When Private Equity International first began reporting on the asset class, private equity was quite a different animal, and not just because it was a much smaller industry. Those around in the mid-2000s will remember well the comments by a certain German politician likening US and UK firms investing in the country to locusts, claiming they stripped assets bare and destroyed jobs. While these accusations were almost certainly overblown, it’s true that, outside of those companies backed by development finance institutions, few businesses of yesteryear explicitly took environmental or social considerations into account when investing.

Fast forward to today and you would be hard-pressed to find a firm that doesn’t claim to at least consider ESG factors in its investment decisions. In fact, the rise of ESG has been one of the biggest changes in the industry over the past 21 years.

The seeds for this were sown in 2005, when institutional investors, asset managers and other parts of the investment ecosystem gathered to discuss the role of ESG in creating long-term value at a conference called Who Cares Wins (accompanied by a report of the same name). The following year also saw the launch of the Principles for Responsible Investment under the auspices of the UN. Yet, it wasn’t until the years immediately following the financial crisis that private equity started coalescing around these principles.

Number of signatories to the UN Principles for Responsible Investment as of 7 November 2022, up from 63 in 2006
Source: UN PRI

LPs that believe adopting a strong ESG policy will lead to better long-term returns in their private markets portfolio
Source: Private Equity International’s LP Perspectives 2023 Study

LPs that take evidence and consideration of ESG into account during manager due diligence
Source: Private Equity International’s LP Perspectives 2023 Study

LPs that expect to increase requests to GPs for ESG reporting over the next three years
Source: ILPA-Bain ESG Survey 2022

GPs for which ESG has been a significant contributing factor in their decision not to invest in a company
Source: Investec’s GP Trends
Report 2022


“The conversation around ESG in private equity really started with the creation of the UN’s PRI, as signatory status became a litmus test for managers,” says Adam Heltzer, a managing director and global head of ESG at Ares Management. “Today the bar is much higher, with greater expectations for the substance of an ESG programme, including clear objectives tied to both risk mitigation and operational value creation.”

This has had a significant impact on private equity operations and resources in the intervening years. “In the early stages, there were very few in-house ESG professionals,” says Shami Nissan, partner in the sustainability team at Actis. “Today, pretty much every GP has a dedicated team and a narrative on sustainability – it used to be a differentiator; it’s now standard.” 

Furthermore, it’s fair to say that within many firms all roles have changed to incorporate ESG factors. “The cultural embeddedness of these activities has moved in line with the mainstreaming of ESG,” says Heltzer. “In an earlier era, ESG integration was the responsibility of a lone dedicated specialist, yet today there’s an expectation that rank-and-file investment professionals can speak to the programme and how it affects their investments.”

Growing sophistication 

ESG is much more sophisticated than it used to be, adds Heltzer: “At one stage, managers were considered advanced if they reported a few qualitative ESG bullet points per portfolio company to LPs. Now, you need to be much more programmatic, systematic and quantitative, clearly demonstrating how you implement ESG processes. 

“This has undoubtedly changed the way alternative investment firms operate. It used to be more opportunistic, but firms now seek to embed it in value-creation plans and engage with management teams on generating meaningful operational change at the portfolio level.”

As with many aspects of private equity, these developments have – until recently – largely come about because LPs have asked for them. The long-term investment horizons of many fund investors, the rising demand for an ESG focus among their stakeholders and the pressing nature of issues such as climate change and social inequality (which was particularly highlighted during the covid lockdowns) have all led many LPs to focus their efforts around net zero and decarbonisation, as well as social inclusion and equity. 

Investors are increasingly directing their capital towards managers that can help them achieve these aims. More than two-thirds of LP respondents to a 2022 Bain & Company and Institutional Limited Partners Association survey say ESG considerations play a role in their organisations’ investment policies. Of those LPs, 85 percent have an ESG policy that is fully (52 percent) or partially (33 percent) implemented in their private equity portfolios. The survey also found that 70 percent of LPs headquartered in Europe agree that ESG commitments influence valuation premiums, although that figure falls to 38 percent among US LPs. 

ESG’s link to value

“ESG has become much better understood as a means of both protecting and creating value,” says Bhavika Vyas, a managing director at StepStone Group. “LPs have overall increased their expectations of what baseline ESG practice looks like and they are driving GPs along the journey.”

There is also mounting evidence emerging that backs up the idea that a focus on ESG can drive returns. For example, a recent review by NYU Stern Center for Sustainable Business of more than 1,000 studies published between 2015 and 2020 on ESG and financial performance found that “improved financial performance due to ESG becomes more marked over longer time horizons” and that “ESG investing appears to provide downside protection, especially during a social or economic crisis”.

However, that doesn’t mean there is universal support for investing according to ESG principles. This year has seen a pushback in some quarters – notably in the US, where several states are considering laws that would prevent pension funds from investing with managers that screen out investments based on environmental impact, and where the Department of Labor ruled in 2020 that pension plan fiduciary duties lay in focusing on financial as opposed to “non-pecuniary” goals. 

This misses the point, says Natasha Buckley, vice-president and head of ESG at HarbourVest Partners. “You can’t put ESG back in the box,” she says. “The pushback we’ve seen in some quarters is perhaps a reaction to ESG becoming so prevalent – and, with it, confusing at times. But we have to be clear that ESG is about risk mitigation, value protection and value creation at exit. It is about acting as a fiduciary.”

The other big issue that has come to the fore over recent years is a fear of greenwashing by fund managers. These fears have also not been totally quelled by the well-intentioned – but ultimately highly confusing – proliferation of frameworks, guidelines and standards issued by a variety of organisations. 

Yet regulators are taking note. The creation of the EU taxonomy around sustainability and the implementation of the Sustainable Finance Disclosure Regulation, along with proposals from the US Securities and Exchange Commission, are squarely aimed at improving disclosures. 

“Until recently, ESG had been allowed to flourish with a wide range of approaches emerging among GPs,” says Buckley. “The onus has been on LPs to test whether GPs align with their own expectations. However, the proliferation of regulation is something of a milestone. This helps create checks and balances to prevent greenwashing.” 

Buckley does, however, stress the need to “guard against creating a compliance culture that punishes those that are trying and disincentivises commitment”. 

There are efforts around harmonisation of reporting, with many in the industry citing the ESG Data Convergence Initiative as particularly helpful, offering the potential for greater clarity. Overall, the collection of data, together with increased sustainability regulation across the whole economy, will push ESG practice and reporting further along the development curve in the years to come. 

“We are getting to a point where everyone agrees what has to be reported on – that’s the core of the ‘onion’ – and regulation will help with this,” says André Frei, chairman of sustainability at Partners Group. “Once that has been agreed, then you can add ‘layers’ to the onion.”

Carmela Mondino, head of ESG and sustainability at Partners Group, adds: “The industry is being pushed to gather and report on more areas, as well as collect more data. Yet it’s not clear that this is coming with any obligation to improve. This will come, in particular as data is aggregated and assessed to create benchmarks, for example. 

“The next stage of development will be around how data can be used to demonstrate what GPs are doing and how they can improve.”