Driving Change: Exploring Impact Investing Themes in Private Markets

Overview

• The impact investing market has seen significant growth with more investors seeking investments that align with their values without compromising investment returns. 
• Private markets offer a unique opportunity for impact investing due to their flexibility, long-term perspective and ability to drive meaningful change. 
• Advancements in technology, increased regulatory support, and growing investor demand are set to further propel the impact investing movement, making it a key component of the global investment landscape.
• In this article, we delve into the key themes that underpin the investment opportunities in impact investing.

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What is Impact Investing?

Impact investing focuses on generating measurable social or environmental benefits alongside financial returns. These investments aim to address pressing global challenges, such as climate change, poverty, and inequality, by investing in companies, projects and organisations that actively seek to make a positive societal impact. Impact investments can span across various asset classes, sectors and regions, providing investors with an opportunity to align their investment portfolios with their values without sacrificing financial returns. 

For a deeper understanding of impact investing, refer to our previous article, "Understanding Impact Investment Funds: A Comprehensive Guide".

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Key Drivers for Impact Investing

Impact investing is gaining significant momentum, driven by a compelling combination of global awareness, technological innovation, and a commitment to positive change. The global push towards achieving net zero emissions is a significant catalyst, as investors back projects that help cut carbon footprints and combat climate change. At the same time, there’s a growing focus on tackling social issues like poverty and inequality. Technology is opening doors for innovative solutions, and regulatory support is making sustainable practices more achievable. The combination of these factors has created an environment that we believe provides the foundation for the long-term growth of impact investments. 

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Private Markets as a Vehicle for Impact

Due to its inherent investment characteristics, private market investments are often well positioned to drive meaningful impact. These characteristics include:

• Long-term focus: The extended investment horizon provides patient capital, allowing impact managers the time and flexibility to implement and drive material and measurable initiatives.
• Control and alignment: By typically obtaining ownership control of portfolio companies, private equity managers can drive intentional long-term value creation and positive impact, aligning strong financial returns with societal benefits.
• Scale: The growth of institutional capital is crucial for bridging the funding gaps that currently threaten the achievement of the UN’s Sustainable Development Goals (SDGs). As of 2024, the funding gap sits at USD $4.2 trillion annually, up from USD $2.5 trillion before the COVID-19 pandemic.¹ This substantial funding gap exists despite increasing regulatory support from governments worldwide. For instance, the Australian Federal Government has established the Australian Renewable Energy Agency (ARENA) to accelerate the energy transition and support renewable energy projects. To date, ARENA has backed 727 projects with $2.60 billion in funding commitments, unlocking a total investment of nearly $12.51 billion in Australia's renewable energy sector.²
• Growing access: The democratisation of private equity and venture capital is starting to offer non-institutional investors with strong social beliefs, investment opportunities that are otherwise not accessible through the more traditional listed markets.

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Common Impact Investment Themes

The UN has established 17 goals known as its SDGs. The SDGs can be grouped in to the following three themes:

• Climate change;
• Circular economy; and
• Basic needs.     

     We outline each of these themes below.

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Climate Change

Addressing climate change involves a comprehensive approach to reduce greenhouse gas emissions, enhance energy efficiency and promote sustainable practices across various sectors. This requires a shift towards low-carbon technologies, sustainable resource management and innovative solutions that can drive systematic change. 

Private market investments in addressing climate change typically fall into several key areas:

1. Renewable Energy: These investments support the transition away from fossil fuels and reduce greenhouse gas emissions. For example, funding the development and expansion of renewable energy projects such as solar, wind, and hydroelectric power.
2. Improving Energy Efficiency: Investing in companies that innovate in energy-efficient technologies, such as smart grids, energy storage systems, energy-efficient appliances and building materials. These technologies help reduce overall energy consumption and improve the efficiency of energy use.
3. Clean Infrastructure: Upgrading existing systems and developing new projects that reduce carbon footprints, such as green buildings, sustainable urban planning, and water and waste management systems. These investments enhance the sustainability of urban environments and infrastructure.
4. Clean Transportation: Investments in this area promote the adoption of clean transportation alternatives and reduce the environmental impact of traditional transportation methods. For example, supporting electric vehicles, public transit systems, and other low-emission transportation solutions.

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Circular Economy

Circular economy involves creating systems where resources are reused, repaired, and recycled, thereby reducing waste and minimising environmental impact. The goal is to transition from a linear "take-make-dispose" model to a circular model where materials are continuously cycled through the economy. This approach supports sustainable growth, conserves natural resources, and reduces pollution.      

Private market investments in circular economy typically focus on several key areas:

1. Waste Management and Recycling: These investments help reduce landfill use, lower pollution, and promote the reuse of materials. For example, investing in companies and technologies that improve waste processing, recycling, and material recovery. 
2. Agricultural Efficiency: Investing in sustainable agricultural practices and technologies that increase productivity while reducing environmental impact. This includes precision agriculture, sustainable farming techniques, and innovations that improve water and soil management.
3. Responsible Consumption and Production: Supporting initiatives that encourage sustainable consumption patterns and production practices. This includes investing in companies that produce eco-friendly products and those that promote sustainable supply chains. 
4. Green Building Materials: Supporting the development and use of building materials that reduce the environmental impact of construction. This includes materials with lower carbon footprints, improved energy efficiency, and sustainable sourcing.

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Basic Needs

Addressing basic needs involves providing essential services and resources that are fundamental for human survival and well-being. This includes access to clean food and water, safe and affordable housing, financial services that support economic stability, and equal access to quality education and healthcare. The goal is to create equitable and affordable access to these necessities, improving quality of life and fostering sustainable development.

Private market investments in addressing basic needs typically focus on several key areas:

1. Clean Food and Water: Investing in technologies and companies that provide access to safe and nutritious food and clean drinking water. These investments can range from sustainable agriculture practices to water purification and distribution systems.
2. Affordable Housing: Supporting the development and renovation of affordable housing projects. Investments in this area aim to provide safe and affordable living conditions for low-income populations, addressing the housing crisis and improving living standards.
3. Financial Wellbeing: Funding financial services and products that promote economic stability and growth for underserved populations. This includes microfinance, affordable credit, and financial literacy programs that help individuals manage their finances effectively.
4. Education: Supporting initiatives that ensure equal access to quality education. Investments can include funding educational technology, building and improving educational facilities, and supporting programs that enhance educational outcomes for underserved communities.
5. Good Health and Wellbeing: Investing in comprehensive healthcare services and technologies that provides affordable and equitable access to healthcare for the low-income population. This includes primary care facilities, telemedicine, health tech innovations, and public health initiatives.

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Challenges and Considerations in Impact Investing

While impact investing in private markets holds promising prospects, it is not without its challenges. 

• Measurement of impact: Quantifying social and environmental impact is complex and lacks standardisation, which can complicate investment decisions. Although, while improving over time, there may still be limited reliable impact data available, which can be challenging for investors to make informed decisions.
• Limited track records: There is a shortage of impact managers with proven track records in both financial and impact performance. To mitigate this risk, it is crucial to select top-tier managers with strong investment capabilities and robust governance and risk management practices.
• Balancing financial and impact goals: Historically, impact investing and philanthropy went hand-in-hand. Investors needed to carefully consider the trade-offs between financial returns and impact objectives, as some investments offered lower financial returns in exchange for greater social or environmental benefits. However, there are a growing number of PE fund managers that have proven their ability to achieve both without compromising on one or the other.
• Regulatory and Policy Risks: Impact investing is often influenced by government policies and regulations. Changes in policy can affect the viability and attractiveness of certain investments, adding an element of uncertainty for investors.

Nevertheless, with the right manager selection and implementation structure, there are attractive impact investment opportunities that can deliver both positive impact outcomes and market-competitive returns to investors.

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Conclusion

The need for private market investments to address critical social and environmental challenges has never been more pressing. Themes such as renewable energy, sustainable agriculture, affordable housing, and healthcare innovation require significant capital and long-term commitment, both of which are well-suited to the nature of private markets. These investments have the potential to drive meaningful change and achieve financial returns. As methodologies continue to improve and awareness grows, private market investments are poised to play a crucial role in solving global challenges, transforming the investment landscape, and fostering a sustainable and equitable future whilst still improving investors’ abilities to achieve their investment goals.

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[1] https://www.un.org/sustainabledevelopment/blog/2024/04/press-release-fsdr-2024/#:~:text=The%202024%20Financing%20for%20Sustainable,before%20the%20COVID%2D19%20pandemic.

[2] https://arena.gov.au/news/record-funding-for-arena-to-supercharge-australias-net-zero-transition/