Impact Management | April 6, 2021

How capital structures in high-risk asset classes can undermine positive impact

Amy Cortese
ImpactAlpha Editor

Amy Cortese

ImpactAlpha, April, 6 – In their search for yields and returns, pension funds, insurance companies, sovereign wealth funds, and endowments with massive amounts of capital have increasingly sought out riskier assets classes, such as private equity and debt, venture capital, high yield bonds, leveraged loans and collateralized loan obligations. Buyout funds alone raised $300 billion in 2020 as they eyed businesses weakened by the pandemic.

Some of the institutional capital has poured into impact investing funds launched by private-equity giants like TPG, KKR, Apollo and Carlyle. That requires impact investors to take stock of how such firms structure investments, which over time have contributed to unsustainable corporate debt loads, lay-offs, and bankruptcies that can destabilize the economy and exacerbate issues such as wealth inequality.

“ESG and impact investing frameworks focus on issues at the portfolio company level, but they do not take into account potential negative impacts from capital structures and investors’ influence in shaping them,” write Delilah Rothenberg, Raphaele Chappe and Amanda Feldman of the Predistribution Initiative, a multi-stakeholder initiative to improve financial structures.

In a new report, ESG 2.0: Measuring & Managing Investor Risks Beyond The Enterprise-level,” the authors offer up 11 potential solutions to address such systemic risks. Investors “need to understand that their allocations to high-risk asset classes can ultimately undermine their long-term return goals and commitments as responsible fiduciaries.”

  • Asset allocation. Revenue-based finance, employee and community ownership models and longer term structures such as evergreen funds and holding companies to accommodate them represent emerging asset classes in the middle of the risk-return spectrum that can provide stable returns, improve diversification and reach more emerging managers and small- and medium-size enterprises.
  • Fund manager, measure thyself. Asset owners and allocators could require fund managers to report on their compensation and pay ratios, political spending, and tax practices, including where the fund is domiciled. Investors need to adopt frameworks that consider systematic risks across a portfolio, argue the authors. One idea: weighting asset values in inverse proportion to their risk

“We encourage large, diversified, long-term oriented institutional investors to consider how their activities may contribute to these issues and how they can improve their own practices to better manage systemic and systematic risks,” write the authors, who plan to hold a series of workshops and webinars to further develop their recommendations.