Columbia Threadneedle’s Andrew Carnwath, director and head of impact, private equity, looks at four questions LGPS funds may want to consider as they evaluate private equity to help them deliver both return and impact.
The recent government consultation, LGPS: Next steps on investments, set out a proposal that Local Government Pension Schemes (LGPS) adopt an ambition to invest 10% of their assets in private equity (PE) to help accelerate investment in UK growth. Columbia Threadneedle’s Andrew Carnwath, director and head of impact, private equity explores whether PE can deliver LGPS return and impact.
1. Is PE an appropriate asset class to invest in high-growth companies?
PE is an ideal way for LGPS to invest in the UK’s high-growth companies with products and services delivering positive impacts. There is a large and growing pool of small- and medium-sized businesses that cannot be accessed through public markets – increasingly the most disruptive and highest growth companies choose to stay private for longer. Additionally, a large number of purpose-led businesses set up to tackle inequality tend to be private.
Good PE managers take a long-term, active approach that supports the creation of sustainable value without the distraction of quarterly earnings. They provide a powerful combination of financial capital and human expertise to accelerate the growth of a business. For example, PE managers often invest in growing family businesses then strengthen the management team to drive the next stage of growth.
The involvement of PE helps these businesses to attract senior and highly experienced professionals. The strong alignment between company management, PE general partners and investors in growing and improving a business provides a strong incentive for all stakeholders to maximise investment returns and deliver positive impact.
2. What opportunities exist to contribute to UK growth capital?
There is a large opportunity set among rapidly growing middle-sized companies. They are often disrupting their sectors and choosing to raise capital through private markets where they also gain from PE expertise in scaling and improving businesses.
There have been recent macro-economic headwinds: rising inflation saw central banks lifting interest rates and tightening availability of credit. This has challenged PE fundraising. However, areas of UK growth capital are less vulnerable and could actually benefit from the current situation; in particular, the lower mid-market, small- to medium-sized growth companies using conservative levels of debt. Those PE funds making co-investments and investing in the secondary PE market will also be less impacted. With inflation now moderating, we should see lower interest rates, more credit and greater consumer confidence.
This is the right time for the LGPS to invest in PE with impact, as young businesses are both delivering positive impact and growing quickly.
Andrew Carnwath, Columbia Threadneedle
3. How can LGPS funds approach impact measurement in PE?
Various initiatives seek to codify the measurement and reporting of impact in PE, such as the Global Impact Investing Network’s IRIS metrics. The global Impact Measurement Project, meanwhile, seeks a common consensus on measuring, managing and reporting on impact.
At Columbia Threadneedle, impact measurement is built into the PE investment process through an impact assessment. For each company we analyse: “what” the intended positive impact of the company’s product or service is, and the risk of any negative impact; “who” is impacted, including underserved populations; “how much” impact (scale, depth and duration); and “additionality”, i.e. positive impact contribution versus what would happen anyway.
This helps us build an impact thesis. To qualify as a PE impact investment a company must:
a) score at least 10 out of 15 under this impact assessment methodology; and,
b) have more than 90% of revenues aligned to one or more of the 169 targets underlying the United Nations Sustainable Development Goals.
We then develop company-specific impact key performance indicators to measure the company’s positive impact over our investment holding period. These are developed in collaboration with company management teams, ensuring buy-in, and articulated to stakeholders – which could include the LGPS funds. We only invest in companies where management actions will simultaneously drive financial returns and a positive impact – with no compromise on either.
4. Can LGPS funds access superior financial returns while driving growth and impact?
The LGPS can select managers whose values and investment objectives align with their own. There is strong non-cyclical demand for products and services addressing key human and planetary needs. Three examples include: “environmental sustainability” businesses in areas such as climate change mitigation, pollution reduction and clean energy; secondly, “health and well-being” – specifically, prevention, curative medicine, rehabilitation and palliative care; and “diversity and inclusion”, where there is demand for products and services that promote equal access to finance and technology, a safe working environment, quality education, affordable housing and cyber security.
In summary, we believe this is the right time for the LGPS to invest in PE with impact, as young businesses are both delivering positive impact and growing quickly, with growing investor interest providing underpinning exit values, underpinning the delivery of strong financial returns from the PE lower and mid market.
