Much of the growth in the breadth and depth of responsible investment activity can be put down to demand from large institutional investors, given growing ambition to develop more rigorous and pro-active investment portfolios that put sustainability objectives at the very core. Impact investment portfolios, for example, can have the dual objective of delivering positive social and environmental outcomes along with attractive financial returns – important for pension schemes to be able to meet their long-term liabilities and payment obligations.
As yields on public bonds have declined, owners of long-term capital that have a tolerance for illiquidity have increasingly recognised the long-term potential for private debt and alternative asset classes to help them meet their investment goals. The case for using private debt to build impact investment portfolios has also gained ground over recent years, with its core focus on privately negotiating transactions, and analysing and managing risk through relationships with borrowers. This style of investment requires skill and experience investing in private debt markets together with expertise in credit analysis, structuring and covenant negotiation to ensure each asset delivers not only environmental and social benefits but also appropriate returns and downside protection for the creditor.
Private debt impact strategies can provide investors with the opportunity to invest their capital in projects and companies that make a positive contribution across a broad range of real world issues, so investors capital can contribute to building a fairer and more sustainable economy.
Building a portfolio of private and illiquid impact assets
The time and resources required to build a portfolio of private and illiquid impact assets should not be underestimated. It can take several months of analysis, structuring and negotiation, to complete a single transaction, so fully building a diversified portfolio of such assets will take some time.
A high level of diversification is important for any value-based, impact investment portfolio whether financing impactful assets – publicly-traded or privately negotiated – through debt or equity. Private debt markets offer access to a diverse range of investment opportunities that have a clear environmental or social outcome, including financing projects such as constructing a new wind farm that generates clean electricity to help to reduce carbon dioxide (CO2) emissions, and building new affordable housing developments that seek to provide a better quality of life and increased opportunities for low-income families, as well as build communities and promote social equality and cohesion. Lack of access to decent social or affordable housing is often associated with poor health and education outcomes, high levels of unemployment and low financial inclusion.
Companies that borrow in private markets tend to be smaller and focused in a narrower range of business activities than companies that borrow in public markets, which also contributes to the greater number of pure-play impact investment opportunities in private markets. There may be some investments, however, that deliver multiple positive benefits to society where the borrower is engaged in activities that have various environmental and social benefits, such as improving the energy and resource efficiency of buildings and providing employment in an area of need.
In any case, the onus is on the lender to perform the due diligence needed to ensure the most impactful projects or companies receive the necessary financing.
Assessing and quantifying the impact of a project or company and the key impact metrics is integral to our analysis and due diligence prior to making an investment. We assess an impact investment as we would any other asset in the private debt universe, with rigorous and detailed credit analysis and making investment decisions on a relative value basis. The only difference is that we carry out an impact assessment at the same time, using criteria we have developed in conjunction with a leading sustainability advisor.
Having scope to select impact investments across a range of maturities and different asset types – by taking a multi-focus approach – creates a wide opportunity set to diversify portfolios and to ensure the best possible value for investors. Private debt continues to evolve at a rapid pace, throwing up possible new avenues in the market, so having the flexibility to accommodate changing markets and go wherever the value opportunities are at any given point in time is equally important.
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The value of investments will fluctuate, which will cause prices to fall as well as rise and investors may not get back the original amount they invested.