1Eyeing ESG for outperformance

The link between performance and good environmental, social and governance practices has been touted for some time. However, a recent report by bfinance highlights the extent of investors’ conviction on the matter.

Just under half of respondents to the ESG Asset Owner Survey that invest in private equity somewhat agree that ESG integration will be associated with outperformance over the next three years and 26 percent strongly agree. While there is some regional variation – 32 percent of European investors strongly agree, compared with 14 percent of North American investors – overall, respondents are even more bullish when a longer-term view is taken, with 50 percent strongly agreeing that ESG integration will contribute to outperformance over the next 20 years.

The covid-19 crisis has of course made plain the risks involved in not paying heed to ESG factors. The fallout from the pandemic, along with movements such as #MeToo and Black Lives Matter, have underlined social, racial, gender and financial inequalities, while the wildfires that ravaged parts of Australia and California last year amplified the urgency around climate change interventions.

But as the bfinance survey findings suggest, taking action on ESG is not just a case of mitigating risk, but of keeping pace with investor expectations and gaining an edge both today and into the future.

ESG is becoming an increasingly important means of driving value across private equity portfolios as consumers and employees place greater weight on sustainable and socially responsible practices.

“What we see is that consumers are starting to shift behaviours because of ESG. They start to buy from company A not company B because of ESG. It’s also the case with business-to-business customers,” Christophe de Vusser, a partner at Bain & Company, tells Private Equity International.

“Employees are also starting to look at ESG – if a company is not at the forefront of ESG anymore, young talent doesn’t want to work there. That means that ESG has become important as a driver of market share, so it’s become a value creation tool.” As PE houses position themselves and their portfolios in line with these accelerating trends, momentum has also been building in the impact investing space. In addition to the launch of dedicated impact funds by a number of industry heavyweights, some of the concepts behind impact investing appear to be gaining ground in more mainstream private equity investment strategies.

“The world is facing unprecedented challenges and there is a new class of entrepreneurs focused on creating solutions, while still building successful businesses. At the same time, corporations and investment firms alike are realising the long-term sustainability risks communities and the planet are facing – and this is likely to increase in the aftermath of the pandemic,” says Maya Chorengel, co-managing partner at The Rise Fund, the impact investing platform managed by TPG.

“These two groups – entrepreneurs and investors – will increasingly join together to drive successful impact solutions. And as the sheer volume of impact solutions increases, we anticipate that impact investing principles will continue to be integrated into a classic investing approach.”

2 Placing talent strategies centre stage

While businesses’ approaches to ESG may be feeding into employee attraction and retention, wider considerations around how talent and culture contribute to portfolio company growth mean human capital strategies are playing an increasingly key role in value creation plans.

Ted Bililies, a managing director at consulting firm AlixPartners, says: “Private equity investors are becoming more sophisticated in that they are making sure they tie financial rewards [for management] to things like employee engagement, retention rates, morale and the like.”

And this focus on talent is not just occurring at the portfolio level. More than half of private equity firms list talent management as a top strategic priority, according to EY’s 2021 Global Private Equity Survey, where talent comes in second only to asset growth.

As private equity, like other industries, becomes more cognisant that a proactive approach to diversity and inclusion can support talent strategies and, ultimately, performance, the momentum behind D&I initiatives appears to be gathering speed. According to the EY survey, increasing gender representation and ethnic minority representation is a talent management priority for 56 percent and 52 percent of PE firms, respectively. This compares with 47 percent and 31 percent in 2020.

Carmela Mondino, head of ESG and sustainability at Partners Group, says: “Diversity and inclusion is now in the right place on the industry’s agenda. Private equity firms want and have the best talent, and excel at delivering – this requires them to quickly get up the curve on D&I. It will take time to develop a pipeline, but now that the necessary commitments are being made, and people see the need to change, I believe the private markets industry will own the topic, transform itself and deliver on results just as it does on anything else.”

3 Pressing home the advantage for fundraising

A quarter of respondents to the EY survey said increasing employees’ ability to work remotely was a top talent management priority, an issue that is unlikely to have registered on many managers’ radars before covid. More than one year on, LPs and GPs seem to have adjusted fairly well, learning to adapt to virtual fundraising and diligence processes. Some firms even raised funds completely virtually, such as Tenzing which brought in £400 million ($543 million; €444 million) for its second fund within nine weeks, and Nordic Capital’s Fund X, which closed at its €6.1 billion hard-cap in under six months.

There was initially some hesitancy about committing to new managers during the pandemic – just under half of investors said they would not commit to a new manager’s fund without meeting face-to-face, according to PEI’s LP Perspectives Study 2021 – which made for a rockier ride for emerging managers looking to raise capital. While covid-19 has thrown up a number of hurdles for first-time funds, some investors still recognise the edge and potential they can offer.

“There are LPs that will back an emerging manager because they see a team that is deeply aligned with the fortunes of this one vehicle and incredibly motivated to make it an outsized success,” says Gabrielle Joseph, head of due diligence and client development at Rede Partners. “They will also back an emerging manager with a clear competitive advantage, something that enables them to access opportunities that other managers can’t get.”

In an increasingly competitive market, a firm’s ability to differentiate itself becomes ever more important in both attracting capital and securing deals. This differentiator could be specialisation by sector or geography where deep market knowledge provides an edge, or a manager’s ability to leverage extensive operational expertise or data insights across the breadth of its portfolio, for example.

Yet when it comes to how firms fare in future fundraising efforts, equally key could be how well they engaged with LPs throughout the pandemic.

Paul Newsome, partner and head of investment solutions in Unigestion’s private equity team, says: “The last 12 months have created a real bifurcation in terms of GPs that have performed well and those that have not. That has come down to sector exposure, level of risk taken and the leverage that has been put on those companies. But future fundraising success will also be impacted by how well GPs have interacted with their investors during this difficult time. Those that have been less responsive might well find that they suffer when we finally make our way back to a new normal.”

4 Surging into secondaries

Another area where competition is heating up is the secondaries market, which has seen the entry of several new players both on the advisory and buyside. Much of this has been driven by soaring activity in the GP-led space, and particularly single-asset continuation vehicles as GPs look to hold on to their star assets for longer.

Indeed, the rise of single-asset continuation funds is one of the trends Credit Suisse’s recently published Redefining Private Equity in the 2020s report zones in on, estimating that single-asset deals reached approximately $14 billion in 2020 transaction volume, representing around 40 percent of the GP-led secondaries market. “As sponsors have gravitated towards the flexibility offered by the continuation fund option, secondary firms have been competing to step up their capacity,” the report notes.

Investment bank Greenhill estimates that GP-led secondaries transactions accounted for 44 percent of secondaries market share in 2020, compared with 30 percent in 2019. Meanwhile, secondaries funds raised approximately $95.6 billion last year, according to PEI data, more than double the amount raised in 2018, which previously held the fundraising record.

As Sebastien Siou, senior principal, asset management at Whitehorse Liquidity Partners, says: “LPs and GPs have become more sophisticated in terms of utilising the secondaries asset class as a liquidity management tool. Simply put, secondaries is no longer a niche industry, it is making an impact within the broader PE asset class.”

This growth could in turn lead to greater segmentation within the secondaries market. “Every growing market will start to segment itself,” says Thomas Liaudet, global head of business development at Campbell Lutyens. “We will see segmentation by strategy, with some funds focusing on GP-leds. We will see segmentation by size. And, increasingly, segmentation by asset class, as a secondaries industry that started out in private equity expands further into infrastructure and real estate, and then into private credit.”