The Pressure Is on Private Equity To Take ESG Seriously

Investors say they lack sustainable options — and most private equity firms aren’t ready to increase the number of them anytime soon, according to new research.

Andrey Rudakov/Bloomberg

Andrey Rudakov/Bloomberg

Pensions and other institutions that want to hire private equity firms that consider the environmental impact or the diversity of a company’s employees in its investment decisions may have to wait a while. Only 24 percent of private equity firms took environmental, social, and governance matters seriously and at the same time had a mature process in place to evaluate these factors before acquiring a company, according to a survey by Ernst & Young.

About half of the investors surveyed by EY plan to increase their ESG private equity and venture capital allocations over the next two to three years, the consulting firm said in a report on the findings, expected to be released Monday. At the same time, 48 percent of investors believed there were enough PE and VC options available. That’s not necessarily good news for private equity firms.

“Investors are looking at how firms are ‘walking the walk,’ meaning how important and serious are ESG risks and opportunities being contemplated as part of the investment process,” said Kyle Burrell, partner at EY. But, “32 percent are still saying ‘we’re not taking ESG into consideration at all’ or ‘we look at ESG issues but investment returns are still the most important factor.’”

Private equity firms are changing, even if not fast enough for a lot of investors. There’s also a meaningful gap between the largest and smallest firms.

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Burrell said 41 percent of firms with more than $15 billion in assets said ESG was one of their top three priorities, right behind asset growth and talent. But only 29 percent of firms with between $2.5 billion and $15 billion in assets said the same. For the smallest firms, those with $2.5 billion or less, the figure plummets to 14 percent. Five years ago, only one to two percent of firms said it was a strategic priority, he said.

For its latest annual study, EY used an outside firm to survey 72 institutional investors and 127 private equity firms globally from June to October.

Forty-one percent of the largest firms surveyed have an internal task force to oversee ESG efforts, with 34 percent of those firms relying on a head of ESG. For mid-size firms, 37 percent have appointed a task force and 12 percent have a head of ESG. Twelve percent of the smallest firms use a task force, 2 percent have a designated executive for oversight, 19 percent rely on either the chief operating officer or chief financial officer, and 19 percent turn to a chief investment officer or a senior portfolio manager for their ESG efforts.

Europe is far ahead of the U.S. Sixty-six percent of European firms offer ESG products, with only 28 percent of North American managers saying the same.

Asset managers and investors that ignore ESG, climate change, and other sustainability issues are facing new and unintended risks.

“As firms integrate ESG elements in their investment decision-making process, those that ignore ESG considerations may unwittingly create an investment portfolio that fails to reflect risk and lacks proper management and disclosure, which makes returns appear to be safer than they are,” according to the report.

Sixty-seven percent of PE firms said the top risk was governance, followed closely by environmental issues, at 47 percent. Climate risk was at the bottom, with only 25 percent of respondents saying it’s a top risk.

Investors also want proof that asset managers are addressing these issues. While 84 percent of the largest firms are discussing policies and process with investors at meetings, only 34 percent are including responsible investment clauses in agreements and side letters. The smallest firms are doing less talk and more contracts. Only 28 percent of firms with less than $2.5 billion of assets are discussing ESG at investor and advisory board meetings, but 40 percent are documenting policies in contracts.

When asked about why more private equity firms aren’t offering sustainable and ESG type investments, Burrell said the answer likely depends on a firm’s sector or specialization, such as technology or consumer. This year’s survey didn’t include questions on the subject, but EY may include a section on barriers and challenges for private equity to offer ESG in next year’s study.