PEI 300: PE learns the value of investing responsibly

The rise of ESG screening and the growth of impact investment managers has paved the way for a new breed of investors.

Private equity investors increasingly want to show they are a force for good. Before the 2008 global financial crisis there was little focus in the industry on environmental, social and governance issues, but the requirements for transparency and accountability across investment programmes have proliferated in the aftermath.

In 2009, the American Investment Council (then the Private Equity Council) issued its first guidelines for responsible investment, covering issues such as health, safety and labour. Invest Europe (then the European Private Equity and Venture Capital Association) also introduced ESG language into its handbook for the first time.

The pressure from LPs to invest responsibly is the primary driver. First came demands from large European institutions, and over the last decade others have followed suit.

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Demographic change is another. Next-generation investors are contributing to a more rapid adoption of sustainable investing, according to the UBS/Campden Wealth Global Family Office Report 2019. One in three family offices surveyed engages in sustainable investing and a quarter in impact investing. The average 19 percent portfolio share dedicated to sustainable investing is expected to increase to 32 percent within the next five years.

The launch of the UN-supported Principles for Responsible Investment in 2006 allowed many efforts to coalesce under a comprehensive framework, says Suzanne Tavill, global head of responsible investing at StepStone. As a result, the promulgation of guidelines and best practices has been streamlined, which has made it easier for GPs and LPs to adopt ESG principles.

Signatories to the PRI have grown to over 3,000, with asset owners making up nearly 20 percent.

‘Cover your backside’

Today, LPs and GPs alike are increasingly recognising ESG issues as material factors in the investment process, Tavill says. “Having LPs that are focused on these issues is a helpful driver to this adoption but, even so, GPs are recognising that climate change will affect assets during the hold period; that diverse management teams lead to better outcomes; and that supply chains need to be clean and certified to maximise exit value.”

How PE firms incorporate ESG is still highly variable, according to a report from Bain & Co. Some firms are taking the “cover your backside” approach by ensuring their holdings comply with existing regulations, while others embrace ESG principles across the investment value chain. At the far end of the spectrum are impact investors, who invest with a “double bottom line” of both financial and social returns.

Once considered a niche area, the arrival of blue-chip managers TPG, KKR and Bain Capital has brought impact investing into the mainstream, attracting a new segment of the LP universe. Since 2015, capital raised by impact funds has grown 154 percent to $28 billion, says Bain & Co.

Given the nature of today’s more challenged investment environment, ESG considerations are set to become more important than ever. A UBS research paper published in May predicts increased investor focus on ESG considerations after covid-19, with “particular demand for greater corporate transparency and stakeholder accountability”, and points out that “sustainability is at the heart of the recovery plan for many governments”.