Rising trends in impact investing within private sectors, but caution is advised against the practice of 'impact-washing'
In the realm of private debt, corporate lending and impact-focused strategies in infrastructure and real estate are gaining traction. This shift is particularly noticeable in Impact Private Debt, where the credibility and robustness of each strategy's impact methodology are under the spotlight during the due diligence process.
Despite Impact Private Equity remaining the most established private markets impact segment, Impact Private Debt is making its mark. The priority during due diligence is alignment with the investor's own impact objectives, including thematic alignment and the manager's ability to measure and report meaningful outcomes.
Some managers focus on lending to companies whose products and services directly address social or environmental challenges, while others rely on Sustainability-Linked Loans or ESG integration in their investment process. Return expectations from Impact Direct Lending strategies are broadly in line with those of conventional direct lending funds, suggesting that impact strategies do not imply concessionary returns.
The European pension fund's engagement with bfinance highlights the importance of structured sponsor assessments, data-driven insights, and active stewardship in Impact Direct Lending manager selection. Sponsor commitment to responsible investment is a critical factor, with the strength of the direct lending manager’s relationships with private equity sponsors who demonstrate a robust commitment to sustainability and responsible investment principles being assessed.
Post-investment monitoring via structured engagement is another key consideration. Since pre-investment interaction with sponsors can be constrained by time, an effective practice is conducting annual post-investment due diligence. This may include issuing detailed questionnaires to sponsors to gauge their sustainability practices and scoring responses to create a data-driven picture of sponsor sustainability profiles.
Risk management of sustainability factors is also essential. Managers should have processes to identify and manage downside sustainability risks across the portfolio, supported by quality data collection. Particularly in distressed or restructuring scenarios, the ability to influence outcomes through governance (such as board seats) can be important to align sustainability with financial recovery objectives.
Asset class and portfolio diversification are also crucial factors. Impact direct lending should be evaluated within the broader context of private credit allocations. Factors such as starting yield levels, seniority in capital structure, and diversification across sectors and credit types are key for resilience and risk/return optimization.
The depth of private market data, including company records accessed by lenders, can allow more thorough due diligence compared to public markets, enabling more detailed assessment of borrowers’ sustainability practices and business fundamentals.
However, live fund-level track records are limited for many Impact Private Debt strategies. The quality and relevance of the track record emerged as crucial in the evaluation process. Several new strategies with experienced teams were identified, emphasizing the importance of revisiting the full manager universe. Fundraising risk, particularly for newer strategies, was a significant concern during due diligence.
The universe of Impact Private Debt has expanded significantly in the past two years, with over 100 strategies available or in development. Defining impact in lending is a challenge due to the considerable variation in how it is defined and implemented across strategies. Despite these challenges, the focus on impact investing continues to grow, with 53% of institutional investors either currently allocating to impact strategies or planning to do so, although the proportion of those already implementing such allocations has only increased marginally since 2022. More than 40% of accepted proposals were for segregated accounts, indicating manager adaptability to client requirements.
[1] bfinance, "Impact Direct Lending Manager Selection: A European Pension Fund Perspective" [2] Preqin, "Impact Private Debt: A Growing Asset Class" [3] KPMG, "Impact Investing in Private Debt: A Guide for Investors" [4] McKinsey & Company, "The Future of Private Debt"
- Many managers in private markets invest in companies that address social or environmental challenges through Sustainability-Linked Loans or ESG integration.
- Impact Private Debt is expanding rapidly, with over 100 strategies available or in development in the past two years.
- European pension funds prefer managers who demonstrate a robust commitment to sustainability and responsible investment principles when selecting Impact Direct Lending managers.
- Post-investment monitoring via structured engagement is essential for Impact Direct Lending strategies to ensure the alignment of sustainability with financial recovery objectives.
