The past few years have shown that corporations are responding to pressure from consumers, shareholders and government to focus on their ESG performance. ESG refers to the consideration of environmental, social and governance factors in business and investment decisions. Many corporate managers conflate ESG with socially responsible investing (SRI) and think that adhering to those principles requires sacrificing financial returns, but that view is outdated. Improving the impact of a portfolio does not always come at the cost of risk-adjusted returns. The rigor and financial analysis of many impact investors is on par with investing in any space, and recent studies have shown that impact investors can deliver market and above-market returns. More than half of global asset owners are currently implementing or evaluating ESG considerations in their investment strategy, and asset owners are increasingly demanding this additional level of ESG analysis in their asset managers. Corporate leaders are also being held accountable by their shareholders for ESG performance. ESG investing strategies are rapidly penetrating various asset classes (from private equity, venture capital and family offices to debt and fixed income) and becoming part of the new normal in the age of COVID-19.
Impact investors’ bets on ed-tech, e-health, wellness, data security, energy and water efficiency, and food safety are a bright spot in a challenging market. Companies with low burn rates, efficient cash management and large addressable markets in a burgeoning space have strong futures. The investing thesis for companies in these sectors who have managed cash conservatively the last twelve months by trusted veteran managers are ripe for investors interested in buyer-friendly terms at Series A rounds where those investors can influence the company’s business trajectory and invest at depressed prices to ride the wave back up.
McGuireWoods partner Penny Zacharias recently moderated a panel at the World’s Largest Virtual Impact Investor Summit (Global Virtual Impact Capitalism Summit – Presented by Big Path Capital) which discussed impact investing in the age of COVID-19 and how the virus may change the traditional hierarchy of values. The next decade will see a test of stakeholder capitalism, and the private sector is increasingly more sensitive to reputational risk of actions and inactions taken during this time of crisis. The pandemic is a manifestation of how deeply we are all connected to one another. Whatever affects one directly, affects all indirectly, and the pandemic and resulting economic crisis has magnified this interdependence. Investments affect everyone, and the traditional drivers of value have shifted in ways which may bridge the gap between what markets value and what citizens value. In a shared-resource system where individual users, acting independently according to their own self-interest, behave contrary to the common good of all users by depleting shared resources, their collective action is a market failure commonly known as tragedy of the commons. Out of crisis, equal transformation can come about, and post-pandemic, it is reasonable to expect people will demand improvements in social support, medical care, the environment, and greater care to plan for and manage tail risks and govern effectively during such times of crisis. There has been a rupture of financial transactions with the common good, and investors are increasingly tackling the world’s most urgent problems using rigorous due diligence, financial acumen and calculated risk.
Family Offices’ Investment Perspective on the Current Environment
Investment capital has the power to create opportunities now and forever to come. Family offices are responding in various ways. Private equity is experiencing a more severe and permanent impact from the pandemic. The nature of deployment will be slower because it is not possible to do on-site diligence. Family offices continue to look at investments. Certain family offices have targets regarding impact investing but need to maintain pre-determined target percentage allocations to certain asset classes, which is a challenge to do when the value of certain asset classes fluctuates in a volatile market. It is too early to know what the future holds, but efficient cash management and collaboration among family office networks, portfolio companies and even in some cases competitors is crucial to survival. There is great power in collaboration when working in the face of challenges like a pandemic.
As we shift from a seller’s market to a buyer’s market, impact investors are finding a more flexible market particularly for bridge financings. Family offices typically have very long-term perspectives so have more flexibility in investments. Bill Gates is just one of hundreds of examples of people taking a long-term view, and sometimes forsaking profits for the sake of the general good. Their share in the overall capital deployment is rising. Impact investors tend to think more holistically and creatively, are generally more open to bold ideas, and more willing to bet on non-traditional teams and approaches. Bridge financing was not a strategic goal, rather opportunistic, but is becoming more common. Investors are focusing on nuance to structures, but diligence remains vigorous.
Climate and social solutions are intertwined with impact investing. Environmental investment continues to remain highly relevant and a priority for impact investors. It makes the thesis for impact investing even stronger. Many impact investors believe ESG, sustainability, education and public health (particularly ed-tech, e-health, energy and water efficiency, food safety) will benefit in some ways from the current environment although the investing environment is challenging for any portfolio.
Advice from veterans in the field is to figure out what you care about and why and go take action on that today. Analysis paralysis is gripping many investors, and few deals are getting done since March. The current environment is uncertain and as challenging as most have seen in their lifetimes, but the gap between winners and losers is widening ever faster. Start by doing even if much smaller dollar amounts than typical.
Investors' Current State of Mind on the Markets & Economy
Although time will tell how they fare in 2020, impact funds have been outperforming the market. Green bonds have done better in downturns than corporate bonds until recently when the Fed came in. Major changes in the market since the lockdowns began include the following: (1) use of videoconferencing tools to get deals done and diligencing companies while working remotely; (2) the rise of e-health and online wellness tools; (3) distance learning tools and widespread remote working infrastructure and plans that likely will remain in place after the pandemic passes; (4) investing in high-performing managers who investors already know and trust and companies with distributed workforces across the U.S.; and (5) more buyer friendly deal terms, including flat rounds, down rounds, inside rounds with recaps and warrants. Impact investors, more so than many traditional investors, have felt a moral imperative to keep investing even as GDP plunges and economies undergo short-term supply disruption and potential destruction. As Winston Churchill once said, it’s not good enough to do our best; sometimes we have to do what’s required.
The S (social) in ESG is rising. Small farmers produce 70% of the world’s food but also constitute 70% of the world’s poor. Food is one of the advantaged industries, but the supply chains are getting re-shuffled. Investors are discussing visibility and traceability of what consumers eat and the long-term sustainability of food supply chains. There will be manifold aftershocks after the pandemic, many of which will be beneficial, including the cleaning up of the food and agricultural system for both environmental and social benefits. It is in everyone’s interest to have healthy farmers in the field. Sometimes a breakdown is required to catalyze a breakthrough. Impact investors are focusing on and investing in the E and S breakthroughs that are presenting real investment opportunities.
Newer family offices are working through and struggling with the incredible uncertainty of investing in today’s market. Overriding that, families are saying that they need to put dollars forward for impact which is creating a virtuous circle, particularly with the interplay of E and S. Creating networks with older family offices who have been through and survived black swan events is creating a tight-knit platform with concentrated focus on impact even in uncertain times. Rigor and discipline are as important as ever but so is action to catalyze impact. Investors are mitigating the headwinds and leaning into the tail winds.
Impact Investing's New Role in the Age of COVID-19
Impact investors are primed to invest in a crisis and, in many respects, more capable of investing opportunistically in a crisis because their goal is to address crises in the ESG space and they have lived through previous crises and come out on top. Co-Founder and Managing Director of the Caprock Group, Matthew Weatherley-White, noted that his impact investors are more patient and primed for investing in a crisis than his conventional investors. One thing we have learned from previous crises is that they accelerate change. When you are forced to lay off employees, you are forced to turn to other automated solutions to survive. Business models focused on stabilizing supply chains will be worth their weight in gold. This crisis may very well begin to reverse the relationship that conflates the market economy with a market society and has resulted in real-world tragedy of the commons examples from the collapse of cod and tuna fisheries to the deforestation of the Amazon region. With reduced emissions, the vision people have seen, particularly the young, will leave an emotional impact which will mean that people will see what the environment might look like with environmental improvements. Renewable energy and energy efficiency solutions will also be key as we emerge from the aftermath of the pandemic.
The crisis is catalyzing the fragmentation of the global economy in ways that are not all bad. We have seen this unfold with an increase in local resilience and self-reliance, i.e. bartering among neighbors for scarce goods and the growth of gardening. As Praveen Sahay, Founder & Managing Director of WAVE Equity Partners, asks, “Does it make sense any longer to depend on producers who are thousands of miles away?” Every community has the opportunity to collaborate and develop into cohesive units, and many communities have seen that transpire. Local food and water sources are critical. Rather than building up massive manufacturing facilities in far-flung areas for efficiency’s sake, entrepreneurs are pushing a local movement that in the aggregate is massive. More clients are interested in moving their money from the traditional markets, such as big Wall Street banks, to small, more local CDFIs. As Tania Carnegie, Leader and Chief Catalyst at Impact Ventures, notes, trust is a key element in impact investing. What better way to engender trust than to focus on those you know and trust already?
In the past century, technology and governance has led to a more centralized hierarchy and concentrated power structure. This has been further accelerated with the digital economy’s “natural monopolies,” increased support for international trade and offshoring, and new and pervasive surveillance tools, all of which have concerning implications. In parallel, civic engagement has declined and social capital has eroded over the last two decades. COVID-19 has now placed a new emphasis on social capital, resilience and localized production, which may prompt citizens to reconsider our current social and economic construct and revisit the salad days of the past century when social capital was more interwoven into the fabric of communities. Until a few months ago, urbanization was seen by everybody as a sure bet to a golden future, but now citizens, particularly New Yorkers, are less certain. Neighbors are again borrowing cups of sugar (and bread flour) from one another.
As physical and global lives contract and digital and local lives expand, value will be created and destroyed. Unprecedented economic state action has deepened the relationship between the public and private sectors. With the rise of the local movement, communities have become more interdependent and citizens have awakened to the understanding that investing is interdependent on the common good. Public values may begin to re-shape private values in the age of COVID-19.
Published July 27, 2020.