Fund Managers, Investors Increasingly Focus on Environmental, Social and Governance Issues

Many of the most recognized names in the private equity industry are currently leveraging environmental, social, and governance (ESG) tools to create financial value for their investment funds. Looking forward, nearly all of the firms surveyed expect to increase their focus on these concerns.

In fact, many funds, such as TPG Capital, KKR, and Blackstone, have already built systems specifically designed to drive cost savings from eco-efficiency initiatives while navigating an increasingly important set of social and governance considerations.

These are a few of the trends we’ve discovered and shared in ESG in Private Equity. In collaboration with Environmental Defense Fund (EDF), we conducted a survey that provides a unique look into the small yet influential universe of decision makers in the private equity sector. The report is a collection of evolving perspectives on ESG and its impact on value creation.

ESG is a term used to describe a range of investment considerations related to issues such as environmental sustainability, social equity and corporate citizenship. We have seen evidence that the private equity sector is moving rapidly through the evolutionary stages of ESG adoption.  These investors are no longer asking what is ESG or why are these issues important, but how to capitalize on them.

“Environmental management has become an important part of our value creation toolbox,” noted Pat Tiernan of TPG Capital. “Energy and waste management drive cost savings while, in some cases, focusing on the environment has led to profitable new product lines.”

Respondents cited cost saving opportunities and the expectations of fund investors, referred to as limited partners (LPs), as the primary drivers for ESG management. And LP expectations will likely continue to grow as more institutional investors become signatories of the United Nations Principles for Responsible Investment.

Interestingly, despite extensive coverage of concerns regarding recent regulations for the financial community, we were surprised to find that the new rules were the least cited factor driving funds to focus on ESG. This is a promising indicator that while government mandates will likely catalyze faster action, they are not required for this transformation to continue.

“ESG and sustainability are macro themes which will influence value going forward,” noted LP respondent Scott Chan of the Sacramento County Employee Retirement System. “We are interested in how to participate in this theme through investment vehicles, as well as how to integrate management tools for ESG-related risks.”

In addition to assessing the current state of the market, here are some best management practices that funds are utilizing to drive value creation through ESG:

• Adoption of a specific policy for managing ESG issues throughout the investment cycle;

• Recruitment of experts or consultants to plan and execute ESG related initiatives;

• Collaboration with portfolio companies to enhance ESG performance at the operational level;

• Enhanced integration of ESG considerations into the due diligence process;

• Metrics and reporting to manage ESG efforts and measure improvements; and

• Development of communications tools highlighting ESG accomplishments.

These findings are promising for the future of private equity and corporate environmental sustainability. Private equity-owned companies represent a significant percentage of the US economy, and growing fund manager focus on improved ESG performance will help a broad swath of privately owned companies profitably reduce their environmental and social impacts.

Andrew Malk and Zach Goldman are Partners at Malk Sustainability Partners (MSP), a specialty management consultancy that guides investors and businesses to leverage resource and environmental management to maximize profitability. The complete study can be accessed here.