Impact is in the eye of the beholder, or at least in the eye of the fund manager.

A new study on the financial performance of private equity impact investments provides fresh data that suggests at least some segments are indeed delivering “market-rate” returns.

Moreover, the report, “Great Expectations: Mission Preservation and Financial Performance in Impact Investments,” from the University of Pennsylvania’s Wharton Social Impact Initiative, found that a focus on social mission may even enhance a company’s acquisition or “exit” value.

“The average impact investments are average, but there are winners,” said Chris Geczy, one of the authors. “Managers say there’s little tension between purpose and profits.”

In my experience that is a belief-based answer, not a data-driven answer.Cathy Clark, Director of CASE i3 Initiative on Impact Investing at Duke University

That reassuring finding, however, begs the question of how to validate that social mission. The authors largely relied on self-reports from impact fund managers that the missions of their portfolio companies would be preserved after they were sold.

Lack of Control

The study examined the financial returns (and estimated unrealized returns) of 53 private equity impact funds from around the globe, including 557 individual investments. Wharton researchers found that the 170 market-rate seeking impact investments included in the study demonstrated a gross internal rate of return of 12.94 percent, nearly identical to that of the Russell Microcap and to the S&P 500 index between 2000 and 2015. For market-rate seeking exits (51 companies), the IRR was notably higher at 18.59 percent. Yet higher, market-rate seeking exits (excluding write-offs) with mission preservation: 33.52 percent (versus all market-rate seeking exits which achieved an IRR of 35.01 percent).

The strong performance of the private equity impact funds in the survey reinforces another major financial performance study this year that showed that for some market segments, investors need not expect a financial tradeoff for impact.

“The Wharton study adds another vote of confidence for the fact that some portion of the emerging set of multi-asset class, multi-mission impact investments can deliver market-rate returns,” Cathy Clark, the director of CASE i3 Initiative on Impact Investing at Duke University, told ImpactAlpha. 

But, notes Clark, “instead of tracking what the concrete intentions actually were of these investments, and whether they remained intact post-acquisition, they relied on self-reporting by investors.”

Of the 42 exits (that were not write-offs) included in the sample, fund managers reported that the social or environmental missions of all but two (a full 95 percent) of the investment companies remained in tact after acquisition. Yet in two-thirds of those exits, there was no contractual obligation to preserve the mission. Rather, fund managers were asked to simply report whether they believe that upon exit the mission of the company had been preserved.

Through the survey, the researcher found that investors into funds give ample latitude to fund managers to pursue social and/or environmental impact alongside financial returns (90 percent have legal documents in place that say as such, 70 percent require them to do so).

However, funds lack control over mission preservation decisions upon exit. In fact, the survey found, for more than three quarters of portfolio companies in the dataset, impact investors failed to secure the majority of board votes necessary to control exit decisions.

Only 13 percent set specific objectives to hold an acquirer accountable to the mission. Without such formal controls, say the researchers, fund managers may be limited in their ability and motivation to scale impact.

Embedded Impact

From where then, does the optimism around mission preservation stem? It appears many impact investors are relying on what the report calls an embedded impact strategy. Investors are pre-screening potential investments for business models that have impact “embedded” as a core business element.

A company that distributes solar energy systems in Sub-Saharan Africa, for example, might have impact embedded: the more systems it sells, the greater the impact.

“All our deals have their brand wrapped up in impact,” responded one manager included in the survey.

“The attribution of mission preservation to pre- rather than post-investment activities may be an indirect result of the limited controls investors retain when seeking liquidity,” says the report. “Without majority control, an “embedded impact” strategy may provide social investors with the greatest traction in ensuring the long-term impact of their portfolio companies.”

The widespread use of pre-screening for embedded impact also was a theme of the JP Morgan and the Global Impact Investing Network’s annual survey of impact investors. That report found that half of investors that seek to protect mission on exit do so by selecting investees with impact embedded in their core business.

That formulation doesn’t satisfy everyone. “In my experience that is a belief-based answer, not a data-driven answer,” notes Clark. “We know that some kinds of impact are not fundamentally locked into the business. And we know exits can and have led to both leveraging and/or challenging missions.”

For many impact investing industry proponents, and for institutional investors with a mandated risk-return profile, validating the “market-rate returns are possible” assertion is essential.

But for a growing number of advocates and practitioners, the industry needs a better answer to the “is it impactful?” question than, “I hope so.”