Amidst the turmoil of COVID-19 and what may be the first recession in over a decade, impact investing, which integrates environmental, social and governance (ESG) factors into analysis and decision making, is gaining traction with investors seeking strong financial performance paired with measurable, beneficial social or environmental impact. And, with a potentially prolonged period of economic and societal uncertainty ahead, now might represent a timely opportunity to allocate to the category. While impact is a developing vertical within the venture capital (VC) asset class versus a sprawling universe of established managers with existing track records, it is showing early evidence of a long-held belief at Greenspring Associates: impact's double bottom line represents a compelling investment case. Read on for our take on why venture capital is the asset class of choice for sustainability-minded investors seeking to make the greatest impact on society, the environment and their bottom line.
Lower Risk, Higher Returns
Contrary to the common misconception that investors must forego profitability in favor of mission-driven strategies, impact investing provides both high performance and ESG alignment. For those who doubt the veracity of this claim, refer to data from the first quarter of this year.
Q1 2020 public market equity returns for ESG and impact-aligned indices examined by investment index provider MSCI featured greater resilience than non-socially-responsible ("SRI") counterparts; MSCI noted "strong performance attributable to the systematic tilt of these indexes toward higher ESG-rated stocks, similar to what we observed over the past five years." When extended out to a five-year time period, from March 31, 2015, to March 31, 2020, the selected ESG and impact-aligned indices exceeded the parent index by a range of 60 to 170 basis points on an annualized basis.
Coincident with the decline in equity markets, fixed income also experienced an extremely high degree of volatility in investment-grade (IG) corporate bonds during the first quarter. Major investment-grade ETFs saw price discounts of up to 6% of net asset value (NAV), a level not seen since 2008. However, MSCI reports that issuers with higher MSCI ESG Ratings outperformed the broad market. In addition, most MSCI US Dollar Investment Grade ESG Leaders Corporate Bond Index sectors outperformed their respective parent index sectors. Therefore, we believe it is probable that screening for ESG factors not only leads to greater environmental and societal good, but also enhanced financial return. Further, this is likely applicable across many different asset classes, including private equity and venture capital. All facets of the capital structure stand to benefit from incorporating ESG considerations.
Meanwhile, analysis of investment performance from Morningstar and the Wall Street Journal concludes that 70% of sustainable funds outdid non-ESG funds, the former publication noting that lower energy and higher technology exposures had the greatest attribution impact vis à vis market indices.
Governance experts Professors Claudine Gartenberg of Wharton and George Serafeim of Harvard corroborate this trend, concluding that data shows that: "companies with high levels of purpose outperform the market by 5%–7% per year, on par with companies with best-in-class governance and innovative capabilities. They also grow faster and have higher profitability.” In one of the loudest signals that sustainable investing’s performance underpins its ascent in popularity, asset manager Nuveen shows that 53% of investors pursued SRI due to returns above market rate and an overwhelming majority claimed they would not have done so if responsible investment meant a dip in performance.
#VCforGood: An Asset Class Built for Impact
We believe that when considering investing with impact, investors would be wise to consider one asset class, in particular: venture capital (VC). First, it is no secret that the publicly traded universe is shrinking as fewer firms pursue an initial public offering, opt to stay private longer, occasionally undertake a direct listing or shun the public markets altogether. Cambridge Associates cites that over the last 20 years the number of publicly traded U.S equities has nearly halved, from 8,909 to 4,336. This compares to 8,352 unrealized and partially realized VC-backed companies in 2019 and a total investable universe of 24,536 venture-backed companies in existence today that were funded during the time period of 2000-2019 (Source: PitchBook. Data as of 12/31/2019).
What is perhaps lesser known is that there is a large and growing opportunity to invest in impact in venture. Over the last five years, 64% of the dollars invested in the U.S. in venture capital has been allocated to impact strategies, up from 18% in the 5 years from 2001-2005.
This can also be observed in the context of a broader societal movement, as millennials become an ever-increasing part of the working, consuming, spending and investing population. Survey after survey indicates that they strongly believe in the notion that corporations have an obligation to help solve societal problems and consider all stakeholders, in addition to seeking profit. And this translates into their willingness to buy from companies with a broader sense of purpose. The 2015 Cone Communications Millennial CSR Study, for example, reports that 91% of millennials would switch brands to one associated with an environmental or social cause (vs. 85% U.S. average); MetLife reports that 70% of millennials believe it is a company’s obligation to solve societal problems.
It is clear that many companies – public and private alike – are aware of these trends and are therefore incorporating them into their corporate strategies and governance. One proof point is the 181 CEOs of large U.S. Companies, from Apple to Walmart, who signed the “Statement on the Purpose of a Corporation” in the summer of 2019. This dynamic has become even more pronounced during the coronavirus outbreak, which has served as a powerful reminder that we are all in this together, and society is increasingly looking at how companies are reacting to the crisis. We are proud to be financiers of the private sector, which represents a bright spot, particularly amid this public health emergency. Compassionate capitalism and private companies of all orientations and sizes have played a pivotal role in contributing resources to tackle the problems they see, using the dynamism and ingenuity that characterize the innovation economy.
As it pertains specifically to venture, we have observed that the same generation of millennials who say they would be more likely to buy from companies with a higher sense of purpose are a large and growing contingent of today’s founders. They feel compelled to launch companies to address some of society’s most pressing challenges. And, even when founding more “traditional” technology businesses in areas such as e-commerce, they bring ideas around ESG and impact to their startups from day one. Proterra (to which Greenspring has indirect exposure through Obvious Ventures), Recycle Track Systems (a Greenspring direct investment held in Greenspring Global Partners IX and Greenspring Opportunities V), Stash (a Greenspring direct investment held in Greenspring Global Partners IX and Greenspring Opportunities V) and Grove Collaborative (a Greenspring secondary investment held in Greenspring Secondaries III) are just a few examples of promising venture-backed companies displaying a strong sense of mission that influences their approach to their supply chain, operations, employees and community, as well as the products or services they offer.
Impact-oriented venture-backed companies are disrupting industries from financial services to clean water, agriculture to climate change, education and healthcare. And, downstream, we have already seen several high-profile case studies illustrating that these disruptions can be accompanied by tremendous financial gain and performance. Tesla, Beyond Meat and PluralSight, detailed below, serve as three compelling later stage examples of how these disruptive mission-driven technologies can lead to better outcomes.
Further, as venture capital has evolved from a cottage industry to a larger and more complex vertical, institutional investors like Greenspring Associates have become more discerning over time in their approach to governance of private companies, particularly in light of the fact that external accountability can be linked to value.
T. Rowe Price comments that COVID-19 may even advance this dynamic: "In just the past few quarters, there have been some important developments involving major investors/capital providers demanding more stringent requirements from companies seeking capital funding. The onset of the coronavirus crisis in early 2020 and the subsequent economic dislocation have only accelerated this trend as private companies scramble to secure funding in the current environment."
Moreover, innovative young companies that aspire to help people and the planet also typically rate very highly on governance. In many cases, before a Greenspring manager invests, there is no governance, no board. In other words, VCs often literally put the G in ESG, with respect to the startups they fund. The oversight they provide is typically significantly more hands-on than that of public company investors or board members. Indeed, in 100% of direct deals that Greenspring Associates has invested in, one of our managers holds a board seat. The value created by a board of directors is compelling enough to give rise to a class of service providers dedicated solely to building boards, like Lodestone Global, whose 2020 Private Company Board Compensation Survey reports that 92% of surveyed companies experienced increased EBITDA since implementing a Board of Directors, in addition to promoting accountability, driving performance and extending networks.
In addition to being board members and providing financial capital, VCs help effect outcomes, investing significant human and enterprise capital, leveraging deep networks and relationships, as well as knowledge and data honed over years of investment, advisory and operating experience, to provide critical mentorship and support (e.g., identifying opportunities through pattern-matching, connecting to beta customers, helping with recruiting). This degree of partnership and integration can inherently encourage a level of transparency conducive to identifying and contributing to good governance practices.
Pandemic aside, our belief is that the opportunity set in impact in venture capital is not only large and growing, but also perhaps features an even stronger case for ESG and impact investment than in the public markets. A recent survey of 1.5 million employees of over 1,100 public and private U.S. companies found that private company employees had a significantly greater sense of “purpose” than their publicly traded counterparts, and that firms with a strong sense of purpose experience better performance. Indeed, we at Greenspring Associates took steps years ago to incorporate ESG considerations into our operational and investment processes, formalizing an ESG Policy in 2016, becoming a signatory to the UN PRI in 2018 and including ESG Questionnaires as part of our operational due diligence on underlying fund and direct investments across non-impact dedicated strategies prior to investing.
We believe that venture – almost by definition - is impactful, since the main objectives of investing in technology and healthcare are to improve productivity, standards of living and overall quality of life. A recent study by SVB, for example, shows that 42% of all new FDA-approved drugs in the U.S. originated with venture capital funding. Even independent of an impact-oriented strategy, the asset class is overwhelmingly a force for social and economic good, providing early stage funding critical to the success of today’s nascent businesses and tomorrow’s power players.
In an illustration of VC’s outsized economic influence, a study by economists at the Universities of Chicago and Pennsylvania, the US Census Bureau, and the Federal Reserve concludes that 28% of aggregate economic growth, crucial to advancing quality of life, would be lost in the absence of venture funding. Other recent studies have found that high-growth startups account for the creation of as many as 50% of gross jobs and an average of 2.9 million net jobs per year between 1980 and 2010. This is in stark contrast to the data revealed by a recent study on the economic effects of private equity buyouts: according to Eileen Appelbaum, Co-Director of the Center for Economic and Policy Research, “the finding in the current paper that employment falls 13% in buyouts of publicly-traded companies is a pretty damning statement about the job destroying effects of PE takeovers of successful companies that trade on a stock exchange. The 13% increase in employment following buyouts of privately-held companies and 10% increase following buyouts of private-equity-owned companies is likely an artifact of PE’s penchant for acquiring ‘add-on’ companies in order to grow, rather than growing organically via the expansion of employment in the original establishments of the company.”
With high returns and positive outcomes for society and the planet, an ever-shrinking public universe of companies to invest in versus a large and growing opportunity set in venture, we believe we are in the early days of a powerful trend that could culminate in venture impact becoming synonymous with venture capital investment.
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