As the economy attempts to recover, governments and businesses are assessing how the disruption will impact them and their constituents over the long term so that they can make informed decisions about where to invest in order to survive, thrive and contribute to a changed world.
Private equity firms also face this challenge. And while few industries are as well-positioned to assess the disruption and respond effectively, the pandemic has reinforced the idea that it is time for the industry to redefine what success looks like.
The pandemic is unlike any crisis PE has yet weathered. Beyond its widespread impact on every industry and geography, the covid-19 pandemic has brought environmental, social and corporate governance concerns to the fore, showing that without strong public health, there can be no strong global economy. It has highlighted the impact of human activity on the environment, with viral pictures of less-polluted cities as residents stay at home. Even more so, its disproportionate impact on minorities and the widespread layoffs it has caused have reminded investors just how important the social component of ESG is.
PE firms, like business broadly, must accelerate a shift to purpose-responsible investing. That is, they can no longer focus just on financial performance, but should instead take a broader view – one in which they also invest in support of consumer, human and societal advancement. They must also move beyond the idea that giving back – for example, with pandemic relief funds – is sufficient, toward a new notion of success: “We create shared value with society.”
Moving toward purpose-driven investing
To move toward purpose-driven investing requires adopting new mindsets. For one, limited partners are not the only stakeholder that matters. Instead, a firm’s employees, portfolio company employees, the communities they operate in and society at large deserve significant weight. Similarly, financial returns are not the only measure of a successful investment. While IRRs remain important, social returns are also a critical goal. How much have the firm and its portfolio companies reduced carbon, improved educational outcomes or increased the availability of middle-class jobs in a community?
The industry already has a place where it can look for successful examples of how to adopt these mindsets: impact investing. Impact investors have moved beyond simply incorporating ESG criteria to an explicit active dual mandate that prioritises both economic and social returns and recognises that deals must be a social additive.
With firms conducting reviews of their value propositions and business strategies in light of the pandemic anyway, there is no better time to incorporate purpose-driven investing. Indeed, including purpose-led goal setting as part of the reviews may help solidify their thinking on what changes are most important in areas including investment strategy, technology implementation and hiring.
Firms are going industry by industry, geography by geography, assessing what has changed due to the pandemic. For instance, they are looking at demand for energy and real estate in light of remote work and adjusting their investment strategies accordingly. But purpose-driven firms will also look at what types of energy investments will best promote a sustainable environment, or what types of real estate investments will help achieve social justice.
The pandemic has crystallised the importance of some technology requirements, such as more standardised reporting across the portfolio. Firms are also considering how they can use “next-gen” technologies such as AI to help cope during the covid-19 crisis. But the purpose-driven firm will also consider how to implement technology to measure its “purpose” metrics and capture all externalities created in the course of business, from social ones such as improved educational outcomes, to environmental ones such as reduced carbon footprints.
Firms are already shifting how they hire in anticipation of new styles of investing such as more corporate carve-outs. Firms additionally are looking for tech-native employees who better understand new technologies. The purpose-driven firm will also aim to build an organisation that reflects society at large, both internally and at the companies it acquires, with better representation of women and minorities.
The PE industry recognises that it is in the middle of a momentous shift that will require all its attention to navigate successfully. The covid-19 pandemic is no small challenge, but periods of change and chaos are when the PE model should stand out as an engine of value, thanks to its flexibility and resilience. To truly thrive, though, the industry would be well-advised to expand its re-evaluation of systems and processes to include a rethinking of its purpose. These days, it isn’t enough for the PE firm to be resilient – its entire ecosystem must be.
Andres Saenz is global private equity leader at EY based in Boston