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 Strategy insights​

Impact investing through private markets

February 15, 2023

5 min read

For more than 40 years, private markets have consistently shown an ability to navigate difficult macroeconomic conditions, outperform public markets, and create value through new investment opportunities. This resiliency continues to be put to the test against a backdrop of declining public markets, rising inflation, energy shortages, and lingering supply chain issues.

While it can be difficult to find investment solutions that play both defense and offense within a portfolio, one strategy steadily gaining momentum is targeting investments that seek to create a measurable social or environmental impact. These types of opportunities tend to benefit from transformational market dynamics and trends, bringing potential for both compelling performance and downside risk protection.

Resilience through purpose

A growing number of investors are adding ESG and impact exposures to their portfolios for their resilience and performance potential. In a recent industry survey, 50% of LPs said they view ESG factors as being additive to performance.1 This potential stems in part from the distinct, two-pronged approach sustainability-focused investments take in assessing risk and opportunity, which typically includes:

1. An ESG risk management framework integrated into the standard due diligence process, providing a level of protection against idiosyncratic risk. This additional angle gives investors a valuable view into how a company or investor manages the myriad of environmental, social, and governance risks.

2. Long-term environmental or social theme(s) as the key return lever, where capital expenditure is lacking, required, and likely relatively inelastic due to supportive regulation, socioeconomic benefits, and/or a shift in consumer preferences.

Why impact investing and private markets are highly compatible

While sustainability-themed and impact investing are still relatively nascent within private markets, there are several key features that make the two a good match:

Long-term focus: Many of the themes targeted are oriented toward critical forward-looking goals. This aligns well with the long-term investment horizons in private markets, which allow sufficient time for thoughtful and meaningful execution against these goals.

Access: Private markets provide access to investment opportunities that are often not available to, or easily accessed by, broader public equity markets.

Point of entry: Developing innovative solutions to support these long-term goals requires both time and capital in the early stages to truly drive progress. Given the key role private markets play across a company’s lifecycle, including the ability to invest in businesses that are not yet revenue-generating, private capital helps facilitate this early development in a rapidly growing space.

Point of exit: Investors are taking note of the premiums being paid for businesses that have a strong focus on ESG or sustainability themes that may lead to real-world impact, such as commitments to diversity, equity, and inclusion and climate change. 

Nearly three-quarters of all private equity firms (72%) say they expect to capture a premium in businesses they are considering exiting based on specific ESG qualities.2

Ability to influence: Many private market opportunities offer majority ownership across a highly concentrated group of stakeholders, providing a greater ability to influence and use specific expertise to guide management teams toward optimal development plans and value creation initiatives. For private markets managers, it allows for more emphasis to be placed on impact in their value creation plans, including not only maximizing value for shareholders, but also for customers, employees, local communities, suppliers and distributors, and the planet. Managers can also leverage their operating partner model to share best practices across their portfolio companies, creating efficiencies and scaling businesses for impact.

Streamlined accountability: Company management teams are not subject to daily market movements or large numbers of minority shareholders, and instead maintain more focused relationships with stakeholders. This nimbleness allows for the optimal development of products or services supporting the goals driving investment.

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Assets in impact-focused investments have doubled in just two years — and surpassed $1 trillion for the first time in 2022.3

Low carbon transition and energy security driving a huge opportunity

The risks posed by climate change are increasingly evidenced by physical damages caused by more frequent and intense extreme weather globally4 and the rising prevalence of climate attribution science.5 Global conflicts have further underscored the importance of more self-sufficiency in power grids and access to local, alternative energy sources. From an investing standpoint, tailwinds from lower-carbon consumption, mandated net-zero targets, and increased demand for energy alternatives are churning out new opportunities across a broad range of energy solutions. The IPCC, for example, estimates a need for annual investment in energy systems of around $2.4 trillion in order to help limit global warming to 1.5°C or less by 2035.6 More broadly, the OECD projects the investment need for water infrastructure to range from $6.7 trillion by 2030 to $22.6 trillion by 2050.7 While the growth projections may vary, the broader takeaway, in our view, is ironclad: There will be significant opportunity for investment into some of these themes going forward and we anticipate private capital playing an increasingly important role. One area that continues to benefit from private investment is clean technology, including renewables like energy and wind solutions and other alternatives such as hydrogen and hydroelectric. While demand has been steady over the past decade, investment in clean tech has shot up recently. In the past decade, private managers have sponsored more than 1,000 US-based cleantech companies, investing nearly $150 billion along the way.8
Clean tech deal activity
Clean-tech-chart-01-01.png

Source: PitchBook, data reflects clean tech companies across global private equity and venture capital categories as of 12/31/2022.

Social disparities driving the need for integrated solutions

These and other long-term, secular trends are driving the need for innovation and investment across key sectors. Increased long-term capital investment into technology, healthcare, and financials – three of the S&P 500’s top-five performing sectors over the past decade9 – should yield an abundant supply of impact-focused opportunities for investors.
SP-500-Sectors-Historical-01.png

Technology

We expect to see GPs focus on digital transformation across end markets. For example, technology is expected to drive improvements in education globally, enhancing accessibility, infrastructure, and student/teacher outcomes. It will also play an essential role in helping to develop more robust cybersecurity solutions as governments, businesses, and personal consumers seek to safeguard sensitive data.

SP-500-Sectors-Historical-02.png

Healthcare

The urgent need for a system that offers more equitable access and distribution of care will require significant investment and is further supported by a heightened global focus on research, development, and deployment. Aging populations, epidemics, and the need for personalized medicine should also be catalysts for investment demand.

SP-500-Sectors-Historical-03.png

Financials

As the need to provide greater access to formalized financial systems continues, we anticipate significant opportunities to help accelerate small business expansion, increase spend on financial and payments technologies, and support financial solutions for lower-income demographics.

The future looks bright

For the foreseeable future, companies in these and other sectors will be focused on solving specific, significant, global challenges that will require long-term private capital support to succeed. There are also strong secular tailwinds in place around climate and energy transition, consumer preferences, and social inequities – transformational shifts that we expect will drive major growth across the private markets landscape for years to come. As investors continue to face an uncertain macroeconomic environment, investing for impact through a private market lens can play a very effective role in portfolios by helping to counter the highs and lows.

Would you like to discuss the expanding opportunities for impact investing through private markets?

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1 Limited Partners and Private Equity Firms Embrace ESG, Bain & Company, 2022
2 E&Y: 2021 Global Private Equity Divestment Study, “How private equity is refining exit strategies for stronger valuations”
3 Global Impact Investing Network (GIIN). “2022: Sizing the Impact Investing Market.”
4 https://www.ncei.noaa.gov/access/billions/
5 https://www.worldweatherattribution.org/
6 Intergovernmental Panel on Climate Change, Global Warming of 1.5°C, Summary for Policymakers, 2018
7 World Economic Forum, Mercer, “Transformational Investment: Converting Global Systemic Risks into Sustainable Returns”, May 2020
8 American Investment Council, “The Clean Tech Revolution”, December 2021
9 S&P 500 historical 10-year returns, data as of 12/31/2022

This material is solely for informational purposes and should not be viewed as a current or past recommendation or an offer to sell or the solicitation to buy securities or adopt any investment strategy. The opinions expressed herein represent the current good faith views of the author(s) at the time of publication, are not definitive investment advice, and should not be relied upon as such. This material has been developed internally and/or obtained from sources believed to be reliable; however, HarbourVest does not guarantee the accuracy, adequacy, or completeness of such information. There is no assurance that any events or projections will occur, and outcomes may be significantly different than the opinions shown here. This information, including any projections concerning financial market performance, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons.

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Professional Investor Definition

“Professional Investor” under the Securities and Futures Ordinance (Cap. 571 of the Laws of Hong Kong) (the “SFO”) and its subsidiary legislation) means:

(a) any recognised exchange company, recognised clearing house, recognised exchange controller or recognised investor compensation company, or any person authorised to provide automated trading services under section 95(2) of the SFO;

(b) any intermediary, or any other person carrying on the business of the provision of investment services and regulated under the law of any place outside Hong Kong;

(c) any authorized financial institution, or any bank which is not an authorised financial institution but is regulated under the law of any place outside Hong Kong;

(d) any insurer authorized under the Insurance Ordinance (Cap. 41 of the Laws of Hong Kong), or any other person carrying on insurance business and regulated under the law of any place outside Hong Kong;

(e) any scheme which-

(i) is a collective investment scheme authorised under section 104 of the SFO; or

(ii) is similarly constituted under the law of any place outside Hong Kong and, if it is regulated under the law of such place, is permitted to be operated under the law of such place,

or any person by whom any such scheme is operated;

(f) any registered scheme as defined in section 2(1) of the Mandatory Provident Fund Schemes Ordinance (Cap. 485 of the Laws of Hong Kong), or its constituent fund as defined in section 2 of the Mandatory Provident Fund Schemes (General) Regulation (Cap. 485A of the Laws of Hong Kong), or any person who, in relation to any such registered scheme, is an approved trustee or service provider as defined in section 2(1) of that Ordinance or who is an investment manager of any such registered scheme or constituent fund;

(g) any scheme which-

(i) is a registered scheme as defined in section 2(1) of the Occupational Retirement Schemes Ordinance (Cap. 426 of the Laws of Hong Kong); or

(ii) is an offshore scheme as defined in section 2(1) of that Ordinance and, if it is regulated under the law of the place in which it is domiciled, is permitted to be operated under the law of such place,

or any person who, in relation to any such scheme, is an administrator as defined in section 2(1) of that Ordinance;

(h) any government (other than a municipal government authority), any institution which performs the functions of a central bank, or any multilateral agency;

(i) except for the purposes of Schedule 5 to the SFO, any corporation which is-

(i) a wholly owned subsidiary of-

(A) an intermediary, or any other person carrying on the business of the provision of investment services and regulated under the law of any place outside Hong Kong; or

(B) an authorized financial institution, or any bank which is not an authorised financial institution but is regulated under the law of any place outside Hong Kong;

(ii) a holding company which holds all the issued share capital of-

(A) an intermediary, or any other person carrying on the business of the provision of investment services and regulated under the law of any place outside Hong Kong; or

(B) an authorized financial institution, or any bank which is not an authorised financial institution but is regulated under the law of any place outside Hong Kong; or

(iii) any other wholly owned subsidiary of a holding company referred to in subparagraph (ii); or

(j) any person of a class which is prescribed by rules made under section 397 of the SFO for the purposes of this paragraph as within the meaning of this definition for the purposes of the provisions of the SFO, or to the extent that it is prescribed by rules so made as within the meaning of this definition for the purposes of any provision of the SFO.

The first of such classes of additional “professional investor”, under the Securities and Futures (Professional Investor) Rules (Cap. 571D of the Laws of Hong Kong), are:

(k) any trust corporation (registered under Part VIII of the Trustee Ordinance (Cap. 29 of the Laws of Hong Kong) or the equivalent overseas) having been entrusted under the trust or trusts of which it acts as a trustee with total assets of not less than HK$40 million or its equivalent in any foreign currency at the relevant date (see below) or-

(i) as stated in the most recent audited financial statement prepared-

(A) in respect of the trust corporation; and

(B) within 16 months before the relevant date;

(ii) as ascertained by referring to one or more audited financial statements, each being the most recent audited financial statement, prepared-

(A) in respect of the trust or any of the trust; and

(B) within 16 months before the relevant date; or

(iii) as ascertained by referring to one or more custodian (see below) statements issued to the trust corporation-

(A) in respect of the trust or any of the trusts; and

(B) within 12 months before the relevant date;

(l) any individual, either alone or with any of his associates (the spouse or any child) on a joint account, having a portfolio (see below) of not less than HK$8 million or its equivalent in any foreign currency at the relevant date or-

(i) as stated in a certificate issued by an auditor or a certified public accountant of the individual within 12 months before the relevant date; or

(ii)  as ascertained by referring to one or more custodian statements issued to the individual (either alone or with the associate) within 12 months before the relevant date;

(m) any corporation or partnership having-

(i) a portfolio of not less than HK$8 million or its equivalent in any foreign currency; or

(ii) total assets of not less than HK$40 million or its equivalent in any foreign currency, at the relevant date, or as ascertained by referring to-

(iii) the most recent audited financial statement prepared-

(A) in respect of the corporation or partnership (as the case may be); and

(B) within 16 months before the relevant date; or

(iv) one or more custodian statements issued to the corporation or partnership (as the case may be) within 12 months before the relevant date; and

(n) any corporation the sole business of which is to hold investments and which at the relevant date is wholly owned by any one or more of the following persons-

(i) a trust corporation that falls within the description in paragraph (k);

(ii) an individual who, either alone or with any of his or her associates on a joint account, falls within the description in paragraph (k);

(iii) a corporation that falls within the description in paragraph (m);

(iv) a partnership that falls within the description in paragraph (m).

For the purposes of paragraphs (k) to (n) above:

  • “relevant date” means the date on which the advertisement, invitation or document (made in respect of securities or structured products or interests in any collective investment scheme, which is intended to be disposed of only to professional investors), is issued, or possessed for the purposes of issue;
  • “custodian” means (i) a corporation whose principal business is to act as a securities custodian, or (ii) an authorised financial institution under the Banking Ordinance (Cap. 155 of the Laws of Hong Kong); an overseas bank; a corporation licensed under the SFO; or an overseas financial intermediary, whose business includes acting as a custodian; and
  • “portfolio” means a portfolio comprising any of the following (i) securities; (ii) certificates of deposit issued by an authorised financial institution under the Banking Ordinance (Cap, 155 of the Laws of Hong Kong) or an overseas bank; and (iii) except for trust corporations, cash held by a custodian.

Institutional Investor / Accredited Investor Definition

An institutional investor as defined in Section 4A of the SFA and Securities and Futures (Classes of Investors) Regulations 2018 is:

(a) the Singapore Government;

(b) a statutory board as may be prescribed by regulations made under section 341 of the SFA, as prescribed in the Second Schedule of the Securities and Futures (Classes of Investors) Regulations 2018;

(c) an entity that is wholly and beneficially owned, whether directly or indirectly, by a central government of a country and whose principal activity is —

(i) to manage its own funds;

(ii) to manage the funds of the central government of that country (which may include the reserves of that central government and any pension or provident fund of that country); or

(iii) to manage the funds (which may include the reserves of that central government and any pension or provident fund of that country) of another entity that is wholly and beneficially owned, whether directly or indirectly, by the central government of that country;

(d) any entity —

(i) that is wholly and beneficially owned, whether directly or indirectly, by the central government of a country; and

(ii) whose funds are managed by an entity mentioned in sub‑paragraph (c);

(e) a bank that is licensed under the Banking Act 1970;

(f) a merchant bank that is licensed under the Banking Act 1970;

(g) a finance company that is licensed under the Finance Companies Act 1967;

(h) a company or co‑operative society that is licensed under the Insurance Act 1966 to carry on insurance business in Singapore;

(i) a company licensed under the Trust Companies Act 2005;

(j) a holder of a capital markets services licence;

(k) an approved exchange;

(l) a recognised market operator;

(m) an approved clearing house;

(n) a recognised clearing house;

(o) a licensed trade repository;

(p) a licensed foreign trade repository;

(q) an approved holding company;

(r) a Depository as defined in section 81SF of the SFA;

(s) a pension fund, or collective investment scheme, whether constituted in Singapore or elsewhere;

(t) a person (other than an individual) who carries on the business of dealing in bonds with accredited investors or expert investors;

(u) a designated market‑maker as defined in paragraph 1 of the Second Schedule to the Securities and Futures (Licensing and Conduct of Business) Regulations;

(v) a headquarters company or Finance and Treasury Centre which carries on a class of business involving fund management, where such business has been approved as a qualifying service in relation to that headquarters company or Finance and Treasury Centre under section 43D(2)(a) or 43E(2)(a) of the Income Tax Act 1947;

(w) a person who undertakes fund management activity (whether in Singapore or elsewhere) on behalf of not more than 30 qualified investors;

(x) a Service Company (as defined in regulation 2 of the Insurance (Lloyd’s Asia Scheme) Regulations) which carries on business as an agent of a member of Lloyd’s;

(y) a corporation the entire share capital of which is owned by an institutional investor or by persons all of whom are institutional investors;

(z) a partnership (other than a limited liability partnership within the meaning of the Limited Liability Partnerships Act 2005) in which each partner is an institutional investor.

An accredited investor as defined in Section 4A of the SFA and Securities and Futures (Classes of Investors) Regulations 2018 is:

(i)  an individual —

(A) whose net personal assets exceed in value $2 million (or its equivalent in a foreign currency) or such other amount as the Authority may prescribe in place of the first amount;

(B) whose financial assets (net of any related liabilities) exceed in value $1 million (or its equivalent in a foreign currency) or such other amount as the Authority may prescribe in place of the first amount, where “financial asset” means —

(BA) a deposit as defined in section 4B of the Banking Act 1970;

(BB) an investment product as defined in section 2(1) of the Financial Advisers Act 2001; or

(BC) any other asset as may be prescribed by regulations made under section 341; or

(C) whose income in the preceding 12 months is not less than $300,000 (or its equivalent in a foreign currency) or such other amount as the Authority may prescribe in place of the first amount;

(ii)  a corporation with net assets exceeding $10 million in value (or its equivalent in a foreign currency) or such other amount as the Authority may prescribe, in place of the first amount, as determined by —

(A) the most recent audited balance sheet of the corporation; or

(B) where the corporation is not required to prepare audited accounts regularly, a balance sheet of the corporation certified by the corporation as giving a true and fair view of the state of affairs of the corporation as of the date of the balance sheet, which date must be within the preceding 12 months;

(iii) A trustee of a trust which all the beneficiaries are accredited investors; or

(iv) A trustee of a trust which the subject matter exceeds S$10 million; or

(v) An entity (other than a corporation) with net assets exceeding S$10 million (or its equivalent in a foreign currency) in value. “Entity” includes an unincorporated association, a partnership and the government of any state, but does not include a trust; or

(vi) A partnership (other than a limited liability partnership) in which every partner is an accredited investor; or

(vii) A corporation which the entire share capital is owned by one or more persons, all of whom are accredited investors.

Continuation solutions encompass a host of transaction types in which a GP secures interim liquidity and/or additional primary capital for their LPs in a strongly performing asset, or set of assets, that the GP will continue to own and control. Specifically, they include continuation funds, new funds created by GPs for the purpose of acquiring the asset(s) that continue to be managed by the same GP and capitalized by one or several secondary buyers, or equity recapitalizations involving a direct equity or structured equity investment into a portfolio company. These transactions can also include a parallel investment from the GP’s latest fund into that same pool of assets (a “cross-fund trade”).