Global Capital, 27 April 2018 Issue
M&G Investments has announced the public launch of a private debt fund that aims to achieve a positive social or environmental impact, while giving investors a return higher than that of public bonds. Meanwhile, a survey suggests funds of this kind make good returns.
The £300bn asset manager, owned by insurance company Prudential plc, has been developing the idea for at least two years and made a soft launch of the fund last year, but this is the first public announcement.
So far, the M&G Impact Financing Fund, managed by Richard Sherry, has £44.5m, having attracted seed investment from Prudential, Big Society Capital and the Swedish Foundation for Strategic Environmental Research (Mistra).
M&G has worked with Sustainalytics, the sustainable investing research firm, to devise a methodology to measure the impact of the fund's investments.
"It's taken quite a long time to get together - we had to do a lot of preparatory work," said William Nicoll, co-head of alternative credit at M&G in London. "The simple first question, what is an impact asset, is complicated. We worked with Sustainalytics for a long time about that. Then when we had worked out what the feasible assets were, we had to work out what kind of fund structure would be most suitable."
M&G has decided to stay, for the time being, within the areas of private credit where it is comfortable and knows it has the analytical skills. The fund will aim to invest in a broad range of private credit assets in many sectors, with an average rating in the triple-B band, that enjoy "an illiquidity premium over equivalently rated public bonds."
Fixed rate assets will be hedged to floating, so the fund will aim to make about 300bp over Libor, going up and down with market conditions.
It will be an open-ended fund. "In some ways it would have been easier to set up a closed-ended fund, but the idea is to have something that can grow for decades and eventually drive investments and drive company behaviour," said Nicoll.
"We've started to talk to people about it, but in a very quiet way," he said. "We're trying to find out exactly where there might be interest. So far, it feels like there is more interest in Sweden and Holland in terms of pension schemes. In the UK it may be charities at first, then maybe moving into pension funds."
The fund it aimed mainly at institutions, although private wealth management investors can also participate. "Because we can't offer daily liquidity it can't be true retail," said Nicoll. Many retail investment platforms emphasise daily liquidity, so M&G finds it difficult to offer retail products where funds need to be locked up for a period.
But there will be some scope for liquidity, as the fund will always hold some public bond. its money will be invested in bonds, screened for environmental, social and governance criteria, until suitable illiquid investments can be found.
Besides Pru, the two seed investors represent the two wings of the fund's intentions: Big Society Capital for the social side and Mistra for environmental.
"We thought M&G had a very considered approach to the impact framwork," said Evita Zanuso, financial sector and investment engagement director at Big Society Capital in London. "This whole idea of impact investing and how to manage impact is still quite new. They seemed very open to learning and willing to hear what others are doing. They have a specific way of thinking about it, but were open to being challenged as well. They also have a team on the debt side that has a very strong track record."
Recently, the Global Impact Investing Network (GIIN), an NGO, released a report on the performance of private debt impact investing funds. GIIN said it was the first comprehensive report on this market. It looked at two kinds of funds: Private Debt Impact Funds, which invest mainly in emerging markets, and Community Development Loan Funds, which invest only in the US. The two groups had made weighted net annual returns since 2012 of 2.6% and 2.9%, respectively. Average loan write-offs were below 1%.
M&G has for many years been one of the largest and most diverse UK investors in alternative, private credit of all kinds, from leveraged loans and US private placements to housing association loans, leasing and trade receivables factoring.
The classic rationale for private debt is that by putting in careful credit work and having the skills to tackle out-of-the-way situations, and to lend in unusual formats, an institution can earn a better risk-adjusted return than by buying public bonds, making it worthwhile to give up liquidity.
Many of M&G's private credit assets already qualify as impact investments, under its definition. "ESG is a fundamental part of a normal credit process, and has been at M&G for a long time," said Nicoll. "The discussion here is to take it beyond ESG. If the purpose of ESG is to do no harm, impact means to do positive good. Then you go to the next stage of what you can measure, because in impact investing you have to be able to measure the impact."
M&G says it already holds £20bn of impact assets in fixed income, of which £6.5bn are private credit. These include loans for renewable energy, social housing and energy-efficient buildings.
These assets are normal credit investments, which M&G would make for their financial merits alone, without needing to justify them on impact grounds.
"Across all of M&G we've run an integrated approach to ESG across all assets," said Sherry. But in pockets we've been sourcing a lot of impact investments, and one pocket is private debt. We are very active in social housing, green real estate, financing for hospitals and universities - we've been sourcing those assets for a very long time."
The difference with the new fund is not so much the nature of the assets, as that it will be M&G's first to make impact investing in private credit an overt strategy.
The assets will be selected from among those that M&G would ordinarily originate with a particular eye to their high impact. The fund will also offer much more detailed reporting about the investments' social and environmental impacts, in an annual report.
"These assets are relatively scarce - they are quite hard to find and structure and we have a large amount of demand for them," said Nicoll. "Because we think that over a long period of time people are going to move to this kind of investing, we are very keen to help with that, and we think it's worth putting some of those scarce assets here."
The fund has already participated in several private debt deals, including lending to the developer regenerating the Greenwich Peninsula in southeast London, supporting solar power in the US and financing UK social housing associations.
Most of the assets it funds are expected to be newly originated loans, partly because for reporting purposes, engagement with the borrower is necessary. But the fund may buy secondary loans if they are particularly attractive.
"For every investment, as well as doing our standard credit analysis, we also do an impact analysis," said Sherry. "The starting point for that is the Sustainalytics criteria, which is a minimum standards, but the analysis we do goes beyond that. If our impact analyst has any additional questions, they will ask those. For example, in a social housing transaction, many of the questions you need to ask as an impact analyst are the same, but there are additional ones, for example around future development plans: how many new homes are they building?"
Before making any investment, M&G will make estimates of what it expects the impact metrics to be and every year it will check on this. If the performance falls far short, it will engage with the borrower.
The reporting will complex, because the beneficial impact of a solar power farm and of social housing are different. Even within these sectors, there are no standard metrics used by investors. But over time, more harmonised and standardised metrics are likely to emerge.
Big Society Capital is an unusual organisation, set up by the UK's Conservative government in 2012 to promote social good through investment. It uses money harvested from dormant bank accounts and funds contributed by the four major clearing banks: Barclays, HSBC, Lloyds and Royal Bank of Scotland. It is governed by a trust, independent of government.
BSC is therefore a kind of hub for impact investing in the UK. Zanuso said M&G's fund was somewhat different from the investments BSC makes in its main social investment portfolio.
"The biggest difference is the additionality," said Zanuso. "With a lot of the investments we make in our social investment portfolio, we ask 'is there a market failure? If we didn't invest, does it mean nobody else will, but if we invest would it bring confidence to other investors?'"
BSC always works through intermediaries, but the ultimate investees are usually charities and social enterprises.
M&G's fund will be different: it is aimed more at borrowers able to pay a commercial return, so the additionality is less clear: these projects could probably find investment elsewhere, from general investors.
"Even without us, it would probably do well anyway," said Zanuso, "but having a seed investor is probably helpful."
Expanding the envelope
Even though M&G's fund would not meet BSC's usual criteria for additionality, the organisation was keen to invest. "Part of our remit is to try and bring more people into the social investment market," said Zanuso. "Our board had made a decision to carve out a set amount of money from our treasury portfolio, where we would fairly actively look for mainstream funds that don't fit within our criteria, but could be best in class and have real potential to bring the idea of impact investing to more investors."
With this pot of money, BSC has also invested in a Columbia Threadneedle social bond fund, focusing on listed bonds, and the Barclays Multi-Impact Fund, a Ucits fund of funds aimed at retail and wealthy individual investors.
Asked whether M&G would ever be tempted to go into the more adventurous reaches of impact investing, Nicoll said: "At the moment we are very clear: we are trying to find assets that offer a sensible risk/reward and have impact. That will limit some of the areas we go into, because our clients all need to have that sort of return coming through. It's more difficult to do some of the more socially-driven investments, because some are done at different levels of return."
M&G is also limiting its scope to developed markets. "We are very much staying within our sphere of expertise," Nicoll said. "But as interest in impact assets grows and our sphere of expertise grows, we will continue to envelop things."
By Jon Hay, 16 Apr 2018