Profits and Purpose: Wharton Study Finds that Impact Investments Can Produce Both Market-Rate Returns and Long-Term Impact
Impact investments are capable of producing market-rate returns alongside long-term impact, according to a study released by the Wharton Social Impact Initiative (WSII) at the Wharton School of the University of Pennsylvania. In their study, Great Expectations: Mission Preservation and Financial Performance in Impact Investments, the WSII analyzes 53 impact-focused private equity funds, representing 557 individual investments, to determine the interplay between investment performance and impact mission preservation of portfolio companies on exit.
Mission Preservation and Fiduciary Duty to LPs – In traditional investment agreements, General Partners (GPs), or fund managers, are held by legal requirements and professional standards to make investment decisions to deliver the maximum risk-adjusted financial returns to their Limited Partners (LPs), or investors. However, in impact investing, GPs must balance their fiduciary duty with LP expectations of social and/or environmental impact in major investment decisions.
Reviewing fund managers’ respective Limited Partner Agreements, Private Placement Memoranda, and other legal investment agreements, the WSII found that a majority (90%) of fund managers had entered into agreements with LPs that explicitly allow and, in most cases (70%), require impact metrics to be considered in investment decisions.
Portfolio Companies and Impact Investor Influence on Exit Decisions – For companies backed by private equity and venture capital investors, it is common for investors to acquire a controlling portion of the portfolio company’s board of directors. This majority control allows investors to make major decisions, including those related to exiting investments.
Of the sampled impact funds, WSII assessed the number of portfolio companies and their board composition, finding that only 23% of partner companies had boards in which impact investors secured 50% or more votes required to control exit decision, meaning a majority of funds may not be in a position to influence mission preservation, within the board structure.
Mission Preservation and Investment Exit – One common misconception about impact investments is that investors must accept concessionary returns in order to achieve impact and maintain a company’s impact mission. To access this, WSII surveyed fund managers to determine their expectation of mission preservation on investment exit as well as access the financial performance of impact investments.
WSII found that 95% of the fund managers surveyed expected the company mission to persist after exit, even though 67% of the representative exits did not have a contractual agreement for companies explicitly stating a commitment to mission preservation. Furthermore, WSII found no evidence to suggest that impact investments draw weaker returns; rather, that impact investments produced strong returns and that investors and shareholders may not have to sacrifice financial return for mission preservation.
Impact Investments and Overall Industry Performance – Further examination into the financial performance of impact portfolio companies provides evidence that impact investments can produce strong financial returns. WSII found that financial performance of portfolio companies is comparable to an S&P 500 index as well as a Russell Microcap index, when looking between the years of 2000-2015. This comparison suggests that impact investments may be financially competitive with other equity investment opportunities.
Making a Profit and Maintaining Purpose - The WSII study provides evidence that private equity impact investments are capable of producing not only strong financial returns, but also long-term social impact through the preservation of portfolio company impact mission. It is important to note that the WSII focused on impact investment funds that specifically seek to make market-rate financial returns alongside impact; the degree to which an impact investor prioritizes financial return and impact may vary based on individual investment strategy and investment type. Nonetheless, the WSII report is part of the growing body of evidence that suggests that impact investments can be both profitable and impactful.