First Quarter Update 2024
Welcome to our Q1 2024 report. As an organization committed to Environmental, Social, and Governance (ESG) principles, we extend our gratitude to both our continuing client relationships and our new clients. Your dedication to conducting business with a conscience is the cornerstone of our mutual success. We remain dedicated to supporting responsible businesses - helping them create enterprise value while protecting their purpose, mission, and core values – through capital raising, ownership transition, and/or strategic acquisitions. Those who share our vision of responsible and conscious business and those who are interested in doing the right things for all stakeholders continue to inspire us and the work we do.
As of the first quarter ending March 2024, economic sentiments and highlights indicate an increasingly optimistic outlook, both domestically and globally. According to the latest McKinsey Global Survey, confidence in the domestic and global economies has significantly improved since the end of 2023. This increase in optimism is attributed to more favorable views on economic conditions across various regions, despite persistent concerns about geopolitical instability and the impact of political transitions, particularly with the numerous national elections occurring in 2024 (McKinsey & Company).
Additionally, a statement from the National Economic Advisor, Lael Brainard, highlighted the increase in consumer sentiment, rising nearly 30% over the last four months, the fastest growth in this metric for some time. This reflects a turning point in consumer confidence, potentially signaling stronger consumer spending and economic activity ahead (The White House).
Overall, the first quarter of 2024 reflects a shift towards a more hopeful economic outlook, driven by improved corporate and consumer sentiment.
In February, the EPOCH team took part as judges in the annual Fowler Center for Business as an Agent of World Benefit Impact Investment Competition. We enjoyed seeing the creative approaches of both the graduate and undergraduate students to creating impact investment solutions for societal challenges and we look forward to participating again in the future. A special thanks to the Fowler Center for hosting the competition.
In this edition of our quarterly newsletter, we highlight deal flow, valuation metrics, and market performance for 1Q24. We also share news we found interesting from the quarter.
Market Analysis
In 1Q24, the lower middle market (<$500 million) experienced a decline in deal volume, with private equity deals decreasing from 1,936 in 1Q23 to 1,352 in 1Q24, a 30.2% reduction. This trend, as reported by Pitchbook, was influenced by a decrease in sponsor-to-sponsor exits, as high debt costs and lower-than-desired enterprise values persisted. However, corporations with strong balance sheets and the ability to raise capital through alternatives such as bond issuances remained active. When interest rate pressures subside, historically, M&A deal flow increases and valuation multiples rise. Therefore, as interest rates decline, we expect to see deal flow increase.
The above index comparison includes the following indices:
(1) JUST 100 – Just Capital’s evaluation of the Russell 1000 companies across 20 core issues, 236 underlying data points, and five stakeholders: workers, communities, shareholders & governance, customers, and the environment,
(2) Fortune Change the World - companies selected by its reporters and editors that embrace corporate purpose and recognize how it can add value to business and society and turn a profit,
(3) Firms of Endearment – companies highlighted in Raj Sisodia’s book of the same name who seek to maximize their value to society as a whole, all their stakeholders and create emotional, experiential, social and financial value; and
(4) S&P 500
These three indices are rooted in the belief that when companies act responsibly for all stakeholders and align their operations with their values for a greater benefit, they can create financial value without sacrificing profit. At EPOCH, we believe responsible companies seeking to do the right thing are more resilient and therefore fare better than those focused solely on the bottom line. In 1Q24, the Firms of Endearment index pulled ahead of each of the other three indexes in our quarter-over-quarter analysis. Notably, Amazon and Chipotle Mexican Grills, part of the Firms of Endearment index, saw the highest gains quarter-over-quarter, exceeding 100%. Our four tracked indices grew an average of 41% quarter-over-quarter. Market gains were in part due to investors anticipating rate cuts from the fed prior to mid-2024 but this sentiment has waned. In addition, Artificial Intelligence drove returns upward as more companies invested in AI tools and AI use cases expanded.
The year 2023 experienced a large reduction in the amount of capital raised for impact investing worldwide, declining from $150 billion in 2022 to $44 billion in 2023. Real assets, previously a dominant strategy, experienced the steepest decline, decreasing from $99 billion to $13 billion, or -86%. Conversely, private equity emerged as the leading strategy in impact capital fundraising, increasing its share from 22% in 2022 to 38% in 2023. The trend over the last decade has shown substantial growth in impact investing, with capital raised increasing from $37.8 billion in 2013 to $150 billion in 2022, according to Pitchbook. 2023 saw the second lowest level of impact capital raised in the past decade, with the lowest being in 2013. After a multi-year period of significant capital inflows for funds and companies, investors slowed their pace of deployment into illiquid assets as they evaluated the changing macroeconomic environment.
Assets Under Management (AUM) for impact investing as of June 30, 2023 were at almost $1.0 trillion USD which is very near the AUM in 2022. This suggests that the year-end Global Impact AUM for 2023 will likely be higher.
What we found interesting:
Purpose Trust: Natural Investments recently converted its company ownership to a Purpose Trust. From their website, "Natural Investments will continue to exist in perpetuity as an independent firm owned by an entity rather than individuals. Now advisors and staff are elected by our advisors to serve terms as trust stewards who have ownership-level authority to prioritize the firm’s strategic direction." The decision by Natural Investments to establish a purpose trust was driven by its remarkable growth in assets under management, which increased almost fortyfold, causing a sale to the company's management team to be very expensive. Again from Natural Investments website, "The sale of the company to the trust involves a combination of external and owner financing. Exiting owners are being paid a significant majority of their share value over many years. To provide a down payment to selling partners, the firm borrowed one-fourth of the sale price from a longstanding community development financial institution that shares the firm’s values, marking the first time in the firm’s 38 years that it has borrowed capital." The purpose trust structure will allow Natural Investments to maintain its values-based approach to investment advisory over the long term.
ESG: As Europe continues to recognize the benefits of ESG – specifically in terms of risk mitigation and enhancing financial returns - the conversation in the United States remains divided. California has introduced new disclosure laws, with one becoming effective January 1, 2024, while the SEC's climate reporting rules were put on hold in April after a series of lawsuits. Despite the evolving regulatory landscape, scrutiny from stakeholders and investors concerning ESG factors will remain. Notably, ESG regulations and reporting policies are also being developed across other regions, including China, India, and Africa. If you’re interested in further insights about what the future holds for ESG, the law firm Latham & Watkins provides their insight here.
On the technical front, multiple ESG frameworks and tools are available for businesses, as collecting and reporting remain complex and time-consuming. Among the many firms trying to solve this problem, ESGgo has introduced a deep-tech data engine capable of utilizing any form of ESG data, cleaning and normalizing it, and producing reports compliant with global ESG reporting standards. GoProdigii’s joint venture with Soothsayer has created a leading data science firm focused on sustainability. Leveraging its expertise in artificial intelligence and data science, GoProdigii connects sustainability to a company’s unique business value drivers, improving revenue, profits, and productivity as well as sustainability, ESG, and sentiment scores.
These tools leverage artificial intelligence and machine learning to streamline the integration of data from various sources, distilling the data to mitigate risks, reduce costs, enhance operational efficiency, and increase both profits and stakeholder/shareholder value. These companies are part of a broader trend of firms like NASDAQ, Reuters, and others that are developing sophisticated tools to simplify and improve ESG information gathering and reporting. These advancements demonstrate a growing industry focus on reducing the resource and time demands associated with ESG compliance, making the information more accessible for organizations of all sizes to make data-driven decisions that drive more sustainable operations, improved financial returns, and enhanced customer sentiment.