By Peter Dunbar, CFA, Private Equity Senior Specialist, PRI
ESG and responsible investment are now becoming mainstream in private equity as the social, environmental, and reputational costs associated with sub-par practices in these areas have rapidly increased for all participants in the market. Continual improvement in private equity responsible investment and ESG practices can also play a vital role in the industry’s ongoing battle to improve its image.
To help limited partners (LPs) play their part in further developing responsible investment in the market, we’ve launched the third edition of the Technical guide for limited partners: responsible investment in private equity.
General partners (GPs) build ESG capacity for a variety of reasons. Some see it as the right thing to do. Others understand that it can improve the risk and return profile of their funds. However, increasing demands from their current and prospective LPs to integrate ESG issues often underly those reasons. LPs, therefore, have a crucial role to play in shaping responsible investment in private equity.
As Michael Cappucci, Chair of the PRIs Private Equity Advisory Committee and MD of Harvard Management Company put it, “We are long past the time to “wait and see” if ESG integration is a worthwhile undertaking for investors. Any LPs or GPs who are not thinking about relevant ESG factors are shirking their fiduciary duty and putting their portfolios at greater risk. I hope the third edition of this guide provides a comprehensive introduction to the topic.”
We are long past the time to “wait and see” if ESG integration is a worthwhile undertaking for investors. Any LPs or GPs who are not thinking about relevant ESG factors are shirking their fiduciary duty and putting their portfolios at greater risk. I hope the third edition of this guide provides a comprehensive introduction to the topic
Michael Cappucci, Chair, PRI Private Equity Advisory Committee, MD, Harvard Management Company
The guide covers the private equity investment process from responsible investment policy formulation, to GP due diligence and on to monitoring and exit considerations. Its primary aim is to help LPs move further ahead in their responsible investment journey and beyond tick-box exercises. It does this by presenting insights and providing actionable ideas into how responsible investing can be implemented by a broad range of LPs and GPs, from venture and buy-out investors to fund-of-funds.
Private equity growth
The growth of private equity as an asset class has been a key theme in capital markets over the two decades. Capital has increasingly turned to private markets – especially from institutional asset owners. Private equity allocations have grown rapidly since the global financial crisis.
This growth poses new challenges and opportunities for LPs and GPs. Private equity faces the same systemic challenges around climate risk, human capital, and resource shortages as public equity investors but through a different regulatory lens. Ultimately, each market also has the same clients.
Private market investments have avoided some of the regulation associated with governance practices or reporting that provide scrutiny in the public markets. But in the eyes of politicians, asset owners and regulators, this is changing – rapidly.
Asset owners realise that efforts they put into reviewing public equity portfolios should be reflected across all asset classes, and regulators see market risk in new areas and asset classes. Regulations such as California’s Transparency in Supply Chains Act and the UK’s Modern Slavery Act do not differentiate between the mechanism of ownership. The relationship between GPs and portfolio companies also puts them in a privileged position in terms of prioritising these types of issues – making a real positive impact in the environments these businesses operate.
More to be done
While much great work is happening in the private equity industry when it comes to ESG, there is evidence to suggest that there is still more to be done. RBC’s 2019 Responsible Investment Survey showed that while 87% of public equity fund managers were incorporating ESG factors into portfolio management, just 34% were doing the same in the alternatives space.
Investment opportunities driven by the energy transition or resource efficiency, plus the increasing evidence around the correlation between returns and better ESG management, are all independent of ownership mechanisms. GPs who are not investigating different ways to allocate capital are missing out on many attractive investment opportunities.
For a range of reasons, private equity GPs and LPs will face pressure to stand up and be counted on meeting a range of global and local challenges. At a minimum, they will need to adhere to the highest ethical and professional standards, deal fairly and honestly, act with integrity and transparency and invest responsibly.
The private equity environment is changing; market participants who ignore that are likely to face a backlash from clients, regulators and politicians. Business as usual, is no longer acceptable.
This blog is written by PRI staff members and guest contributors. Our goal is to contribute to the broader debate around topical issues and to help showcase some of our research and other work that we undertake in support of our signatories.
Please note that although you can expect to find some posts here that broadly accord with the PRI’s official views, the blog authors write in their individual capacity and there is no “house view”. Nor do the views and opinions expressed on this blog constitute financial or other professional advice.
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