ESG in Private Equity: Emerging Opportunities for Private Markets

There’s a lot of hype around companies restructuring their ESG governance policies to embrace a more authentic stock label. The draw for C-Suites across industries to do so? ESG funds are projected to grow from US$8 trillion today to as much as $30 trillion by 2030. 

And while every sector can take advantage of embracing more transparent and ethical business models, there’s one industry well-positioned to reap the benefits of pouring capital into ESG leaders and backing their initiatives: private equity (PE). 

Why exactly? Below, we dive into the evolution of PE’s involvement in ESG, how it became primed for a bounty of investment opportunities in the sustainability space, and why the time is now for firms to strike deals.

ESG Opportunities for PE 

Since its rise in the late 70s and early 80s, PE has grown beyond its Wall Street allure to become a pillar in the global economy. In 2021, the sector had $6.3 trillion in assets under management—a stark contrast to the $90 trillion for public equities—and nearly $2 trillion in “dry powder.” Together, these assets are expected to exceed an $11 trillion valuation by 2026. 

But as large-scale PE firms like Apollo, Blackstone, and Carlyle go public, they, too, will face the pressures that come with investors, shareholders, and the like who are investing in a more eco-conscious future. For these firms, that means actively conducting due diligence into where capital should be funneled and what stocks are authentically labeled as ESG.

Funds actively investing in ESG have already seen significant financial benefits, like stronger sales, lower costs, higher employee engagement, and superior valuations. Further, a survey from Bain & Company and the Institutional Limited Partners Association (ILPA) shows the true value of ESG and how it can affect the outcome of an investment. 

According to a survey conducted by Bain & Company and ILPA, 93% of limited partners would turn down an investment opportunity if there were any ESG concerns associated with it. Meanwhile, 50% of funds cite better investment performance as a key reason to incorporate ESG.

PE Suited for ESG Success 

The business model for PEy gives it a clear advantage over investors in public equities when it comes to implementing a sustainability agenda. Ultimately, a PE firm has control of its portfolio companies from an ownership and governance perspective even when it doesn’t own 100% of a company. 

Additionally, a PE firm can access any information it wants on both financial and sustainability performance, whereas investors in public companies can only rely on what a company decides to report. And while public investors can liquidate their company stocks when they are dissatisfied with performance, only PE firms can fire a CEO who is not delivering—and even determine executive compensation. 

Large Time Frames and Lax Authority

PE-owned companies have a longer time horizon than publicly traded companies do, providing a longer timeframe to focus on ESG. The average holding period for portfolio companies has increased from about two years in the industry’s early days to roughly five today, which gives general partners and their handpicked CEOs ample time to make investments without the glare of quarterly earnings calls.

Private equity firms commonly did not integrate ESG into their management unless they saw potential long-term profitability—which is why firms have largely ignored it until recently. However, this is a mindset that is already changing and will continue to do so in future quarters. 

Continued Growth

Principles for Responsible Investment (PRI) reports that the number of PE and venture capital managers among signatories to the network has quadrupled over the past five years, for a total of 1,090 today. Nine of the top 10 GPs globally are now members of PRI. Of the world’s 100 largest PE firms, 70 are based in the United States. Twenty-eight of those are PRI signatories, and 13 have signed on in the past two years—evidence of how quickly the industry is evolving.

Driving Forces Behind ESG in PE

There are three forces currently pushing ethical and transparent policies within the industry:

1. ESG is becoming a priority with limited partners and their beneficiaries. The largest asset owners—pension and sovereign wealth funds—are voicing concerns about climate change and inequality.
   • Note: A survey from INSEAD’s Global Private Equity Initiative found that 90% of LPs factor ESG into their investment decisions and 77% use it as a criterion in selecting general partners.
2. Many LPs and GPs believe that ESG will be essential within PE to continue delivering historically high returns. According to Harvard Business School’s George Serafeim, the increased attention surrounding ESG could lead to outperformance in public markets.
   • Note: In HBS’s July-August 2022 magazine, a piece stated that “LPs such as CalPERS, the largest U.S. pension fund, and Nuveen, a subsidiary of TIAA, believe that ESG is as relevant to private equity as it is to public equities. ESG is important for all asset classes.”
3. Potentially the most important driver is the growing recognition of ESG issues within corporate leadership. But where does it stem from? An evolving zeitgeist concerned with climate change, social demands for diversity, equity, inclusion, and sustainable practices.

Staying Ahead of ESG Developments

ESG is no longer a nice to have—it is now a necessary piece of criteria that both investors and consumers are incorporating into their purchasing decisions. Today it is challenging to research and benchmark ESG performance due to the lack of standardization. 

But these obstacles aren’t stopping firms and funds from informing themselves and their clients on ESG matters. Learn how Baillie Gifford, a global investment management firm, is discovering more sustainable ways to operate with the help of AlphaSense. Rather than spending countless hours searching for key information, Baillie Gifford has streamlined the information-gathering process through our aggregated library of financial content sources. 

If you’re looking for more opportunities to seize beyond ESG, download our whitepaper, Opportunities for Private Equity: Finding Growth in a Downturn.

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