Rekha Unnithan, Co-Head of Impact Investing at Nuveen, says private equity can achieve long-term positive impact.
How do you create positive long-term impact on people and the planet when your investment horizon is inherently short term? With holding periods for portfolio companies recently reaching a record high of just 5.4 years, private equity is still not exactly synonymous with stewardship.
But US-based private equity specialist Nuveen has been investing for impact for several decades and now has a US$1.18 billion Private Markets Impact Investing portfolio dedicated to inclusive growth, resource efficiency and affordable housing.
“Our conviction is that the two of the largest issues facing the world today are income inequality and climate change,” says Rekha Unnithan, Co-Head of Impact Investing at Nuveen.
“We also believe that there are investment opportunities where entrepreneurs and businesses use those topics as opportunities to address a completely under-served market with a very large total addressable market size. We invest in that intersection where the commerciality of the business reinforces and scales impact,” she says.
Originally created in 2008, Nuveen’s Private Markets Impact Investing portfolio is majority invested by TIAA, the US$1 trillion-plus insurance and retirement firm which acquired Nuveen in 2014. Nuveen also attracted US$150 million in third-party investment via the initial close of the Nuveen Global Impact Fund last July, including the Danish pension fund Velliv which committed US$50 million in capital.
Operating in its current form since 2012, the portfolio invests in private equity and real estate.
Private equity with a twist
According to Unnithan, private equity can deliver positive impact with just a twist to its traditional model, by integrating a wider range of factors into how portfolio companies are selected, managed, measured and sold on.
Selection criteria is key. Nuveen only invests in firms which provide well-targeted products and services to the ‘emerging low-income customer’ or ones which contribute to resource efficiency by improving the sustainability profile of large-scale value chains, in sectors such as real estate, agriculture, manufacturing and automotive.
“These firms aren’t charities. They’re going into parts of the market that mainstream companies don’t go into, because they find it too difficult or there are too many barriers to entry,” says Unnithan. “By being able to deal with that through expertise, product design and focus, they can be very successful commercially and deliver profits for investors.”
Most businesses in both developed and developing countries focus on middle and higher income backets. But Nuveen’s inclusive growth strategy is based on the belief that the low-income customer has an ability and willingness to pay for the right products and services.
“We’re backing companies which are bringing innovative products and solutions to customers in sectors such as healthcare, financial services and education. They are developing unique products, pricing differently, having a differentiated customer acquisition strategy, and serving that customer well in order to scale responsibly, and grow their value proposition,” says Unnithan.
The third leg of the fund is affordable housing, which involves investing in property across the US (the other strategies are global) on a large and efficient enough scale to keep rents low and provide security and added-value services to low-income households.
Nuveen’s Private Markets Impact Investing team targets risk adjusted returns in the range of 17-20% for private equity and 9-11% for real estate net IRRs.
Impact by intent
Long associated with asset-stripping and leveraged buy-outs, private equity firms aren’t known for the nurturing nature of their relationships with the management of portfolio companies. Some are parachuted in to achieve a very precise brief in a short period with ruthless efficiency, others can feel harangued and brow-beaten by their new owners.
Unnithan says there are two broad types of firm in Nuveen’s impact portfolio. The first are businesses that don’t necessarily consider themselves as ‘impact’, but are achieving such via the nature of their solutions or services, and work with Nuveen to grow and scale that impact. “If there isn’t a connection, around the importance of metrics, talking about them to the board, and driving the business, those are not investments we would make. We don’t want impact to be a passive by-product, but an intent,” she says.
The second group often consider themselves as impact investors in their own right, typically entrepreneurs who have formed businesses to address a big problem.
“They work with us to figure out better ways of measurement that can help the business and help us examine their progress towards the goal. It’s written into our contracts and is in our ethos, so our management teams know what we care about,” Unnithan says.
Impact measurement and management is central to Nuveen’s investment process. The firm is a strong proponent of industry-wise standards and third-party verification, but also appreciates the need to develop its own forms of measurement as priorities evolve in a dynamic and fast-changing environment.
Along with the World Bank’s International Finance Corporation, and major asset managers and multilateral development banks, Nuveen was a founder of the Operating Principles for Impact Management in April 2019, a framework based on nine core principles, which now has 128 signatories across 31 countries.
Unnithan serves on its advisory board as well as that of the Global Impact Investing Network’s Institutional Investor Initiative. Last year, Nuveen published a report on the alignment of its impact management practices with the Operating Principles for Impact Management, verified by a third-party consultant.
“We see further guidance principles and uniformity with respect to process as being very important to the integrity of this market. We want to make sure that when capital is raised and invested, impact is created, i.e. measurable, incremental change and positive impact on the big issues that we all need to solve for. No single investor can solve these problems we need collective action,” she says.
Positive and negative impacts
In parallel with its use of industry-wide frameworks, Nuveen has also developed a proprietary ‘Net Impact Score’, which attempts to track both the positive and negative impacts of its portfolio companies.
One example is Advanced Battery Concepts (ABC), a firm which supports the transition from fossil fuels by developing and licensing patents and technologies to manufacturers globally to produce clean, green and recyclable batteries. ABC’s batteries have the potential to help developing countries shift away from two-stroke engines in scooters and rickshaws, as well as supporting grid storage solutions at utility level and for domestic use.
This clearly has a positive environmental impact, but Nuveen has also worked to ensure the firm trades with partners which follow fair labour standards and have clean supply chains. It has also worked with the company on diversity and inclusion within its own factories.
“For each investment, criteria are set up at the outset as part of the investment process, which get measured, discussed and reported to investors on a quarterly basis,” Unnithan explains.
Where there is no industry-level consensus yet on impact measurement, such as contribution to the UN Sustainable Development Goals (SDGs), Nuveen takes a conservative approach. In its recent impact investing annual report, the firm has tagged specific impact metrics to particular SDGs where they apply.
For example, Nuveen estimates that its portfolio companies’ services reached 129 million low-income borrowers in 2019, contributing to SDG1 (no poverty). But it selects a maximum of three core SDGs for attributing the impact of individual portfolio companies.
Unnithan says reporting must reflect the impacts that are “germane and critical” to a particular investment and its purpose, rather than a more sweeping approach.
“We created our practice well before the SDGs came about, but we think it’s important to be able to show our progress towards that framework because investors care about that as well and it allows us to talk a similar language,” she adds.
Private equity firms famously have a very focused approach to exit strategies, concentrating firmly on maximising their return on investment, having either turned around a failing business or accelerated the growth of an early-stage venture. The ethics and ethos of the purchaser are rarely a major consideration.
For Nuveen, there are a different set of priorities. Unlike the traditional private equity model, the firm tries to ensure management stays in place for the long term. And it doesn’t just sell its stake in a portfolio company to the highest bidder. “It’s a different discussion, because you are concerned about what the next control investor is going to do to the business,” says Unnithan.
As a growth equity investor which typically takes a minority stake, Nuveen uses its position on the board and its shareholder rights to support fast-growing companies with a strong appetite for capital in order to scale up their operations. As such, public or strategic exits are more frequent than selling on to another private equity firm.
Public exits are not uncommon, not least due to growing demand among public equity investors for impact investing opportunities. In such cases, the critical importance of governance issues such as continuity, accountability and transparency means it’s incumbent on early-stage investors such as Nuveen to put the necessary checks, balances and structures in place.
“Going public is often a good solution because it will bring in substantial new capital flows that can take the firm to the next level,” says Unnithan.
Strategic exits are also common, she notes, citing portfolio companies in the finance sector which have built challenging and disruptive models, often leveraging digital technologies to serve low-income or developing markets more effectively and efficiently than incumbents. Such firms can quickly become acquisition targets among bricks-and-mortar institutions.
“When we get strategic investors coming in, the question is, ‘how will the company be able to continue to do what it’s doing, and perhaps do it deeper?’. It is a nuanced discussion on a case-by-case basis.”
Barbarians no longer
For many, private equity will be forever associated with the buccaneering corporate raiders and leveraged buy-out experts portrayed in ‘Barbarians at the Gate’, Bryan Burrough and John Helyar’s 1989 account of the acquisition of RJR Nabisco.
But Unnithan’s brand of investing is becoming more mainstream and she believes it will scale successfully if practitioners retain their focus. “There needs to be continued rigour from managers like us around sticking to disciplines, articulating how and why we are making our investments, the impact we choose to have. It also requires us to disclose our learnings and show performance over time,” she says.
In an industry not known for it, some humility and collaborative spirit would not go amiss either. “We have to keep in mind that we don’t always know the best way to do it. We have to work in concert with science and academia. We need to collaborate to identify the best collective way to avoid pitfalls. Private equity has as a decent quotient of arrogance. Keeping that in check is critical.”