The Rise of Impact Investing in Private Markets

Impact Investing Balances Financial with Social and Moral Benefits for Some Investors

In recent years, there has been a shift in the investment landscape as more individuals and institutions are prioritizing social and environmental impact alongside financial returns. This growing trend, known as “impact investing,” is extending its reach into private markets.

As traditional models of investment are being challenged, impact investing presents a unique opportunity to drive positive change by directing capital toward ventures that generate measurable social and environmental outcomes. In this blog post, MicroVentures looks at the rise of impact investing in private equity and its potential to shape a more sustainable and equitable future.

What Is Impact Investing?

Impact investing is an investment approach that aims to generate positive social and environmental impact alongside financial returns. It goes beyond traditional philanthropy by aligning investment capital with sustainable development goals.

Impact investors actively seek out ventures that address key global challenges; common impact investing industries include healthcare, education, clean and renewable energy, agriculture, and also expand into other industries. This form of investment not only targets financial profitability but also evaluates measurable social and environmental outcomes.

In an ideal world, an investor could see their investments align with and benefit social or environmental causes. While investment returns and social or environmental change are not guaranteed, impact investing is a strategy many investors have been choosing to utilize in recent years.

Other Types of Impact Investing

Investors can also make an impact through their investments by other means, with two main approaches standing out from the rest:

Environmental, Social, and Governance Investing (ESG)

ESG investing is a subcategory of impact investing that uses a set of criteria to evaluate a company’s environmental, social, and governance track record. Environmental criteria include carbon emissions, deforestation, pollution, and green energy initiatives. Social factors include employee diversity, fair labor practices, and human rights. Governance factors include lobbying, board member diversity, and political donations.

These criteria are used to set an ESG score, which measures the long-term commitment of the company to one or more ESG categories. There is not a standardized set of ratings for ESG categories, so they are subjectable criteria which may have different results from different evaluators. Nevertheless, ESG investing has attracted significant attention recently and many asset managers use this framework to help choose investments.

Socially Responsible Investing (SRI)

Socially responsible investing takes ESG investing to another level by actively selecting or eliminating investment opportunities based on specific ethical guidelines. SRI investing typically takes ESG factors and can approve an investment opportunity that reaches a certain score or reject opportunities based on the score.

One example of an SRI metric would be the refusal to invest in companies involved in alcohol, tobacco, or gambling. Instead, SRI investors may seek out alternative energy sources or companies leading social justice initiatives.

Socially responsible investing tends to mimic political and social climates; for example, in the 1960s investors were focused on contributing to women’s rights, civil rights, and the anti-war movement. Investors should be aware of these trends as the investment may suffer if the social value decreases in popularity.

Private Markets and Impact Investing

While impact investing has gained momentum in public markets, potential also lies within the private markets. Private markets encompass a wide range of investments, including venture capital, private equity, and real estate. These markets can offer unique opportunities for impact investors to support early-stage startups, innovative solutions, and social enterprises that may not yet be accessible to the general public.

By investing in private markets, impact investors can provide crucial capital, mentorship, and strategic guidance to mission-driven ventures, helping accelerate their growth with the goal of amplifying their impact.

Benefits of Impact Investing in Private Markets

The rise of impact investing in private markets can present numerous benefits for investors and society as a whole. Firstly, impact investors can diversify their portfolios and potentially achieve financial returns while making a positive impact on society. Private market investments, although inherently riskier, have the potential to outperform traditional asset classes[1]. Moreover, by investing early, impact investors may have the opportunity to shape the trajectory of companies, encouraging sustainable practices, and promoting positive social outcomes from the outset.

Impact Measurement and Reporting

One of the critical aspects of impact investing is measuring and reporting the impact generated by investments. Impact investors recognize the importance of transparent and credible reporting to help assess the effectiveness of their investments.

Over the years, frameworks and standards such as the Global Impact Investing Network’s (GIIN) Impact Reporting and Investment Standards (IRIS) have emerged to guide investors in measuring, managing, and reporting impact. These standards enable impact investors to assess the social and environmental performance of their portfolios and communicate their impact to stakeholders, enhancing accountability and credibility.

Overcoming Challenges

Despite its growing popularity, impact investing in private markets faces several challenges. One of the significant hurdles is the lack of standardized impact measurement practices, making it challenging to compare investments and assess their impact accurately. Additionally, due diligence can be more complex in the private markets, requiring investors to evaluate not only financial metrics but also the social and environmental implications of investments.

However, initiatives are underway to help address these challenges, including collaborations among industry players to develop common frameworks and metrics for impact measurement.

Final Thoughts

As impact investing continues to gain traction, its expansion into private markets is expected to bring new possibilities for driving positive change at scale. By directing investment capital towards ventures that prioritize social and environmental impact, impact investors can play a role in addressing the world’s most pressing challenges.

The rise of impact investing in private markets offers an opportunity for investors to align their financial goals with their values, foster innovation, and help create a more sustainable and equitable future for generations to come. Through this approach, we can aim to amplify the potential of private markets to create meaningful social change.

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[1] https://www.forbes.com/sites/baininsights/2017/03/14/private-equity-returns-still-outperform-public-markets/?sh=48a6db046553

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The information presented here is for general informational purposes only and is not intended to be, nor should it be construed or used as, comprehensive offering documentation for any security, investment, tax or legal advice, a recommendation, or an offer to sell, or a solicitation of an offer to buy, an interest, directly or indirectly, in any company. Investing in both early-stage and later-stage companies carries a high degree of risk. A loss of an investor’s entire investment is possible, and no profit may be realized. Investors should be aware that these types of investments are illiquid and should anticipate holding until an exit occurs.

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