Must impact fund managers sacrifice their funds’ missions to satisfy investors’ demands for returns? That’s the question a new paper from the Wharton School seeks to answer.
The results are promising. On a gross basis, funds that sought market-rate returns kept pace with the S&P 500, the paper found.
The Social Impact Initiative at Wharton, the University of Pennsylvania’s business school, surveyed 53 global impact investing private equity funds to determine how much permission and control was granted to managers in making investment and exit decisions, and how those decisions affected performance.
Those 53 funds represent 557 individual investments with a median $22.5 million in committed capital. Over three-quarters had less than $50 million in committed capital, and just 8% had more than $100 million.
Acknowledging the small size of the sample, the Wharton Social Impact Initiative used data from ImpactBase, the Global Impact Investing Network and Thomson One to compare the sample to the overall industry and assess potential biases. It found the number of funds under management and the number of portfolio companies are a good proxy for size and success of the industry, while the level of committed capital was a proxy for size and maturity.
In the report, general partners are the fund managers who provide capital for portfolio companies, and limited partners are the investors who provide capital for the general partner to invest.
The report examined impact investments based on four components of liquidity and mission preservation: Did the fund managers have legal permission to pursue investments based on their impact mission? Assuming they had permission, were they given sufficient control to make investment decisions? Were they motivated to pursue mission-aligned exits? And how did that affect financial performance?
“In traditional investment arrangements between fund managers and investors, general partners are held to professional standards and legal requirements to make investment decisions that deliver maximum risk-adjusted financial returns for limited partners,” the authors wrote. “However, in impact investing, virtually all GPs surveyed in the sample reported that LPs permitted them to pursue impact as part of the investment decision-making process, and in most cases required them to do so.”
The report found 90% of managers have investment or legal documents that explicitly allow them to consider social or environmental issues, and 70% require them to do so.
The survey also found, though, that while LPs give some control to GPs, it’s usually not a controlling interest. To control exit outcomes, which produce liquidity for the fund, mission-aligned investors need to have the majority on the board of directors, but two-thirds of respondents said they controlled less than half of the votes on company boards, and 9% said they had zero votes.