Utilising the private equity model to make a greater impact
A growing number of investors are targeting not just a financial return but an environmental or social impact as well. Seven years after the introduction of the UN SDGs, which gave investors a clear set of goals, the sophistication of impact investing has grown significantly, and spread across asset classes.
In many ways, private equity is a natural fit for impact investing. Private equity investors have always been active investors – buying undervalued companies, working with management to improve operational efficiencies and providing guidance on strategic planning to help companies realise their potential. Now that approach can go deeper – assisting companies to improve their performance on a range of environmental, social and governance (ESG) issues, as well as specifically supporting social enterprises whose business models are focussed on positive impact.
Private equity aligns well with the time horizons required in this space given the long-term focus of the asset class. The most common form of ownership in private equity tends to be majority or outright control positions, which enables strong alignment between the owners of a business and management to drive intended impact and financial outcomes. Private equity also brings material additionality, from helping businesses secure funding to contributing talent and operational expertise to improve the business and help drive growth. And private equity has a track record of developing the type of innovative solutions that are needed to solve complicated environmental or societal challenges.
Different investors will put greater emphasis on financial returns or sustainability goals, but an increasing number say they do not have to sacrifice one for the other. BlackRock’s most recent family office survey found that 59% do not believe they have to compromise at all to achieve their sustainable goals and 74% plan to increase their sustainable investments.1
In fact, ESG issues can materially impact the long-term profitability of businesses and integrating ESG data and insights within investment processes can lead to improved outcomes. And as investment flows are in their early stages, the full consequences of a shift to sustainable investing are not yet fully appreciated or priced into markets and a return advantage can be gained during the transition.
Where to make an impact
That transition is accelerating as the Covid-19 pandemic highlighted and exacerbated inequality, particularly in access to healthcare, with less than half the global population covered by essential health services. It is also spurred on by the increasingly obvious consequences of climate change, with 2019 marking the end of the warmest decade ever recorded. Therefore, while impact investing can attempt to tackle a range of environmental and societal problems, there is a growing demand for companies that focus on improving healthcare and reaching net zero.
Health is probably the most established sector within private equity and there are many opportunities to improve access to and affordability of basic medicines and healthcare services, such as better access to treatments to improve survival rates for chronic conditions, or generic drugs which provide better affordability for patients. Companies that lower the cost curve in the healthcare system, such as a technology company that lowers administrative costs and increases physicians’ productivity, innovative business models like telemedicine and next-generation treatments for major diseases like cancer and Alzheimer’s can increase the quality of patient health outcomes.
Climate-related investments may be the biggest opportunity set, as reaching net-zero across the global economy will require $4.5 trillion of investment per year to 2050.2 Innovative businesses that reduce the costs of renewable technology, leading to wider adoption and demand for green energy, as well as companies delivering emerging technologies such as large-scale renewable batteries and low-cost energy storage solutions are key areas for investment.
Make an impact – and a return
The potential to make an impact is clear. But to be successful, it is important for investors to develop a robust framework that defines the criteria for impact investments. Investors need to identify KPIs for the financial return and the impact, guided by the associated UN SDGs. Then formulate target expectations for the development of the KPIs during the holding period. And finally, monitor development year-on-year to ensure goals are being achieved.
There are many reasons to be optimistic about the financial returns of private equity as well. As an asset class, it has demonstrated its resilience and continues to outperform public markets over long time frames3. The market is growing – it has tripled in the last decade, from about $2 trillion in 2010 to over $6 trillion in 2021, and the number of active private equity investors has tripled.4 Transactions are also growing in size and are increasingly global.
It is estimated that $7 trillion of capital needs to be invested every year between now and 2030 in order to build a healthier, more sustainable economy.5 Private equity investors have a unique opportunity to play a role in that transition.
Produced by EI Studios, the custom division of Economist Impact.
1 BlackRock Inside view – BlackRock Global Family Office Survey
2 IEA, Net Zero by 2050, October 2021
3 BlackRock 2022 Private Markets Outlook
4 BlackRock 2022 Private Markets Outlook
5 PRI, Investors and the Sustainable Development Goals, Oct. 2017
