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The ESG advantage of private equity

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There is no doubt listed companies have historically been ahead of private equity-backed companies when it comes to ESG and this shows in the focus the topic gets when listed companies report. On earnings calls, for example, more than 20% of listed companies now highlight ESG, up from just 1% in 2005.

ESG data is also more widely available, with listed companies reporting on ESG matters at least annually. Private equity usually focuses on good governance – that’s part of the way it generates value – but the ‘E’ and ‘S’ elements have often been missing. Many small companies don’t even have ESG policies.

But things are changing. Private equity investors and private companies have woken up to the fact that sustainable trends are here to stay for the very long term. Themes such as climate transition, biodiversity and circular economy will touch all consumers, countries and companies. For example, more than $3trn will need to be spent globally for renewables to increase to a 55% share of the global energy mix by 2030 while around $9trn annually is needed to decarbonise heavy industry.

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Whether they are private or not, companies have to reinvent themselves across sectors with stakeholder objectives extending beyond profit maximisation to include social and environmental goals.

Focus will move from ESG, which measures how a company produces to impact, which focuses on what a company produces for society or our planet. Investors’ interest in sustainability has moved beyond it being seen as a risk mitigator to a value creator.

It is like an industrial revolution in fast forward, and as with every disruptive event there will be huge risks and also huge investment opportunities. And I think private equity, although currently behind public markets with respect to ESG and impact, has a huge advantage when it comes to encouraging change.

Private companies are well-placed to implement sustainable practices. They generally have pure-play business models with a tradition of being nimble and able to come up with innovative products and services.

Investors in private companies have three key advantages: influence, experience and long-term thinking.

You can influence listed companies in which you are a major shareholder either directly or, if a smaller investor, by collaborating with peers. But if you don’t like what a company is doing and the pace of change is slow, the best solution is usually to sell.

The private equity investment model of ownership is completely different and well adapted. As a majority or significant minority owner of a portfolio company you typically have one or two seats on the Board. You get to see the company’s inner workings, get timely information on financial and ESG and impact key performance indicators, and can drive change directly, and quickly, when needed.

Private equity investors with experience in sustainability investing can also offer an investee company their own experience. At Unigestion, our own experience not only of ESG investing over the past 18 years but of implementing Corporate Social Responsibility practices in our own firm has proved very attractive to the growth companies in which we are looking to invest.

And then there is the long term view. Far from the image of corporate raiders and asset stripping loved by the tabloids, most private equity investors have a longer time horizon than listed equity investors. Private equity funds typically have a 10-year life so there is time to really make a difference.

These are advantages which we have seen play out in our portfolio for many years, having launched our first environmental private equity fund in 2010. Although early, we learned quickly and, today, ESG factors are now integrated across all our private equity investments as they are for our equity portfolios.

We favour investment in private companies that promote social and environmental characteristics, some of which meet one or more Sustainable Development Goals.   We also work hard with them to improve their ESG practices and monitor progress rigorously, which can make a tangible difference to returns. One British nursery company we invested in, for example, implemented new health and safety policies on our guidance, reducing staff turnover and increasing demand from parents who gained extra trust from the new approach. Profits increased as a result.

Given these advantages, it is unsurprising that ESG and impact in the private equity industry is evolving fast. We have been members of the UNPRI since 2013 and the number of other private equity firms joining us has taken off in recent years.

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The Harvard Business Review has recently reported that more than 1,000 private equity and venture capital firms are now members of the UNPRI, four times as many as five years ago. ESG and impact is becoming more important to clients, with around three quarters factoring ESG into their investment decisions. As a result, investors are not just integrating in ESG into investment processes but starting to launch impact funds, some of which meet Article 9 of the SFDR – as does our climate impact fund which we are preparing for launch on climate impact does.

And data is also starting to improve following the launch last year of the ESG Data Convergence Project, bringing together over 100 general partners and limited partners, including Unigestion, representing some $8.7trn in AUM with the objective of standardising ESG metrics and providing a mechanism for comparative reporting.

While there is still much improvement to be made, there is no doubt that ESG and impact have moved to the forefront of private equity investors’ minds. And as our long experience working across equities and private equity has shown, both have much to learn from each other. By doing so, our broader industry can enforce the change our global economy needs to meet the climate challenge.

Fiona Frick is CEO of Unigestion

 

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