Partners Group

and Distinguished Fellow at INSEAD』s GPEI.

In 2010, INSEAD』s Global Private Equity Initiative (GPEI) started

to explore the nascent trend of responsible investing. In 2014, it published its

first report on environmental, social and governance (ESG) factors within the

private equity (PE) context. Four years hence, the industry has evolved

significantly.

The increasing demand for public accountability and transparency

around environmental and social issues has led limited partners (LPs) to push

for increased ESG awareness. Many of the LP requirements are formalised in their

internal guidelines and form part of their fiduciary duties. For United States

public pension plans – the largest allocators to PE – and other

government-affiliated LPs, direct oversight from government institutions and

additional regulatory requirements lead to additional emphasis on ESG. As LP

beneficiaries are often large groups of citizens, there is strong motivation for

institutional investors to improve sustainable practices and increase

accountability.

In our recently published book Mastering Private

Equity, my co-authors and I dedicated a chapter to responsible

investment because we strongly believe that PE can serve as a force for good. PE

firms are well positioned to implement responsible investment strategies and

promote sustainable business practices due to their active ownership and

corporate governance model. In the past decades, the PE industry has created

considerable wealth and employment in the advanced economies. As it expands its

reach into emerging markets, its potential impact on the economic, social and

ecological environment of communities might be even greater.

Although there is no commonly accepted definition of responsible

investment, we consider it a mandate to go beyond a narrow target of financial

returns and incorporate a commitment to do good or, at a minimum, be a

responsible guardian of the portfolio company and its environs.

The ways in which PE funds can implement responsible investment

strategies range widely: from negative screening to proactive ESG management

strategies to impact investment funds. The framework below distinguishes five

main approaches to investment based on the importance assigned to social

returns.

The mainstreaming of impact investing

In the past couple of years, a number of the biggest and

best-known GPs announced impact strategies (e.g. TPG』s Rise Fund, BainCapital』s

Double Impact and KKR』s Global Impact). To understand this recent trend of

responsible investing from a GP』s point of view, I had a conversation with Kevin

Lu, one of the GPEI』s Distinguished Fellows, and the Chairman for Asia at

Partners Group. Lu was closely involved in the recent launch of the group』s

first impact investment vehicle called PG LIFE and chairs its Impact

Committee.

Lu mentioned that as with many product innovations in PE, the

recent trend of responsible investing is driven by client demand. A diverse set

of LPs, from sovereign wealth funds and public pensions to high-net-worth

individuals and multi-family offices, recognise that it is not necessary to

trade off return for positive impact. Accordingly, there is increased demand for

products that can deliver this dual return at scale. Within the private markets

industry, he foresees outsized growth in the mid-term mainly due to a tighter

regulatory environment, increased cooperation on the political front, and a more

socially and environmentally conscious millennial generation, set to inherit an

estimated US$40 trillion in the next 40 years.

However, he adds that this mainstreaming of impact integration is

not totally new. It is the culmination of over ten years of increasing LP focus

on the area. Identifying, measuring and reporting the positive impact of

investments is a natural extension of long-established responsible investment

practices that drive companies to systematically improve their ESG

performance.

Lu warns that as the strategy becomes more mainstream, many PE

firms will be tempted to develop similar strategies to meet fast-growing client

demand. That said, many will be apprehensive about positioning themselves in

this space if they don』t have the appropriate responsible investing or impact

credentials. The brand and reputational risks of following this trend without a

credible offering would be too high.

Impact investing requires highly skilled professionals and

institutional-quality platforms to deliver on both financial and

social/environmental impact. Lu adds that there will be a clear differentiation

between those whose intentions are oriented toward the merits of impact

investing in the long run, and those who might be leveraging the industry』s

tailwind for short-term gains.

The differentiators will mainly be the ability to deliver the

social/environmental impact and financial returns, the contribution to and

consolidation of the broader industry』s best practices and the ability to

provide transparency to clients on their impact.

Benchmarks for international impact

Partners Group』s PG LIFE will address global social and

environmental challenges by investing in line with the United Nations』

Sustainable Development Goals (SDGs), a set of universally relevant impact

targets. While other funds are primarily PE funds, PG LIFE is a blended private

markets fund, which will also include allocations to real assets like

infrastructure and real estate. Lu highlights that global tilt and multi-asset

fund composition provide diversification, which enables better risk

management.

PG LIFE benefits from two internal investment governance bodies,

both of which need to approve every investment. PG』s Global Investment Committee

assesses investments in terms of their ability to deliver attractive

risk-adjusted financial returns, while the PG LIFE Impact Committee focuses on

assessing their ability to deliver positive social or environmental impact.

Lu does not see a contradiction between a companys commercial

attractiveness to a private markets investor and its potential to generate

positive social and environmental impact. In fact, he would argue that

sustainability-minded businesses can be better positioned for long-term value

creation. As an example, he explained that analysis of past PG investments that

aligned with the PG LIFE strategy established a track record with "normal"

private markets returns, specifically a blended gross IRR of 17.9 percent. All

of these track-record investments underwent – just as all PG LIFE investments –

Partners Groups rigorous Global Investment Committee process.

Measuring the impact of ESG initiatives is one of the biggest

challenges to overcome. When Lu was asked how PG LIFE measures impact, he

mentioned that three to five impact metrics that best capture the targets

potential are identified during due diligence. These metrics will be closely

tied to the targets core business and projected business plan throughout the

ownership period.

My conversation with Kevin Lu made it clear that the

institutionalisation of responsible investment』s best practices is increasingly

aligning the fiduciary duty of GPs with the ESG interests of the LP community.

With this expansion of the PE mandate beyond financial returns, regulation and

improved benchmarking tools continue to emerge that will drive development and

enforcement, allowing the PE community to continue discovering which practices

deliver social impact and which do not.

以上內容摘自：

https://knowledge.insead.edu/blog/insead-blog/impact-investing-comes-into-its-own-8956#kHIM4FpADD1ubII1.99