While resources and information for the ethically minded investor are becoming increasingly abundant, classical sustainable investment approaches appear to be less applicable to private equity. While impact investors often venture into the area, the incorporation of ESG priorities into decisions for more traditional firms will be more complex, providing lucrative opportunity for the scrupulous investor.
When selecting capital market products, sustainable considerations including ESG ratings and the specifics of a company’s behaviour can feasibly be factored in to selection alongside typical performance metrics such as debt-to-equity or price-to-earnings ratios. Comparisons and purchases of different products can be made without so much as a conversation, or indeed leaving the sofa and can be undertaken in small volumes.
Private equity (PE) investment on the other hand, almost always requires an investment bank to act as a go between for the investor and the specific company they are to invest in. As PE occurs in stages rather than continuously, there are inherently fewer opportunities and options in the PE world. Furthermore, these options typically require high volumes of capital, necessitating funds which eliminate the individual investor’s autonomy to discriminate on ESG bases.
While public offerings provide access by proxy to innovative, high-growth businesses, the number of companies help by a PE firm can obscure any identifiable ESG impacts in many cases. It is therefore apparent that a sustainable PE investment will never be as straightforward to make as it’s publicly traded counterpart. We must ask ourselves what means are available for the investor looking to earn returns from this highly lucrative investment type, while securing a better future for the planet?
PE firms are certainly not blind to the need for changes in investment, in 2016 PWC found that three quarters of firms had made explicit policy commitments to responsible investment. Unsurprisingly, few of these decisions incorporated sustainability into business analyses and decisions, with only 25% of firms able to say they were ‘taking action’, on environmental issues.
These figures are particularly surprising when balanced against the mounting evidence for the profitability of sustainable practices. In 2019 Bain & Co. reported that deals with environmental or social impacts could expect to see nearly 100% greater return than other deals on average. This alongside trends in public opinion highlighted by Bain and regulations like Mifid II give a strong taste of things to come, investors will expect more transparency from the PE firms of the future.
While the importance of sustainable investment is being incorporated, at least superficially by leading houses like TPG and KKR, a more material commitment is therefore to be carefully examined for, particularly in the opaque world of PE. This is not only for the ethical investor, but also for those simply looking for profit.
While Brad Cornell’s recent editorial for the FT argues that the inflation in value experienced by firms like impact focused PE funds mean that lower return is to be expected over time, we at Ingena, believe sustainability consciousness has only reached the tip of the iceberg. With immense development possible in areas like socially responsible investment, an investment in a genuinely sustainable PE firm will be rewarded exponentially, in line with the exponential growth of sustainability in finance over the coming decades as ESG issues continue to move toward the forefront of public consciousness.