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LPs Are Turning Down Alternatives Managers Over ESG Concerns

Almost 40 percent of allocators surveyed by Preqin said they would reject a private capital fund that doesn’t meet their ESG standards. A quarter said they’ve already done so.

If alternative managers don’t embrace ESG, they may risk losing business.

A quarter of limited partners surveyed by Preqin said they have turned down an investment opportunity due to concerns over ESG standards, according to the research firm’s latest report on environmental, social, and governance investing, expected to be released Thursday. Another 39 percent of limited partners said they are prepared to do the same if necessary.

Currently, 42 percent of the $10.3 trillion private capital is managed by funds with active ESG policies, but the penetration rate differs across asset classes, Preqin said. Private equity and venture capital firms lead ESG investments by value, with a total of $2.26 trillion assets dedicated to ESG-related products. But in terms of percentage, PE and VC firms are dwarfed by infrastructure and private debt managers, which have 64 percent and 59 percent of assets under management dedicated to ESG, respectively. 

“While many GPs do consider ESG as part of their long-term risk exposure within investment appraisal, much of their increased focus in recent years has been driven by investor demand,” Preqin said in the report. Limited partners agree: Seventy-two percent believe they are one of the main reasons why general partners have established ESG policies, according to Preqin. 

One reason behind the high ESG penetration rate in private debt funds is that the rise of the asset class has coincided with the growth of ESG investing. Private debt only become a standard part of institutional portfolios in the wake of the financial crisis, as investors sought out yield amid record-low interest rates.

Meanwhile, venture capital and early-stage strategies are the most widely used for impact investing. Ninety-eight North American VC funds and 33 European VC funds are categorized as impact funds, according to the report. In addition, 55 North American private equity funds and 52 European PE funds are impact funds.

Despite the growth of ESG in alternatives, the lack of standardization remains a large challenge. In a recent survey of asset owners, only 23 percent said they were satisfied with the data provided by their ESG index providers. According to Preqin, some private market funds have attempted to address this issue by adopting ESG frameworks set up by the UN PRI Corporate Reporting Reference Group and the ILPA Convergence Project.

“While progress is being made, alignment on common framework and guidance continues to be an issue,” Preqin said in the report. “Unless there are clear and well-defined standards and definitions, assessing the quality and integrity of ESG commitments will remain a challenge.”

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