Private Equity and ESG investing

Marta Zadravec

Private equity (PE) asset managers have actively developed products to meet increasing demand in the ESG space.  Private equity companies have been waking up to the importance of purpose, responsibility and transparency for the last several years. The pandemic has put these ESG concepts to the top of the agenda.

There was an increased interest in transparency and accountability and in developing ESG policies by private equity firms, according to research. Increasing demand has been noted in terms of transparency and accountability, particularly around ESG policies.

Investment companies are adopting ESG policies for practical reasons as well. Decreasing utility bills and focusing on energy efficiency are the cornerstones of ESG, and in the light of the pandemic, these policies can be effectual methods of saving.

Moreover, some sources state that ESG investing has become mainstream. With the global pool of exchange-traded fund (ETF) assets under management considered ‘ESG-focused’ now reportedly exceeding $100bn (£76.2bn). Companies are raising their ESG credentials in AGMs and annual reports and on occasion, companies perceived to have strong ESG credentials appear to enjoy enhanced valuation compared to their peers.

Private Equity ESG Intentions and Actions

In 2020, private equity firms have raised in excess of $370bn (about £282bn) of commitments to funds that integrate ESG principles into their investment decisions, according to data provider Preqin. But a recent survey by Institutional Investor found that fewer than 10 per cent of 8,810 global private equity firms, with a total of $3.4 trillion under management, are signatories to the UNPRI.

Source: Preqin and PRI, chart from Institutional Investor

Analysis by Institutional Investor shows that the majority of the private equity firms reporting to PRI have a responsible ESG investing or ESG policy. However, ESG policies focus on process, not outcomes. To assess ESG progress at PE firms is to examine their reporting. Overall, the opacity of ESG reporting by PE firms contrasts with the increased transparency provided by many public companies.

Private equity still has considerable room to deliver improved public – social and environmental outcomes. The growing prevalence and severity of environmental and social challenges have elevated the issue set to the highest ranks of PE firms.

According to a report by Private Equity International, “The current state of affairs allows flexibility for GPs to choose how much to report and how often to do it, which leaves the door open for managers to cherry-pick examples of favorable outcomes while burying unfavorable ones.” In addition, GPs can determine if they want to share ESG information at the GP or the portfolio company level.

Lastly, to address climate change and challenges, institutions, including those in finance and private equity, will have to play a more active role in social and environmental problem-solving. The current support for ESG investing appears to be a combination of several factors. The holy grail of investments that not only generate acceptable rates of return to owners and advance the better interests of stakeholders and society is obviously appealing.

Standardisation of ESG

For those working and investing in private equity, the inclusion of ESG criteria in the investment screening and decision-making process is often a recent adaptation and a learned process.

Approaches should become more standardised and more authentic, with skills more broadly disseminated. For now, there is still an experience gap that makes implementation challenging. One of the early challenges identified in the space is the plethora of metrics, standards and styles of reporting on ESG. Recently, several industry leaders agreed to make more collaborative efforts to harmonise measurement standards.

Positive change is possible and happening. Increasing the transparency and rigour of assessment and reporting will benefit performance.