Investing for powerful impact: ESG in private equity

Sustainable investments, sustainable returns. Pioneering private equity firms are showing that profit and purpose can go hand in hand. Here’s how.

Environmental, social and governance (ESG) criteria have acted as a driving force within investment portfolios for venture capitalists and other investors for years. Yet, the private equity (PE) sector is lagging.

To catch up with the times, PE firms can combine the entrepreneurial mindset that built their industry with the ESG value creation that is essential now. In doing so, they will forge a new model for success—one far more sustainable than their current one.

1. Millennial investors & employees are on the rise

US$68 trillion in wealth will transfer to millennial investors by 2030. Seven out of 10 of them expect their wealth managers to screen investments based on ESG criteria. Nearly three-quarters of millennial employees say they would take a pay cut to work for a sustainable company that shares their ESG values.

2. Regulatory environments are embracing ESG

Around the globe, regulatory bodies are adopting ESG mandates for company and investor actions. Europe is the most advanced in this respect.

3. Early mover advantages abound

PE firms that cannot reposition in time are leaving money on the table that is up for grabs by ESG frontrunners. Talent attraction and retention, sellers attracted by an ESG mindset, and investment gains are just a few of the advantages for early movers.

4. Portfolio rebalancing provides opportunities

From activist investors to evolving corporate governance, conglomerates are high grading their business portfolios to meet investor quarterly internal rate of return (IRR) expectations. These trends have forced boards to rethink their current business models, where they aren’t advantaged owners of businesses. PE firms have the capital and speed to transform legacy businesses with a focus on ESG.

This is what PE leaders see as challenges and opportunities

We asked 120 private equity executives currently working on ESG investment strategies about the most important and the toughest areas of change when it comes to ESG investing.

While every PE firm is unique, grouping responses paints a picture of what executives feel is most important to change, versus the level of difficulty of that change. Some highlights:

Sourcing

Sourcing ESG-winning deals came out as the most important change area. With respondents gaining experience, this change was seen as not too difficult.

IT & Measurement

IT & Measurement areas, including the knowledge infrastructure behind ESG investing, ranked as both highly important and difficult to change.

HR

HR topics, such as recruiting experts and management with the right ESG mindset for investee companies, was seen as the most difficult challenge of all.

Balancing priorities and challenges for a better world

PE firms are reevaluating their operating model on two levels—the portfolio level and the fund level. This is done with a focus on strengthening their “Sustainability DNA” and incorporating ESG into the business model and investment value chain.

While there is no one-size-fits-all approach, certain foundational changes are commonly relevant to transformative operating models. To learn what private equity leaders told us they are doing to balance ESG priorities and challenges, as well as what your private equity team can do to embed ESG into your operations strategy, read our short report.

The time is now. The world has left behind a “tick-the-box” mentality regarding ESG, as citizens and leaders embrace the gravity and enormity of the sustainability goals our globe is facing. Private equity has some catching up to do but it’s already begun—a sign of hope for future progress.