Preview
As the world faces ever-growing social and environmental challenges - from the IPCC’s gloomy temperature rise predictions, to all seventeen UN Sustainability Development Goals (“UN SDGs”) falling short of achieving their 2030 targets - investors are increasing their allocation to impact investing and are building sound impact frameworks to measure and manage the positive real-world changes they generate.
Impact investing promotes both financially sound and environmentally & socially positive outcomes. With most market participants requiring solid financial returns that meet or exceed market expectations, financial performance considerations have become key elements underlying the momentum that the strategy is gaining.
The landscape of impact investing is evolving. While private equity and venture capital have traditionally dominated (with these two representing over 60% of impact funds launched in the past decade), new strategies like direct lending are gaining traction. This shift is largely due to asset owners seeking to balance their impact goals with the need for stable, risk-adjusted returns.
As a result of the increasing dual demand for impact products with stable financial returns, direct lending investors and managers are increasingly interested in seizing this opportunity and designing impact investing strategies by leveraging the close relationships they build with businesses, and the influence they have, throughout the structuring phase of transactions.
Impact direct lending strategies provides investors with several advantages compared to the wider private debt asset class (which include real estate & infrastructure). This includes closer relationships & access to management, a broader investible universe, and an ability to structure bespoke deal terms and impact objectives. Furthermore, as opposed to dedicated impact funds, which may suffer from concentration risks, generalist direct lending funds with impact-like features can meet LPs’ financial & impact objectives without additional concentration risk.
At Alcentra, our European Direct Lending team supports mid-market businesses achieve positive impact by targeting sectors that provide solutions to environmental and social issues as well as scaling up the use of Sustainability-Linked Loans (SLLs) to tie borrowers’ positive outcomes to financial rewards.
In this whitepaper, we provide insights into some of the key characteristics and the evolution of impact investing, with a deep dive into why we think direct lending to be a particularly well-suited investment strategy to achieve impact and financial goals. Additionally, we will showcase our approach to impact direct lending as an additional overlay to our standard ESG integration process, aimed at maximising the positive change generated by our investments.
WHAT ARE THE RISKS?
All investments involve risks, including the possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested.
Investments in many alternative investment strategies are complex and speculative, entail significant risk and should not be considered a complete investment program. Depending on the product invested in, an investment in alternative strategies may provide for only limited liquidity and is suitable only for persons who can afford to lose the entire amount of their investment. An investment strategy focused primarily on privately held companies presents certain challenges and involves incremental risks as opposed to investments in public companies, such as dealing with the lack of available information about these companies as well as their general lack of liquidity. Diversification does not guarantee a profit or protect against a loss.
An investment in private securities (such as private equity or private credit) or vehicles which invest in them, should be viewed as illiquid and may require a long-term commitment with no certainty of return. The value of and return on such investments will vary due to, among other things, changes in market rates of interest, general economic conditions, economic conditions in particular industries, the condition of financial markets and the financial condition of the issuers of the investments. There also can be no assurance that companies will list their securities on a securities exchange, as such, the lack of an established, liquid secondary market for some investments may have an adverse effect on the market value of those investments and on an investor's ability to dispose of them at a favourable time or price. Past performance does not guarantee future results.
Investors considering a strategy which focuses on investments related to sustainability related issues, should consider that changes to the regulatory landscape, physical climate related events, political events, and market perceptions could have material adverse effect on such investments. Potential challenges to such investments include cost-effectiveness, performance and reliability of novel technology, changes in political and social institutions, as well as the potential for unforeseeable disruptive technology and innovations. Currently, there is not a universally accepted Environmental, Social, and Governance standard, as such the manager may apply (or not apply) standards and considerations in their sole discretion. In the future, the various regulators may choose to implement more universal standards which could have an impact on climate related investments.
Any companies and/or case studies referenced herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. The information provided is not a recommendation or individual investment advice for any particular security, strategy, or investment product and is not an indication of the trading intent of any Franklin Templeton managed portfolio.