The Growing Role of ESG Initiatives in Private Markets

Similar to their public market counterparts, ESG trends in the private equity (PE) space are gaining momentum with investors. In the last couple of years there has been a material shift toward formalizing operating models and reporting standards as sustainable portfolio integration becomes the norm.

The passing of regulatory milestones such as the Inflation Reduction Act (IRA) in 2022 created incentives to fuel private capital into clean energy and climate-conscious firms.

Furthermore, a heightened focus on ESG is organically increasing transparency into a once opaque private sector. In an effort to have greater appeal to retail investors, it will be essential for PE investors to adopt standardized reporting, disclosures, and increased data transparency to meet growing retail demand.

Within the AlphaSense platform, we observed a notable increase in “private equity esg” document activity over the last 90 days, capturing the growing interest and momentum ESG is gaining in the PE space.  

In this article, we’ll take a look at the driving forces behind ESG in private markets, new research drawing a correlation between ESG integration and performance, the influence of growing retail interest, and recent efforts to heighten transparency through reporting and metrics.

Forces Driving ESG in Private Markets

According to a recent Harvard Business Review publication, there are three primary forces driving sustainability practices within the industry:

• Among limited partners (LPs), their beneficiaries, and asset owners— ESG initiatives have taken precedence and are integral to decision-making: 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.

• Many LPs and GPs believe that ESG will be essential within PE to continue delivering historically high returns, just as public markets have experienced outperformance when there is emphasis on ESG integration. Experts and fund managers alike recognize the importance of ESG irrespective of asset class or ownership structure. 
• There is a growing recognition of ESG issues among portfolio companies and the realized opportunity to gain value through meaningful initiatives. Stakeholders are voicing concerns about climate change and demands for diversity, equity, and inclusion. An awareness of the focus on sustainability in publicly listed companies as well as increasing regulations contribute to this effect as well.

Related Reading: Private Equity Trends and Outlook for 2024 

ESG Integration Bolstering Performance

The forces driving ESG adoption in the PE space—stakeholder criteria and sentiment, a growing belief that integration should be agnostic of asset class, and consensus for addressing climate change and social justice—are significant and relevant in their own right. 

Perhaps the most compelling outcome and force driving ESG in the space is that integration results in outperformance.

A recent industry publication sourced from the AlphaSense platform shows a positive correlation between PE investors that apply ESG management instruments among their portfolio companies and long-term performance, “Improving fund-level ESG footprints by 50% explains a statistically and economically significant net IRR increase of up to 12.4% over a fund’s life cycle.” 

This positive correlation reiterates the importance of sustainable investing and also serves as a win-win for investors potentially torn between principles and performance. 

A Shift Toward Standardized Reporting and Metrics

A recent study published by State Street found that “more than sixty percent of private markets asset managers believe environmental and social elements will attract more retail demand for private assets.” 

With growing retail demand for private investment comes the need for GPs to adequately adopt, implement, and execute operational best practices that the retail sector is accustomed to. Specifically, this means instituting standardized reporting and data transparency—which have not been characteristic of the PE space in the past. 

Private managers are heeding the call, it seems. The 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. 

Recently, there has been a new initiative to increase the transparency and availability of portfolio company data. The ESG Data Convergence Initiative (EDCI) was established in 2021 by an open partnership of GPs. 

An industry publication sourced from the AlphaSense platform outlines the EDCI’s core initiatives. GP members commit to report data across a core set of ESG metrics within six predefined categories: greenhouse gas emissions, renewable energy use, diversity of board members, work-related injuries, net new hires and employee engagement. The data is then aggregated into a benchmark by The Boston Consulting Group (BCG).

According to the document, as of September 2023, EDCI already comprised more than 350 members, who together account for over US$28 trillion in assets under management. 

The Institutional Limited Partners Association (ILPA) also recently developed an ESG Assessment Framework designed to “help LPs evaluate and benchmark GP responses to due diligence efforts, inform goal-setting conversations with GPs and measure ESG integration progress over time.” 

It is evident that the GP and LP community have made significant strides over the last couple of years to enhance, standardize, and adapt to the growing demand for data reporting and transparency, with ESG initiatives at the forefront. There are a growing number of resources and initiatives available to facilitate demands from asset owners and stakeholders, attract new retail interest, and ultimately promote successful fundraising.

Navigate ESG Trends with Confidence

In a rapidly evolving landscape, you need to stay ahead of trends and developments in the private equity space with confidence and ease. AlphaSense’s leading AI-search driven market intelligence platform equips you with the insights, market intelligence, trends, and expert opinions to remove the complexity and guesswork of conducting your research. 

Learn how Baillie Gifford 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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