Do ESG Factors Help or Hurt Private Fund Returns? A New Report Has an Answer

Private ESG funds perform as well as others but impact funds have “significantly lower returns,” according to a Preqin report.

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In the often dogmatic debate over whether using environmental, social, and governance factors helps or hurts investment returns, neither side is going to cheer the findings of a recent Preqin report: ESG didn’t matter.

Preqin, the private markets data and research firm acquired by BlackRock this week, analyzed the internal rate of return for over 11,000 funds, including over 200 ESG funds, and found “no statistically significant difference in performance.” The average performance of ESG funds was 13.5 percent, compared with 15.0 percent for all private capital funds. The results were similar even after accounting for different asset classes. ESG funds did show lower variance in returns, “potentially because they are better able to manage downside risks,” according to the report.

The findings help affirm what Preqin reported in June after a survey; 66 percent of investors said they didn’t believe there was a link between ESG and performance.

But “[T]he necessity of ESG continues to divide opinion across the alternatives industry. While some managers may use ESG purely as a fundraising tool, many others continue to acknowledge its ability to help identify, monitor, and manage real risks to commercial returns and reputation,” Preqin’s report says.

Research findings in the sector have often conflicted. Some research has shown that ESG factors can boost private-equity fund performance and that ESG scandals — which can hurt an asset manager’s fundraising — don’t necessarily impact the performance of their funds.

Nonetheless, ESG factors are ultimately a bet that making the world a better place will translate into improved performance, or at least be more appealing to limited partners, so asset managers are paying attention to them.

Preqin’s survey of investors shows that 60 percent have turned down a deal over concerns about ESG, or would do so. The firm’s report says that is “proof that, despite skepticism, many still see ESG alignment as critical. For those that do not see ESG as a deal breaker, they should at least acknowledge its relevance for some of their competitors, and so remains strategically relevant.”

The report’s findings were also reassuring signs of ESG’s continuing relevance within alternatives, despite pushback, according to Preqin. In North America, ESG has become politicized and disruptive to some asset managers that have been vocal about using these factors to make investments, especially BlackRock. Investor interest in ESG funds has cooled since 2022 and lags that of global peers. Still, the majority of legislative efforts to bar the use of ESG factors when investing, and anti-woke proxy campaigns, have failed.

It’s possible, however, the anti-ESG efforts could gain momentum again. “The Presidential election later this year, and the potential for Donald Trump to return to the White House, could see this trend reinforced in North America, the most important regional market for alternatives, both as a source of capital and location for deals,” Preqin’s report says.

A related finding of the Preqin report was that a subcategory of ESG funds hasn’t performed well. The average performance of impact funds was only 7.4 percent, meaningfully lower than the 13.5 percent average for all ESG funds. (This is not the case for venture capital impact funds, which tend to perform just as well as other VC funds, research has found. Others argue that values-oriented investing is far from dead.)

“Impact funds hold investments made with the intention of generating positive and measurable social or environmental impact, alongside a financial return,” the report said. “These funds are usually values-driven and pursue social or environmental objectives which may come at the expense of financial performance.”