Why private equity firms should be embedding ESG in their portfolio

With ESG moving up the agenda, PE managers need to embed it in their long-term value narrative.

In brief

• PE firms need to create value in a meaningful and sustainable way.
• PE firms are looking to progress their ESG focus to a more long-term value approach.
• The COVID-19 pandemic has provided the opportunity to PE’s to embed ESG in their business.

In the current private equity (PE) environment, there is an emphasis on purpose and transparency. This is being driven by a combination of things: demand from limited partners (LPs), the dynamics of origination, regulatory developments, and being able to attract the best talent.

There is also social pressure and the question of PE’s license to operate. The PE industry is under greater scrutiny than ever before, and PE firms must do a better job of capturing and tracking the value they are creating and the impact of their activities.

It is not difficult to grasp that value these days is increasingly being driven by nonfinancial factors. For PE, incorporating these new value elements can open doors — offering new types of investment opportunities, as well as partnerships with entrepreneurs and family owners who care about their business’s legacy.

The PE purpose and transparency imperative

A variety of drivers show the importance of embedding purpose and transparency into PE strategies, and there are abundant statistics to support this:

• According to the Pitchbook 2020 Sustainable Investment Survey, 95% of LPs are either already evaluating ESG risk factors or will be increasing their focus on ESG risk factors in the coming year.
• The 2019 EY CEO Imperative Study states that 80% of CEOs believe government, business and the public will reward companies for taking meaningful action over the next 5–10 years.
• Companies that rank well on ESG metrics have outperformed the market by up to 3% per year over the past five years, according to the 2019 Bank of America Merrill Lynch Global Research.
• According to the New York Times, employees at purpose-driven companies are 1.4x more engaged and enjoy 1.7x more job satisfaction. These employees are also 3x more likely to stay at their company.
• According to the UN, an estimated US$3t–US$5t per year is needed to meet the United Nations Sustainable Development Goals (UN SDGs), and PE is likely to play an important role in contributing financial support to achieve this.

While the COVID-19 pandemic has forced a reassessment of operating models and investment priorities, it also provides PE with an opportunity to embed purpose and transparency more deeply throughout its business — at the firm, fund and portfolio levels.

In our latest Keynote Interview in the PEI Annual Report, Andres Saenz, EY Global Private Equity Leader and Simon Abrams, Director, Sustainable Finance, discuss how ESG is becoming a top focus area for PE. Read more here (pdf).