When a primary market matures, a derivative secondaries market inevitably develops. Impact investing is no exception.
You can count on one hand the number of established impact secondaries firms. Minnesota-headquartered North Sky Capital closed its fifth Clean Growth fund on $220 million in 2019, and made its final investment from the impact secondaries fund last June. London-headquartered Stafford Capital Partners has raised three Sustainable Secondaries funds, according to data from affiliate title Private Equity International.
The market seemed to move up a gear over the last year. Madrid-headquartered Arcano Asset Management raised €200 million against a €300 million target for its debut impact fund of funds, which makes primary fund investments alongside secondaries and direct co-investments, Secondaries Investor reported in June 2021. In May this year, Capital Dynamics closed its second Future Essentials fund, an ESG-focused vehicle with a similar mandate.
Commonfund Capital took a slightly different approach. Its debut sustainability fund, which closed in April on $233 million, invests in the growth, buyout, renewable energy, agriculture, water and resource efficiency sectors on a direct and secondaries basis.
What is the current state of the impact secondaries market? Do these fund closes show it is entering the next phase of growth?
The primary impact market has experienced two distinct waves, the first of which peaked just before the financial crisis, when assets under management got as high as $28 billion, Secondaries Investor reported. Much of that was invested in early-stage venture capital funds, many of which came a cropper. The second wave has proved to be bigger and – thus far – more resilient due to lessons learned from the crisis.
“[The impact industry] started to de-risk from a technology perspective, and really scale those companies,” says Tom Jorgensen, a managing director at North Sky. “It made room for growth equity, buyout strategies and then power generation and real assets. From a secondaries market perspective, you will be able to find opportunities and have sourcing capabilities across that spectrum.”
There is a steady stream of impact secondaries dealflow, a majority of which is in the LP portfolio market, Secondaries Investor understands. LPs commonly sell to free up capital to reinvest in different areas of impact as their priorities shift or the composition of their investment teams changes.
According to a London-based secondaries adviser, impact stakes often trade at a 30 percent discount to net asset value or more, even when buyout stakes were trading in the nineties on average. Due to the immaturity of the sector, impact managers have yet to show they have repeatable processes that produce consistent results. Maximising value is not always the most important thing either. “These LPs are committed to impact investing as a strategy,” says the adviser. “Sellers are often just looking for a quick solution.”
Secondaries investing arguably gives LPs lower-risk exposure to the impact strategy. Secondaries funds are more diversified by vintage, and the greater maturity of the assets acquired gives visibility into their likely success.
At the same time, the amount dedicated to the strategy is still tiny in the grand scheme of things. The quality of assets on the market is highly variable and managers need to do detailed bottom-up diligence to understand what is worth buying.
“That’s what makes this market still niche, small and definitely a lot more time-intensive as a buyer [than PE secondaries],” says Jorgensen. “You have to make sure that you’re doing that proper underwriting, otherwise you’re not [setting yourself up] for a good outcome.”