MCKINSEY ON INVESTING - PERSPECTIVES AND RESEARCH FOR THE INVESTING INDUSTRY NUMBER 5, NOVEMBER 2019
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McKinsey on
Investing
Perspectives and research for the investing industry
Number 5, November 2019
McKinsey on Investing Editorial Board: McKinsey Practice Publications
is written by experts and Pooneh Baghai, Alejandro Beltran
practitioners in McKinsey’s global de Miguel, Onur Erzan, Martin Editor in Chief:
investor-focused practices, Huber, Duncan Kauffman, Bryce Lucia Rahilly
including our Private Equity & Klempner (lead), Hasan Muzaffar,
Principal Investors, Wealth & Asset Rob Palter, Alex Panas, Vivek Executive Editors:
Management, and Capital Projects Pandit, Mark Staples, Marcos Michael T. Borruso,
& Infrastructure Practices. Tarnowski Bill Javetski,
Mark Staples
To send comments or request Editor: Mark Staples
copies, email us: Copyright © 2019 McKinsey &
Investing@McKinsey.com. Contributing Editors: Company. All rights reserved.
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McKinsey & Company.
Managing Editors:
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Editorial Production:
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Gwyn Herbein, Pamela Norton,
Katya Petriwsky, Charmaine Rice,
John C. Sanchez, Dana Sand,
Sneha Vats, Pooja Yadav,
Belinda Yu
Contents
3 More than values: The value-based
sustainability reporting that 42 Is a leverage reckoning coming?
Not yet. Despite rising corporate-
investors want debt levels, research shows
Nonfinancial reports helped stimulate companies can cover their obligations
the growth of sustainable investing. for now. But they should prepare for
Now investors are questioning current a possible downturn by stress-testing
practices—and calling for changes their capital structure.
that executives and board members
must understand.
11 Catalyzing the growth of the
impact economy 48 Private equity opportunities in
healthcare tech
A mature impact economy would Although private equity firms have
help power economic growth been hesitant to invest in healthcare
while solving global social and tech, they have reason to invest in
environmental challenges. Here’s promising targets now.
what it will take to accelerate the
impact economy’s development.
22 Advanced analytics in asset
management: Beyond the buzz 57 How private equity can maximize
value in US financial services
Leading firms are applying advanced The industry may be on the cusp
analytics across the full asset- of a new and less forgiving era.
management value chain—and Private owners can take steps now
getting results. to get ready.
29 Pricing: The next frontier of value
creation in private equity 65 A turning point for real estate
investment management
Few private equity firms focus on As institutional investors flock to real
pricing transformations, though such estate, investment managers must
programs can create substantial avoid getting stuck in the middle of the
value. Here’s how pricing value can be market—too big to be nimble yet too
captured at any stage in the deal cycle. small to reach scale.
36 Private equity exit excellence:
Getting the story right 73 Highlights from McKinsey’s
2019 sector research
While a successful exit has many This year has seen intriguing new
elements, a clear and evidence-backed dynamics in many sectors. In this
equity story detailing an asset’s compilation, McKinsey experts break
potential may be the most important. them down. All articles and reports
Three key principles can help funds are available on McKinsey.com.
maximize exit returns.
Introduction
Welcome to the fifth volume of McKinsey on Investing, developed to share the best of our recent research
and thinking relevant to investors. Colleagues from around the world and across many disciplines—
including asset management, infrastructure, institutional investing, and private equity—collaborated to
develop these insights. We hope this combination of perspectives will provoke reflection and dialogue
and prove an insightful guide to some of the best current practice in the investment industry.
We begin with a pair of articles drawn from our latest research on responsible investing. The first piece looks
into investors’ desire for greater consistency and reliability in sustainability metrics—an urgent need as
sustainable-investment strategies swell to more than $30 trillion in assets. The second draws on interviews
with more than 100 investors and others to sketch out what a true impact economy might look like.
Four more articles offer a range of strategies for private investing. One explores how leading asset
managers are already deriving considerable benefits from advanced analytics. Another investigates pricing,
a lever that many GPs have not fully tapped. As the economic cycle winds down, exits are top of mind for
many GPs; the third article in this section offers insights into how to craft a persuasive exit narrative. And a
fourth article considers the current state of leverage across the corporate landscape.
Finally, we are pleased to offer in-depth looks at opportunities for private managers in three sectors:
European healthcare technology, US financial services, and global real estate. We close the issue with
capsule summaries of some of the most investor-relevant industry research published by McKinsey in 2019.
We hope you enjoy these articles and find in them ideas worthy of your consideration. Please let us know
what you think: you can reach us at Investing@McKinsey.com. You can also view these articles and many
others relevant to investing at McKinsey.com and in our McKinsey Insights app, available for Android and iOS.
The Editorial Board
Pooneh Baghai Duncan Kauffman Alex Panas
Alejandro Beltran de Miguel Bryce Klempner Vivek Pandit
Onur Erzan Hasan Muzaffar Mark Staples
Martin Huber Rob Palter Marcos Tarnowski
2 McKinsey on Investing Number 5, November 2019
More than values:
The value-based
sustainability reporting
that investors want
Nonfinancial reports helped stimulate the growth of sustainable
investing. Now investors are questioning current reporting
practices—and calling for changes that executives and board
members must understand.
by Sara Bernow, Jonathan Godsall, Bryce Klempner, and Charlotte Merten
© Vgajic/Getty Images
More than values: The value-based sustainability reporting that investors want 3
As evidence mounts that the financial performance findings might not surprise readers involved with
of companies corresponds to how well they sustainable investing or sustainability reporting, it
contend with environmental, social, governance was striking to learn that investors also support legal
(ESG), and other nonfinancial matters, more mandates requiring companies to issue sustainability
investors are seeking to determine whether reports (Exhibit 1). In this article, we offer executives,
executives are running their businesses with such directors, and investors a look at how sustainability
issues in mind. When companies report on ESG- reporting has evolved, what further changes
related activities, they have largely continued investors say they want, and how investors can bring
to address the diverse interests of their many about those changes.
stakeholders—a long-standing practice that
involves compiling extensive sustainability reports
and filling out stacks of questionnaires. Despite Reporting today: Focused
all that effort, a recent McKinsey survey uncovered on externalities, inconsistent,
something that should concern corporate executives yet informative
and board members: investors say they cannot The current practice of sustainability reporting
readily use companies’ sustainability disclosures to developed in the 1990s as civil-society groups,
inform investment decisions and advice accurately.¹ governments, and other constituencies called
on companies to account for their impact on nature
What’s unusual and challenging about sustainability- and on the communities where they operate. A
focused investment analysis is that companies’ milestone was passed in 2000, when the Global
sustainability disclosures needn’t conform to shared Reporting Initiative (GRI) published its first
standards in the way their financial disclosures must. sustainability-reporting guidelines. The following
Years of effort by standard-setting groups have year, the World Business Council for Sustainable
produced nearly a dozen major reporting frameworks Development and the World Resources Institute
and standards, which businesses have discretion released the Greenhouse Gas Protocol. The
to apply as they see fit (see sidebar, “A short glossary same period also saw the creation of voluntary
of sustainability-reporting terms”). Investors initiatives, such as the UN Global Compact and
must therefore reconcile corporate sustainability the Carbon Disclosure Project (now CDP),
disclosures as best they can before trying to draw encouraging corporations to disclose information
comparisons among companies. on sustainability. Since the financial crisis,
additional frameworks and standards have
Corporate executives and investors alike recognize emerged to help companies and their investors
that sustainability reporting could improve in some develop a greater understanding of the risks and
respects. One advance that executives and investors benefits of ESG and nonfinancial factors. For
strongly support, according to our survey, is reducing example, the International Integrated Reporting
the number of standards for sustainability reporting. Council (IIRC) advocates integration of financial
Many executive respondents said they believe this and nonfinancial reports, the Sustainability
would aid their efforts to manage sustainability Accounting Standards Board (SASB) identifies
impact and respond to sustainability-related trends, material sustainability factors across industries,
such as climate change and water scarcity. And many and the Embankment Project for Inclusive
investors said they expect greater standardization Capitalism assembles investors and companies to
of sustainability reports to help them allocate capital define a pragmatic set of metrics to measure and
and engage companies more effectively. While these demonstrate long-term value to financial markets.
1
For this research, we conducted a survey of 107 executives and investors, representing 50 companies, 27 asset managers, and 30 asset
owners. The survey, carried out in January and February of 2019, covered Asia, Europe, and the United States. We also conducted interviews
with 26 representatives of asset managers, asset owners, corporations, standard-setting organizations, nonprofit organizations, and
academic institutions.
4 McKinsey on Investing Number 5, November 2019
More than values: The value-based sustainability reporting that investors want
Exhibit 1 of 4
Exhibit 1
Investors and executives say that reducing the number of sustainability-reporting standards
would be beneficial—and even that there should be legal mandates for reporting.
Respondents who agree with statement,¹ %
Companies should be required by
law to issue sustainability reports
There should be fewer sustainability-
reporting standards than there are today 14
82
28
66
There should be 1 sustainability-
reporting standard 75
58
Investors Executives Investors Executives
% of investors who agree or strongly agree that more standardization % of executives who agree or strongly agree that more standardization
of sustainability reporting would enable the following actions1: of sustainability reporting would enable the following actions1:
enhance my
help my firm help my firm help my company
company’s ability
allocate capital manage risk benchmark itself
to create value
more effectively more effectively against its peers
or mitigate risk
85 83 80
68
1
Respondents who answered “agree” or “strongly agree.” For investors, n = 57; for executives, n = 50.
Source: McKinsey Sustainability Reporting Survey
Given the proliferation of reporting frameworks for increased disclosure about how companies
and standards, companies have had to decide for address opportunities and risks related to
themselves which ones to apply. These frameworks sustainability trends, such as climate change and
and standards allow businesses considerable water scarcity, which can meaningfully affect
freedom to choose their sustainability disclosures. a company’s assets, operations, and reputation.
Many companies select their disclosures by
consulting members of stakeholder groups— The scope and depth of these disclosures differ
consumers, local communities, employees, govern- considerably as a result of the subjective choices
ments, and investors, among others—about which companies make about their approaches to
externalities, or impacts, matter most to them sustainability reporting: which frameworks and
and then tallying the stakeholders’ interests in standards to follow, which stakeholders to address,
some way. More recently, stakeholders have asked and which information to make public. According
More than values: The value-based sustainability reporting that investors want 5
A short glossary of sustainability-reporting terms
In this article, we use the following can be a stand-alone document or a disclosures a sustainability report
terms for certain elements of sustain- component of the annual report. should cover. The International
ability reporting: Integrated Reporting Framework,
—— Sustainability-reporting published by the International
—— Sustainability disclosure. This requirement. This requirement is Integrated Reporting Council (IIRC),
disclosure is an item of qualitative or a mandate from an authority (such is one example.
quantitative information about as a regulator, a stock exchange,
a company’s performance on a or a civil-society group) about a —— Sustainability-reporting standard.
topic not addressed by standard sustainability report’s content and This standard is a set of specifications
financial and operational disclosures. nature. Some requirements apply to for measuring and disseminating
Sustainability disclosures ordinarily all companies in a given jurisdiction— sustainability disclosures. Examples
relate to environmental, social, and for example, Directive 2014/95/EU include the Global Reporting
governance matters, including of the European Parliament and the Initiative’s GRI Standards and the
companies’ sustainability impact and European Council, requiring some 77 industry-specific standards
responses to external sustainability large companies to issue nonfinancial published by the Sustainability
trends. These disclosures sometimes disclosures. Others, such as the Accounting Standards Board.
encompass other topics, too, such as UN Global Compact, apply only to
HR and intellectual property. companies that have voluntarily
pledged to abide by them.
—— Sustainability report. This report
is a document containing a set of —— Sustainability-reporting framework.
sustainability disclosures from an This framework is a set of guidelines
organization for a period of time. It for determining what topics and
to the executives and investors we surveyed, the trends in companies’ responses to sustainability
diversity of these disclosures is a defining feature of issues but compare and rank businesses as well.
sustainability reporting as we know it—and a source
of difficulty, as we explain in the following section of Analysts in academia, government, and the
this article. private sector have also used these sustainability
disclosures to examine the link between sustain-
Thirty-odd years of sustainability reporting have ability performance and financial performance. A
produced a trove of useful data. Stakeholders substantial body of research shows that companies
can use this information to track the relative that manage sustainability issues well achieve
sustainability performance of companies from year superior financial results.² (Research has shown
to year. By aggregating data from many companies, only that these two phenomena are correlated,
stakeholders can not only discern patterns and not that effective sustainability management leads
to better financial outcomes.)
2
Alexander Bassen, Timo Busch, and Gunnar Friede, “ESG and financial performance: Aggregated evidence from more than 2000 empirical
studies,” Journal of Sustainable Finance & Investment, 2015, Volume 5, Issue 4, pp. 210–33; Robert G. Eccles, Ioannis Ioannou, and George
Serafeim, “The impact of corporate sustainability on organizational processes and performance,” Management Science, 2014, Volume 60,
Issue 11, pp. 2835–57; Gordon L. Clark, Andreas Feiner, and Michael Viehs, From the stockholder to the stakeholder: How sustainability can
drive financial outperformance, a joint report from Arabesque and University of Oxford, March 2015, insights.arabesque.com; “Sustainability:
The future of investing,” BlackRock, February 1, 2019, blackrock.com.
6 McKinsey on Investing Number 5, November 2019
Investors and asset owners appear to be taking note From our interviews and survey results, it is
of corporate sustainability disclosures and adapting apparent that investors want companies to provide
their investment strategies accordingly. The Global more sustainability disclosures that are material
Sustainable Investment Alliance has found that to financial performance. According to a senior
the quantity of global assets managed according sustainable-investing officer at one top 20 asset
to sustainable-investment strategies more than manager, “Corporations do not provide systematic
doubled from 2012 to 2018, rising from $13.3 trillion data on one-third of the sustainability factors
to $30.7 trillion.³ BlackRock reports that assets in [that we consider] material.” This could change
sustainable mutual funds and exchange-traded funds as more companies issue reports in line with
in Europe and the United States increased by more the sector-specific standards that SASB created
than 67 percent from 2013 to 2019 and now amount in consultation with industry experts and investors.
to $760 billion.⁴ And research by Morgan Stanley
indicates that a majority of large asset owners are Government authorities and civil-society
integrating sustainability factors into their investment organizations also appear to be coming around
processes. Many of those asset owners started to do to investors’ views about the material connection
so only during the four years before the survey.⁵ between a company’s handling of sustainability
factors and its financial performance. The European
Union’s 2014 directive on nonfinancial reporting
What investors want: Financial and the Financial Stability Board’s creation of the
materiality, consistency, and reliability Task Force on Climate-related Financial Disclosures
With so much capital at stake, investors have in 2015 are two signals that financial regulators
begun to question prevailing sustainability- realize sustainability-related activities can materially
reporting practices. The shortcomings investors affect the financial standing of companies and
now highlight have existed for some time but were should be reported accordingly.
mostly acceptable to early sustainable investors
and the diverse civil-society stakeholders that Consistency
used to be the primary readers of sustainability With so many reporting frameworks and guidelines
reports. But now that more asset owners and asset to choose from and so many potential stakeholder
managers are making investment and engagement interests to address, companies rarely make
decisions with sustainability in mind, a louder sustainability disclosures that can be compared
call has gone out for sustainability disclosures that as neatly as their financial disclosures can. This
meet the following three criteria. circumstance makes the job of investors more
difficult, as they indicated in response to our survey
Financial materiality (Exhibit 2). As the head of sustainable investing at a
Investors acknowledge that their expectations for major asset manager explained, “We have positions
sustainability disclosures have shifted. As the head in over 4,500 companies. Unless [sustainability
of responsible investing at a large global pension information] is comparable, hard data, it is of little
fund remarked, “The early days of sustainable use to us.”
investing were values based: How can our investing
live up to our values? Now, it is value based: How Inconsistencies among sustainability disclosures,
does sustainability add value to our investments?” which arise through no fault of the companies
producing them, can also create problems for the
3
Global Sustainable Investment Review 2012 and Global Sustainable Investment Review 2018, Global Sustainable Investment Alliance,
gsi-alliance.org.
4
“Sustainability: The future of investing,” BlackRock, February 1, 2019, blackrock.com.
5
“Sustainable signals: Asset owners embrace sustainability,” Morgan Stanley, June 18, 2018, morganstanley.com.
More than values: The value-based sustainability reporting that investors want 7
many investors that obtain sustainability data companies do not have the systems in place to collect
from third-party services rather than individual quality data for [sustainability] reporting.” For certain
sustainability reports. These services use different tangible sustainability factors, such as greenhouse-
methods to estimate missing information, so there gas emissions, performance-measurement systems
are discrepancies among data sets. Some services are generally well established. For other factors, such
normalize sustainability information, replacing as corporate culture, human capital, and diversity
actual performance data (such as measurements and inclusion, clear ways to gauge performance are
of greenhouse-gas emissions) with performance more elusive.
scores calculated by methods the services don’t
reveal. Research shows a low level of correlation Investors also harbor doubts about corporate
among the data providers’ ratings of performance sustainability disclosures because few of them
on the same sustainability factor.⁶ undergo third-party audits. Nearly all the investors
we surveyed—97 percent—said that sustainability
Similarly, proprietary indexes and rankings of disclosures should be audited in some way, and
sustainable companies, which some asset managers 67 percent said that sustainability audits should be
use to construct index-fund portfolios, can also as rigorous as financial audits (Exhibit 3).
diverge greatly. It is not unusual for a company to
be rated a top sustainability performer by one index
and a poor performer by another.⁷ And some data Refining the practice of
services fail to include sustainability data companies sustainability reporting
have disclosed.⁸ In our survey and interviews, one priority for
improving sustainability reporting stood out: ironing
Reliability out the differences among reporting frameworks
As the head of responsible investing for one of the and standards. When we asked survey respondents
world’s five largest pension funds put it, “Many to assess the challenges of sustainability reporting,
GES 2019
More than values: The value-based sustainability reporting that investors want
Exhibit 2 of 4 6
Gregor Dorfleitner, Gerhard Halbritter, and Mai Nguyen, “Measuring the level and risk of corporate responsibility—an empirical comparison of
different ESG rating approaches,” Journal of Asset Management, 2015, Volume 16, Issue 7, pp. 450–66. The correlation between ratings of the
same performance factor is typically less than 0.6 and can fall to as low as 0.05. By comparison, credit ratings are highly correlated (0.9).
7
James Mackintosh, “Is Tesla or Exxon more sustainable? It depends whom you ask,” Wall Street Journal, September 17, 2018, wsj.com.
8
“Sustainability: The future of investing,” BlackRock, February 1, 2019, blackrock.com.
Exhibit 2
Investors report that the main shortcomings of current sustainability-reporting practices are
inconsistency, incomparability, and lack of alignment in standards.
Top challenges associated with current sustainability-reporting practices,1 mean rating on 1–5 scale, where 5 is
most challenging
Inconsistency, incomparability,
or lack of alignment in standards 3.47
Too costly or time intensive 3.33
Unclear benefits or value added 3.11
0 1 2 3 4 5
1
n = 57.
Source: McKinsey Sustainability Reporting Survey
8 McKinsey on Investing Number 5, November 2019executives and investors both rated “inconsistency, Most of the investors we surveyed—63 percent—
incomparability, or lack of alignment in standards” also said they believe that greater standardization
as the most significant challenge. A majority of will attract more capital to sustainable-investment
respondents to our survey—67 percent—said there strategies. However, about one-fifth of the surveyed
should be only one standard, and an additional investors said that uniform reporting standards
21 percent said there should be fewer than exist now. would level the playing field, diminishing their
opportunities to develop proprietary research
The investors and executives who participated insights or investment products (Exhibit 4).
in our research also described several benefits
of making reporting frameworks and standards Executives made clear, in our conversations,
more uniform. Investors expect greater uniformity that they devote excessive effort and expense
to help companies disclose more consistent, to answering numerous specialized requests
financially material data, thereby enabling for what is essentially the same information, such
investors to save time on research and analysis as greenhouse-gas emissions data that must
GESto2019
and arrive at better investment decisions. be tabulated in different ways to conform to
More than values:
Some efficiency The value-based
gains would accrue as third-party different standards.
sustainability reporting
data providers begin aggregating thatsustainability
investors
want
information as consistent as the information they This kind of burden would be lessened if the
Exhibit
get 3 of 4 financial statements.
from corporate providers of reporting frameworks and standards
combined or rationalized their rules and thereby
reduced the number of major frameworks and
Exhibit 3
standards to one or two. Companies could then use
More investors believe that sustain- the same disclosures to fulfill the reporting demands
of multiple authorities. (They could still develop
ability reports should be audited and
additional sustainability disclosures if they chose to
that the audits should be full audits, address stakeholder queries or concerns that the
similar to financial ones. main mechanism didn’t cover.) Establishing one or
Respondents who agree with statement,¹ % two reporting standards would also simplify the task
of auditing sustainability disclosures, making it more
Sustainability reports Sustainability reports economical for companies to have their reports
should undergo some audit should undergo full audit,
similar to a financial audit independently verified.
97
88
How investors can help effect change
Reducing the number of reporting frameworks
67 and standards will probably involve several more
years of effort by businesses, investors, and
standard-setting organizations—which have
begun to identify gaps and redundancies among
disclosures—and by other stakeholders, such as
36
civil-society groups and regulators. As it is, many
investors avoid participating in standard-setting
efforts. Some we interviewed said they distance
themselves because they feel that standard setting
should address their needs as a matter of course.
Investors Executives Investors Executives Yet some standard setters told us they assume
1
Respondents who answered “agree” or “strongly agree.” For
that investors can readily obtain the sustainability
investors, n = 57; for executives, n = 50. information they value and therefore focus on the
Source: McKinsey Sustainability Reporting Survey interests of other stakeholders.
More than values: The value-based sustainability reporting that investors want 9More than values: The value-based sustainability reporting that investors want
Exhibit 4 of 4
Exhibit 4
Many investors believe that harmonized sustainability-reporting standards will attract more
capital to sustainable investors, though some express concern about losing an edge.
Investors who agree with statement about effect of harmonized standards, % of respondents1
Will weaken proprietary Will have
Will help attract more capital insights or specialized both effects
to sustainable investments or differentiated products described
63 19 15
100
Note: Figures may not sum to 100%, because of rounding.
1
Respondents who answered “agree” or “strongly agree”; n = 57.
Source: McKinsey Sustainability Reporting Survey
Our conversations lead us to believe that there’s and disclosures. Some investors have developed
some truth to both viewpoints. Yet our survey findings algorithms that automatically gather nonfinancial
and interviews also suggest that investors could data from public sources (such as government
make valuable contributions to standard-setting databases of health and safety incidents or websites
efforts if they chose to increase their participation. where people post comments about their employers)
Active investors are likelier to do so, since they and scan these data for patterns that relate
pay more attention than index investors to the meaningfully to corporate financial performance.
sustainability disclosures of individual companies.
Until investors clarify which sustainability disclosures
they want and help to rationalize frameworks and
standards, sustainability reports might continue to As the market for sustainable investments expands,
deliver less material information than they would like. more investors are taking a keen interest in
sustainability reports from companies. Yet the
Investors can do several other things to make information these investors find seldom meets
better use of the sustainability-related information their expectations. From an investor’s standpoint,
companies now make available. First, they can sustainability disclosures tend to be loosely related
articulate the sustainability disclosures that matter to financial performance, difficult to compare
most for their investment decisions and convey from one company to another, and less than reliable.
these interests to businesses. Going a step further, Investors who take part in efforts to improve
more investors could engage companies (through sustainability-reporting practices could gain an
direct dialogue and shareholder voting) about their edge over their more detached peers. Executives
approach to managing sustainability issues. and board members should stay attuned to these
efforts, and even participate in them, to maintain
More investors could also adopt the still-uncommon their companies’ standing with shareholders.
practice of collecting and analyzing data from
sources other than corporate sustainability reports
Sara Bernow is a partner in McKinsey’s Stockholm office, where Charlotte Merten is a consultant; Jonathan Godsall is a
partner in the New York office; and Bryce Klempner is a partner in the Boston office.
The authors wish to thank Lisen Follin, Conor Kehoe, and Taylor Ray for their contributions to this article.
Copyright © 2019 McKinsey & Company. All rights reserved.
10 McKinsey on Investing Number 5, November 2019Catalyzing the growth
of the impact economy
A mature impact economy would help power economic growth while
solving global social and environmental challenges. Here’s what it will
take to accelerate the impact economy’s development.
by David Fine, Hugo Hickson, Vivek Pandit, and Philip Tuinenburg
© d3sign/Getty Images
Catalyzing the growth of the impact economy 11Since the term “impact investment” was introduced that various impact-economy constituencies—
in 2007, the field of impact investing has grown and investors, asset managers, entrepreneurs,
diversified in notable ways. Impact-fund managers governments, and philanthropists foremost among
have amassed record sums, continuing a trend that them—would play in a mature impact economy.
can be traced back at least five years. Funds have Finally, we present three potential developments that
streamed money to impact investments from a would enable the impact economy to mature fully:
variety of sources, and asset managers are making
more investments outside the sectors that formerly —— instituting public policies that provide incentives
attracted the lion’s share of capital. Researchers and disincentives and create certainty
have engineered novel ways of tracking and reporting
impact, giving investors greater confidence that —— achieving a broad commitment to mutually
their money is producing social benefits and helping reinforcing operational, measurement, and
entrepreneurs make more effective decisions about reporting norms for fund managers, social entre-
their strategies and business models. preneurs, and impact-economy intermediaries
—— creating an industry body that promotes
Amid these encouraging developments, it is
policies and standards of excellence and moves
possible to define a sharper vision for a healthy,
all participants to adopt them
mature impact economy that involves a wider range
of actors and institutions than today’s impact- These changes would enable and encourage
investing industry. In an impact economy, the stakeholders to reset some of capitalism’s
norms—practices, policies, and standards—that assumptions and rules so that two goals receive
are attached to the pursuit of social impact would equal priority: powering economic growth and
be as widely accepted, consistent, and stable as wealth creation while also solving global social and
the norms that are associated with the pursuit environmental challenges.
of profit. Encouraged by the added measure of
certainty and transparency surrounding their
activities, investors large and small would allocate Envisioning a mature impact economy
more capital to the financing of social initiatives, Although some of the ideas and practices that
and entrepreneurs would devise business models are fundamental to impact investment and social
whose ambition and growth potential match entrepreneurship originated decades ago, it was
investor and market demand. Consumers would in 2007 that a group of foundations and investors
direct greater shares of their spending to social convened by the Rockefeller Foundation originated
enterprises, thereby spurring large mainstream the term “impact investing,” which was later
companies to measure and pursue impact. Overall, defined as “investments intended to create positive
the impact economy would achieve breakthrough impact beyond financial return.”¹ (Others have
increases in scale and productivity, with capital proposed varying definitions of impact investment,
delivering higher risk-adjusted levels of social although we do not seek to join that debate.²)
impact than we now see in many cases. Extending the idea at the heart of that definition—
the creation of social or environmental impact in
In this article, which incorporates findings from our addition to financial return—to all other economic
in-depth interviews with more than 100 investors, activities makes it possible to define an impact
fund managers, social entrepreneurs, and other economy as a system in which institutions and
impact-economy stakeholders, we consider what it individuals give equal priority to social impact and
will take for the impact economy to reach maturity. financial impact when making decisions about how
We begin by exploring the vision for the impact to allocate resources.
economy outlined above. We then look at the roles
1
argot Brandenburg, Antony Bugg-Levine, Christina Leijonhufvud, Nick O’Donohoe, and Yasemin Saltuk, “Impact investments: An emerging
M
asset class,” JPMorgan Chase, the Rockefeller Foundation, and Global Impact Investing Network, November 29, 2010, jpmorganchase.com.
² For example, the Global Impact Investing Network defines impact investments as “investments made into companies, organizations, and funds
with the intention to generate social and environmental impact alongside a financial return.” American Development Bank, 2017, publications
.iadb.org.
12 McKinsey on Investing Number 5, November 2019An impact economy is thus a very different kind Investment deployment
of system from a traditional capitalist economy The past few years have seen capital flow into
that prioritizes only financial returns. In an impact impact investments from a wide variety of sources
economy, consumers and shareholders will (Exhibit 1). Overall, impact fund managers have
challenge entrepreneurs and executives to show amassed record quantities of assets under
that they generate their profits in a manner that management: more than $228 billion, according
contributes to the public good. This approach to one estimate.³ Yet even this amount of money
to doing business is already being enacted by is small compared with the annual capital outlay—
some organizations on several levels—in making estimated at $1.4 trillion to $2.5 trillion of additional
strategic choices, in managing their supply chains, spending—required to achieve the Sustainable
in allocating funds to investments—and by some Development Goals (SDGs) set forth by the United
municipal authorities. But we have yet to see it Nations by 2030. To close the gap, asset owners
embraced comprehensively by entire industries or and fund managers will need to adopt investment
national economies. As such, we determined the strategies that put still more emphasis on positive
social outcomes, rather than strategies that merely
McK on Investingmajor
2019 dimensions of a full-fledged impact economy
to be investment deployment, asset management, seek to minimize or prevent negative outcomes.
Catalyzing the growth
delivery of solutions, and measurement and reporting.
Exhibit 1 of 4
³ Rachel Bass, Hannah Dithrich, and Abhilash Mudaliar, Annual impact investor survey 2018, Global Impact Investing Network, June 2018,
thegiin.org.
Exhibit 1
Capital flows into impact investments from a variety of sources.
Impact investing assets under management by investment source,¹ % of total
6
5
20
3
Pension funds and
insurance companies
5 Family offices and
8 22
high-net-worth individuals
15 6 Development-finance
institutions
2014, $46 billion 2018, $228 billion
Banks and diversified
17 financial institutions
16
Retail investors
17 12
Foundations
48 Others2
¹ Assets under management reported as of beginning of year. Figures combine direct investments into companies, projects, or real assets and indirect investments made
through intermediaries such as fund managers. Data are based on the Global Impact Investing Network’s annual investor surveys and not intended to be exhaustive.
² Includes funds of funds, sovereign-wealth funds, and others.
Source: Global Impact Investing Network; McKinsey analysis
Catalyzing the growth of the impact economy 13Investment trends appear to be moving in that with a correspondingly diverse variety of ambitions.
direction. Based on surveys showing that a The past few years have seen a trend in this direction,
substantial number of investors, including “main- as asset managers have directed an increasing
stream” investors, are seeking impact-investment proportion of investments beyond the financial-
products, there may be significant latent demand services and microfinance sectors (Exhibit 2).
for impact investments. In a mature impact
economy, then, we would expect to see more asset We would argue that a mature impact economy will
owners prioritizing the financing of solutions to also be characterized by a wide variety in the types
environmental and social challenges, and a major of investment instruments that asset managers offer
increase in commitments of capital to impact- clients. Impact-investing assets under management
seeking investment vehicles. are more evenly spread among different types of
investment instruments than they were just three
Asset management years ago, with private placements of debt and
Considering that the 17 SDGs address a wide range equity making up a considerably smaller share of the
McK on Investingof2019
issues—from human-development challenges market (Exhibit 3).
Catalyzing the growth
such as poverty, health, and gender equality to
Exhibit 2 of 4 environmental concerns such as climate change and Delivery of solutions
water scarcity—asset managers in a mature impact A mature impact economy would feature a
economy might be expected to back enterprises market-clearing quantity of solutions to social
Exhibit 2
Impact investors are broadening into sectors beyond financial services and microfinance.
Impact investing assets under management by investment sector,¹ % of total
4
4
5 19
Financial services²
1 6
Microfinance
6 3
21 Other³
8
Energy
8 9
8 Housing
2014, $46 billion 2018, $228 billion
Food and agriculture
11 21
Healthcare
Education
21
14 Water, sanitation,
and hygiene
31
¹ Assets under management reported as of beginning of year. Data are based on the Global Impact Investing Network’s annual investor surveys and not intended to be
exhaustive.
² Other than microfinance.
³ Includes arts and culture, conservation, information and communication technologies, manufacturing, and others.
Source: Global Impact Investing Network; McKinsey analysis
14 McKinsey on Investing Number 5, November 2019and environmental challenges. In other words, impact investors and social enterprises, more
impact enterprises would crop up to address than 80 percent of social enterprises have annual
environmental or social challenges that might be revenues of less than £1 million.
profitably addressed, although there will remain
a large set of such challenges that cannot be In addition, the “buy side” of the “market” for social
solved with for-profit models. Moreover, these impact remains underdeveloped. Consumers are
social enterprises would be no more likely to go increasingly aware of the social and environmental
unfunded than enterprises that measure their impact of businesses, and more consumers have
returns strictly in terms of profit (see sidebar, “A stated a preference for goods and services that
glimpse into the future of the impact economy”). help make a positive impact. This preference has
This is not the situation today. Impact-focused become prevalent enough that companies can no
McK on Investingenterprises
2019 have proliferated, and many of them longer afford to ignore it. Indeed, we are seeing large
operate on a modest scale, solving a particular
Catalyzing the growth companies make greater efforts to align their market
Exhibit 3 of 4 problem in a single locale or a small number strategies with their customers’ social compass,
of locales. In the United Kingdom, for example, while new enterprises are emerging that have social
which has a relatively well-developed cohort of impact built into their business models.
Exhibit 3
While various investment instruments are in use, government pay-for-performance services
remain underdeveloped.
Impact investing assets under management by type of instrument,¹ % of total
0.3
14
0.3
6
3
9 Private debt
41
11 Private equity
Other²
2014, $46 billion 2018, $141 billion⁴
53 Public debt
24 Public equity
21 Pay for performance³
18
¹ Assets under management reported as of beginning of year. Data are based on the Global Impact Investing Network’s annual investor surveys and not intended to be
exhaustive. Figures may not sum, due to rounding.
² Including real assets, guarantees, and leases.
³ Outcome-based contracts, such as social-impact bonds, that pay investors when enterprises achieve preagreed social outcomes.
⁴ The 2018 total given here differs from the 2018 total given in Exhibits 1 and 2 of this article because it excludes the particularly large pools of capital managed by two
respondents to the Global Impact Investing Network survey.
Source: Global Impact Investing Network; Social Finance; McKinsey analysis
Catalyzing the growth of the impact economy 15A glimpse into the future of the impact economy
Even when social entrepreneurs can are low. (Some loans have a minimum of these revenue-based mezzanine loans
show potential investors that their monthly payment; enterprises can and other quasi-debt instruments. The
companies have good prospects of reduce the principal they owe by paying fund invested in seven small and medium-
achieving profitability, they sometimes more than the minimum.) The loan also size impact businesses in the healthcare,
have difficulty raising funds if they includes an equity-conversion option at education, low-income-housing, and
cannot offer a clear exit strategy. Adobe a predefined multiple. The convertible alternative-energy sectors. One of these
Capital, an impact-investment company amount decreases as the principal is businesses, NatGas, converts vehicles to
focused on small Mexican companies repaid, which allows the founder to engines that run on gasoline and natural
with strong growth potential, developed retain more equity. And if the enterprise gas and operates compressed-natural-gas
a new financing structure for early-stage surpasses expectations and chooses filling stations. It also offers a financing
enterprises that have begun to generate to prepay the loan at the fixed multiple, program that helps its customers, mostly
revenue: a revenue-based mezzanine loan the investment’s internal rate of return taxi and bus drivers with unstable incomes,
with flexible schedules and a repayment (IRR) increases. An underperforming to make smaller up-front investments.
grace period. enterprise can still produce an IRR of ASMF I made an 18 million peso investment
20 percent in US dollars. in 2014. The company achieved profitability
Because the payments are revenue- that year and saw its revenues grow through
based, the peso-denominated loan Adobe Capital launched its $20 million 2016. In 2017, ASMF I exited NatGas,
allows an enterprise to avoid large loan Adobe Social Mezzanine Fund I (ASMF I) realizing a 22 percent IRR and a 1.5 multiple
payments during periods when revenues in 2012 to make investments in the form of the original investment.¹
1
ndrea Armeni and Miguel Ferreyra de Bone, Innovations in financing structures for impact enterprises: Spotlight on Latin America, Inter-American Development Bank, 2017,
A
publications.iadb.org.
At the institutional level, though, there is only and reporting social and environmental impact, which
modest demand for what social enterprises can would help to quantify the value of social outcomes,
provide. Social enterprises are not yet widely support accurate tracking of progress toward the
recognized as potential bidders for public tenders SDGs, and create the transparency that stakeholders
or as partners for large companies, and government need to make effective resource-allocation decisions.
pay-for-performance schemes (outcome-based Such standards would represent the impact-
contracts such as social-impact bonds) have economy equivalent of the Generally Accepted
limited uptake. In a mature impact economy, where Accounting Principles to which US companies
social enterprises will come to be seen as reliable adhere, or the International Financial Reporting
producers of social goods, we might expect such Standards used in many countries across the world.
pay-for-performance schemes to account for more (It is worth noting that even for financial accounting
of the impact-investing market. and reporting, there are still multiple sets of standards
in use.) Impact-economy standards would ideally
Measurement and reporting supersede or harmonize existing frameworks, such
A mature impact economy would operate according as the Impact Reporting and Investment Standards
to generally accepted sets of standards for measuring (IRIS) and Social Return on Investment (SROI).
16 McKinsey on Investing Number 5, November 2019It is reasonable to expect that even in a mature social and environmental performance that
impact economy some enterprises and investors will consistently exceeds industry benchmarks.
choose to define their impact goals in unique ways
that don’t conform to generally accepted standards Social entrepreneurs would undergo a radical
and track their performance against those goals. change in composition: away from the private-
Such idiosyncratic approaches, however, will likely sector stars whom many investors and fund
become much less prevalent than they are today managers now hope to attract into executive roles,
and occur only in contexts where generally accepted and toward proven “public-sector champions.”
standards can’t be applied easily. These are seasoned government officials and civil
servants who have firsthand experience dealing with
environmental and social problems that are rooted
Redefining the roles of impact- in market failures and therefore resistant to market-
economy stakeholders based solutions. As executives and managers at
Transitioning to a mature impact economy will social enterprises, these public-sector champions
involve significant changes in the ways that its not only commit to developing their own skills as
various constituencies, or stakeholders, conduct leaders, they also assemble capable teams to pursue
their business. Governments, for example, would major opportunities for both revenue and impact,
pay for social outcomes that have been measured tapping into an expanding pool of millennials who are
and verified, instead of paying service providers interested in impact-economy careers.
to do work that may or may not have the sought-
after impact. Some stakeholders will find that Governments would make a significant change
a mature impact economy no longer requires them to their operating model that sees them partner
to perform the same functions they performed actively with private-sector organizations to deliver
when the impact economy was less developed, and social outcomes. Amid rising costs (government
so they will take on different roles (Exhibit 4). spending is more than one-third of global GDP)
and strained budgets (the global public-sector
Asset allocators, such as foundations and pension deficit is nearly $4 trillion a year), governments’
funds, would gradually progress from screening long-standing approach to financing and
companies or sectors out of their portfolios implementing public services appears increasingly
depending on whether they fail to meet specific unsustainable. In a mature impact economy,
thresholds for social or environmental performance governments would work with other stakeholders
(a “no negatives” requirement) and toward actively to produce social outcomes that governments
targeting companies that intend to help solve lack the capacity to deliver and to boost the
social and environmental challenges (a “positive” productivity of public spending on core services.
or “positive offset” requirement). This approach would require policy makers and civil
servants to first adopt the mind-set that private-
Fund managers, responding to the needs and sector collaboration offers a means of increasing
expectations of asset allocators, would devote less governments’ effectiveness. Governments will
time and effort to seeding and nurturing early- also need the ingenuity to finance the delivery of
stage impact models and more time to financing social outcomes in a way that aligns the interests
the expansion of organizations with large-scale of private investors and enterprises with the
impact potential. Some fund managers would interests of citizens. That will mean reassigning
also consider financing carve-outs and major their most talented and creative people to engineer
transformations of organizations that can have a governments’ collaborations with the private sector.
disproportionate impact on social or environmental
opportunities. For fund managers, the ability to Just as important, governments would enact public
help impact enterprises scale up their activities policies that favor the continued development of
to a significant degree would become an enduring the impact economy by providing incentives and
source of what might be called “impact alpha”— reducing uncertainty for investors, entrepreneurs,
Catalyzing the growth of the impact economy 17Catalyzing the growth
Exhibit 4 of 4
Exhibit 4
Each stakeholder’s part will change as the impact economy matures.
Stakeholders by
level of maturity Seedling Burgeoning Mature
Asset allocators Major allocators adopt screening Allocators of all sizes apply “no Broad targeting and support of impact
requirements negatives” requirements at minimum enterprises
Fund managers Narrow range of investment Wider array of investment Comprehensive array of institutional
products for institutional clients, products, including some retail and retail products; sophisticated
targeting relatively few sectors offerings; broader sector coverage financing models
Social Small-scale enterprises with Large- and small-scale enterprises Numerous large social enterprises
entrepreneurs limited public profiles with greater visibility with strong reputations and
experienced leaders
Governments Desire to learn from other countries Substantial reliance on pay-for- Policies that incentivize the continuous
and to introduce pilot programs performance schemes; increased development of impact economy
supporting the impact economy support of social enterprises
Social-sector Small-scale efforts to seed and Greater investment in R&D to Consistent generation of ideas for
organizations launch enterprises according to drive business innovation and talent large-scale enterprises; endowments
proven models acquisition are invested for impact
Intermediaries Primary function is defining and Major functions include convening Independent rating agencies and
explaining “rules of the road” stakeholders and promoting professional-certification bodies
knowledge exchange create transparency and establish
economy-wide norms
Consumers
Participation largely limited to Closer alignment of stated Impact-oriented purchasing is
communication and dialogue; preferences and spending patterns a mainstream practice; active
some spending directed toward signals the narrowing of the attitude- engagement with companies regarding
social enterprises behavior gap key causes
Media and analysts Intermittent coverage that treats Serious coverage of impact High-profile coverage of impact
impact enterprises as curiosities economy featured frequently in economy, on par with coverage of
business press traditional businesses
18 McKinsey on Investing Number 5, November 2019and other stakeholders about the viability of the activity further, intermediaries might develop and
social sector. For example, the National Institution administer professional-certification programs
for Transforming India (also known as NITI Aayog), for fund managers and other impact-economy
a think-tank-style branch of India’s government, participants, thereby acting as gatekeepers for the
has mapped the activities of various government impact economy.
ministries against the SDGs and tracks the social
outcomes they produce. Consumers would shift out of their relatively passive
roles, in which they have weak affiliations with
Social-sector organizations would pursue fewer organizations that support progress toward positive
innovations in cost containment and excellence in environmental and social outcomes, and adopt
donor management, and more innovations in scaling patterns of actively consuming goods and services
and excellence in outcomes. This would represent from social enterprises and sustainable brands. This
a significant shift away from the risk-averse mode shift would represent the closure of the so-called
in which many social-sector organizations now attitude-behavior gap that separates consumers’
operate, by which they adhere to such practices as stated preferences from their spending habits.
keeping employees’ salaries low to avoid criticism Consumers would also help drive the development of
for excessive spending on administrative activities. an impact economy by engaging in local communities
Instead, social-sector organizations in an impact and political systems and expressing their views
economy would increase their spending in research directly to institutions through traditional media,
and development or use part of their long-term social media, and other channels.
endowment to make impact investments. These
approaches would embolden impact investors and Media organizations and analysts would take
social entrepreneurs to invest more in their own a more sophisticated approach to appraising
institutional capabilities and people. and documenting the impact economy and its
stakeholders. As the impact economy matures,
Intermediaries would move beyond merely media organizations would have less need to publish
explaining how to use various impact measures stories about the market distortions caused by
and instead compile and publish impact ratings in traditional capitalism and could offer more stories
a new role as independent rating agencies. This about the positive outcomes produced by social
activity would create greater transparency across enterprises and sustainability-focused enterprises.
the impact economy and reinforce demand for Top-tier media outlets would offer serious and
consistent, reliable ratings among asset allocators, high-profile coverage of the impact economy, as
investors, impact organizations, and policy makers. they do for the rest of the business world—think of
Highly rated agencies would be rewarded for an “Impact 500” business ranking that commands
their work and interventions, such that they would as much attention as annual rankings of the
receive more or lower-cost funds. Taking this largest companies, wealthiest individuals, and
Some stakeholders will find that
a mature impact economy no longer
requires them to perform the same
functions they performed when the
impact economy was less developed, and
so they will take on different roles.
Catalyzing the growth of the impact economy 19You can also read
