Impact investing in private equity is not just ethical, it's strategic

The idea that investing in companies or assets that aim to achieve positive social or environmental goals (impact investing) means you have to accept lower financial returns is false. In the private equity sector, the latest data shows that impact investing is not only financially competitive, but in many cases it also outperforms traditional strategies. This is according to a new study by Schroders and Oxford University’s Saïd Business School of over 250 publicly listed companies that have been approved through Schroders’ proprietary Impact Framework, which draws on 25 years of pioneering impact manager BlueOrchard’s experience and covers over a decade of performance.

From the research, commented by Nadina Stodiek, Co-Head of Impact Management The firm's impact portfolios, Paul Lamacraft, Head of Sustainability and Impact, Private Equity , and Catherine Macaulay, Co-Head of Impact Management, found that they generated strong absolute and risk-adjusted returns that were competitive with broader, unconstrained portfolios , while also demonstrating lower volatility and smaller drawdowns, thereby reducing downside risk and demonstrating greater stability during market downturns.

The study also found that companies with a higher alignment of revenues to impact-oriented products and services (impact materiality) generated superior financial returns , suggesting that impact itself can be a driver of financial performance and a source of alpha.

According to the Global Impact Investing Network’s (GIIN) Sizing the Impact Investing Market 2024 report, there is currently nearly $1.6 trillion in impact investing AUM under management globally, across more than 3,900 organizations. Additionally, according to GIIN’s “State of the Market 2024” report, based on its annual survey, 43% of all impact AUM is allocated specifically to private equity, making it by far the largest asset class for impact investing. A solid 73% of respondents said they have at least some of their impact AUM in private equity.

The beating heart of impact investing in private equity lies in the ability to combine returns and measurable impact. According to data collected by Schroders Capital, the set of deals identified as impactful – for a total commitment of 1.8 billion dollars – recorded an annual internal rate of return (IRR) of 21% , which rises to 30% if only deals that have already been at least partially completed are considered . This figure is to be compared with the ten-year returns of the sector for buyout and growth investments, equal to 16.5% and 13.7%, respectively.

Even more relevant is the composition of these portfolios. Over 70% of the operations are concentrated in the healthcare and technology sectors, areas highly exposed to structural megatrends such as digitalization and healthcare innovation, two key levers also for the sustainable transition. Geographic diversification is broad, with operations distributed between Europe , the United States and Asia , mirroring the overall allocation of the Schroders platform.

So on an annual basis, Schroders Capital’s private equity impact investments have generally outperformed , and future forecasts suggest this trend will continue.

This outperformance is also evident in broader industry data, confirming that this is a widespread trend rather than a localized dynamic. For example, data published in 2020 by Preqin , based on the returns of approximately 1,700 private equity funds with vintages ranging from 2010 to 2017, showed that impact and ESG funds performed in line with unconstrained private equity funds, with impact funds slightly outperforming .

Additionally, a study published in November 2023 by Pensions for Purpose , a UK-based organisation that promotes impact investing among UK pension funds, found that impact-focused private equity funds outperformed public markets . The analysis showed that the average quarterly net IRR between Q1 2014 and Q1 2023 for the group of impact private equity funds was 1.7%, slightly higher than the FTSE All World Index’s quarterly net return of 1.6%. Again, volatility was lower, with a narrower dispersion of performance and an average standard deviation of 3.5%, compared to 8% for public markets.

In summary, industry data confirms that not only are private equity impact returns competitive, but in some cases, they are also higher than the returns of the broader market. At the same time, the data also shows that impact returns are much less volatile overall than broader market returns. This may initially seem counterintuitive, given that these investments are highly constrained, but it is also true that impact investments are highly selective and actively managed, with a bias towards sectors and themes aligned with long-term megatrends, such as the global energy transition.