Private equity investors always have to be ahead of the game. When there’s a big market trend, firms need to anticipate it, understand it and invest in it. For example, there is already a third of all US assets under management that are managed with sustainable investing strategies.1 So, now that the broader investment community is thinking about environmental, social and governance (ESG) issues, it shouldn’t be surprising that leading PE firms have already gotten on board.
Many PE firms now treat ESG topics as worthy of the same attention as any other important business priority. They realize that, while today ESG may not have the same bottom line impact as other business issues, it will very shortly. Given that we expect private equity assets to increase 30-40% worldwide over the next five years, ESG’s importance in their portfolio company’s operations will only go up.
Even if some PE firms haven’t yet focused on ESG, they should—because their limited partners are. Limited partners are likely looking beyond the acquisition due-diligence phase of a potential investment to how portfolio companies address equity and sustainability. They’re asking questions, and they’re not settling for superficial answers. PE firms should be prepared to respond.
The broader business community is likely coalescing around what ESG means, specifically. The way we see it, ESG goes beyond issues such as climate change and socially responsible investing. It includes issues such as diversity, labor policy, product safety, environmental and corporate impacts on the communities where companies operate, and security of the data they are entrusted with. It also covers governance issues such as executive compensation and corporate ethics.
Even if you are skeptical about ESG, we have seen real success across a host of companies that focus on the broader stakeholder group, and not just shareholders. It's a profitability issue, and as time goes on, it may become a bigger issue for every portfolio company, regardless of industry or ESG topic.
Private equity firms are in a particularly strong position to help drive change, and we have seen several initiatives that leading firms are rolling out to help meet the demands of the broader market:
Some firms are going as far as encouraging portfolio company boards to have oversight to help shape sustainable practices. This includes identifying factors with significant impact on the company’s sustainability, while simultaneously managing costs. Examples might include managing consumption to save on energy bills, addressing health and workplace safety issues to lower the frequency and severity of safety incidents, identifying sources of potential fraud and cyber risk, and engaging directly with the workforce to help find what ESG priorities are important to them.
However you look at it, having a well-defined ESG strategy is likely driving both real value and real differentiation in the market. In short, this is no longer an option, especially in the fight for assets under management. It's good for the world—and it’s good for your portfolio company’s bottom line.
While we likely expect an eventual consolidation of ESG reporting standards, for now you face any number of frameworks that may or may not fit your needs. You don’t need to manage all this on your own. There’s been an explosion of resources you can turn to for help, including the CEO Investor Forum, which includes PwC. You should consider strategies that incorporate portfolio companies as part of the solution—and help show investors the impact of their capital stewardship. Every ESG journey will likely be different, but inaction is a value-losing proposition.
1. Clint Proctor, “Impact investing finances companies that aim to do good in the world—here's how it works and how to get involved,” Business Insider, January 15, 2021, accessed via Factiva, January 26, 2021.