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Sustainability gains importance for private equity funds

<p>Environmental, social and governance issues take on increased prominence in the private equity industry.</p>

Private equity funds are paying close attention to sustainability issues these days, according to a new study.  The development is due partly to increased pressure from investors and partly to structural changes in the industry that require private equity funds to put more of their own capital at risk, said the study, released today by Malk Sustainability Partners in collaboration with Environmental Defense Fund.

The report surveyed 18 organizations in the private equity industry, including both fund managers (GPs) and investors, known as limited partners (LPs). The respondents’ answers showed that a lot more attention is being paid to environmental, social and governance (ESG) issues -- in other words, issues related to sustainable development, environmental stewardship and other non-financial investment considerations.

"This study confirms that ESG management amongst private equity funds now goes well beyond the commendable programs of early adopters. The majority of funds surveyed are working to generate higher returns from actively addressing these issues," said Andrew Malk, managing partner of MSP, in a statement. "In a private equity investing environment that demands more operational involvement to create value, ESG management practices are being deployed as effective new tools in the investor's growing toolbox."

The inclusion of LPs particularly distinguishes this study -- their interest in ESG management is key to the trend of GPs adopting ESG management programs. The GPs ranged from funds with $500 million of capital under management to those with $60 billion investment records.

Although just six LPs were surveyed in the report, they included some powerhouse institutions, including the California Public Employees' Retirement System (CalPERS), the largest public pension fund in the U.S. CalPERS has invested in a green fund, developed an ESG code, and collaborated with consultancy Mercer on a number of ESG-related reports, according to the study.

Other LPs said private equity funds are responding to increased interest from investors in ESG. "My general impression is that ESG issues have risen quite rapidly on the priorities list of private equity general partners," said David Russell, co-head of responsible investment for the U.K.'s Universities Superannuation Scheme, in the report.

More than half of the funds in the study have developed (or are developing) an ESG management program to create value, often highlighting cost savings from eco-efficiency. For example, the Carlyle Group created a tool called the EcoValuScreen to help investment managers target cost-saving or other value creation opportunities during the due diligence process, according to the report.

"It's a positive sign that many of the ESG approaches we are seeing and applying at our portfolio companies are reflected in the broader industry," said Don Anderson, chief sustainability officer at Blackstone Group, in a statement.

The study also identified some challenges, including the current “lack of clear, standardized metrics to effectively measure and monitor ESG issues and their relationship to value creation.”

Other findings in the study:

  • 69 percent of fund managers say they have observed increased concern about ESG issues from their investors during the past three to five years.
  • More than 60 percent of respondents cite the increasing expectations of LPs, as well as the benefits of cost savings as the biggest drivers of increasing ESG focus.
  • A resounding 92 percent of fund managers expect to increase their attention to ESG management in the coming three to five years.
  • 85 percent of respondents noted that the rising cost of resources and the opportunity to boost earnings by cutting energy and other input costs is a major factor in their focus on ESG issues.
  • 62 percent of respondents noted ESG as material to a fund’s reputation.

The second half of the report explores detailed best-practices findings related to leadership, due diligence, operations and other areas.

Since structural changes in the private equity industry are boosting competition, GPs are looking to creating value beyond financing structure. It seems that the trend of ESG management -- and by extension sustainable practices -- will play an increasingly important role in the relationship between fund managers and their LPs in the years to come.

Photo of graph provided by violetkalpa

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