Here’s how some buyout bosses want to rejig their industry to meet public demands for a kinder form of capitalism.

Step one is to cut out all that focus on filthy lucre, fundraising and stratospheric pay cheques. No more conspicuous excess or Babylonian birthday parties. Then start focusing on more socially acceptable outcomes such as higher employment or more environmentally-friendly production.

Sounds likely? Well, who knows, but it is a message that has been broadcast by some grand old industry figures. Both the US buyout veteran Carl Thoma and Guy Hands of Terra Firma have mused about the possibility of private equity firms making such socially-aware investments, even floating the heretical idea of trading off lower financial returns for social impact.

“Some pension funds might rather have a 13 per cent return than 14 per cent if they know this one that earned 13 per cent has created 10,000 more jobs,” Mr Thoma suggested recently. “Especially in their home state if they’re representing one.”

Of course, one cannot be sure either really thought through the implications. Quite possibly the real message was aimed elsewhere. Private equity has come under mounting political pressure over some of its financial tactics.

Buyout firms have been called “vampires” by politicians such as the US Democratic presidential candidate Elizabeth Warren. Meanwhile, Mr Hands has faced criticism over his involvement in the financial difficulties of one of Britain’s largest chains of care homes. It does no harm to hint at a softer, cuddlier side.

Whatever Mr Thoma and Mr Hands intended, their words raise important questions about social-impact investing. The business of “doing well by doing good” has mushroomed, and now accounts for some $500bn of assets, according to the Global Impact Investing Network. Yet it remains very hard to pin down how to measure that elusive non-financial benefit. How do social impact investors know they have achieved their goal?

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The answer many funds give is that they measure all the outcomes. This can involve totting-up mechanisms of steampunk-like complexity, such as that championed by Rise, a $2bn social impact fund created by the buyout firm TPG with Bono, the Irish rock star. Its system, known as “impact multiple of money”, involves assessing both the scale of product or service produced by the investment and valuing the consequential social or environmental outcome in dollar terms. This is then divided by the cash value of the investment. Rise aims to produce an IMM of at least $2.50 for each $1 it spends.

Now you can raise plenty of quibbles about this method. The number might be miscalculated, leading to misallocation of capital. There can be no certainty about its veracity: it’s not a real cash number.

Then there is a second concern, which has to do with the amount of difference you are actually making with your investment. Imagine a deal that has bags of “IMM”, but which also generates a high enough financial return to attract socially-neutral investors. The IMM is therefore going to be generated regardless of whether you, the “impact investor”, do this deal.

This is the concept known as “additionality”. The simplest way to avoid redundant investing is to accept up front that there is a trade-off. But that means accepting sub-market returns (which is what Mr Thoma and Mr Hands actually suggest).

One-third of self-identifying impact investors say they are prepared to do this. But the majority find it hard to accept, or it conflicts with their fiduciary responsibility.

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The fallback position then is to focus on “intentionality” and measurement. Principles issued last year by the International Finance Corporation look less at how impact is measured or whether the deal is additional. They claim it is enough to have the intention to generate impact in the first place, and a system for assessing the consequential benefit.

Impact investing is trying to reinvent capitalism by measuring two bottom lines at the same time. At an early stage in such a complicated experiment, it is perhaps unrealistic to expect fully formed rules and answers.

But the emotional and political rush of good intentions must not obscure hard questions. It would be very convenient if there was no trade-off between financial return and social impact. That would create an incentive to “social wash”, and could leave us believing we are doing more good than we actually are.

When students recently demanded that an Oxford college divested its investments in oil stocks to salve their environmental consciences, the request was rejected. The bursar did however offer to “arrange for the gas central heating in college to be switched off with immediate effect” if they wanted to help the planet. “Please let me know if you support this proposal,” he said. The heating remains on.

This seems to hold a lesson for social impact investing. If you want to really make a difference, there is a cost.



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