Shilpa Tiwari is executive vice-president of social impact and sustainability at Citizen Relations and the founder of Her Climb.
In 2015, the United Nations established the Sustainable Development Goals (SDGs) – a blueprint of 17 ways to make the world a more just, inclusive and sustainable place. The UN estimated that it would take approximately US$5 to $7 trillion per year in investments to achieve the SDGs. These goals provided the first real opening for private equity to take a firm step into the sustainable finance arena. But, while the door was wide open for the industry to start focusing on environmental, social and governance (ESG) criteria, private equity players have historically been slow to move on this opportunity.
Private equity (PE) generates value by its oversight of business units that are disregarded inside conglomerates or badly managed private companies and family-run businesses. The industry’s focus has been generally on short-term returns, leaving the long play to institutional investors, and with it most ESG considerations.
But PE is well placed to lead sustainable investing. The industry is large – so large that society won’t be able to tackle the climate crisis and other major challenges without the active participation of PE firms and their portfolio companies. In the last 15 years, the industry has been a steadily growing area of interest for limited partners (essentially silent partners, who have less liability then general partners and do not participate in business operations) because it offers diversification from listed assets. In 2021, the PE industry reached more than US$5 trillion in assets under management, with expectations to grow well beyond $11 trillion by 2026. Research by BlackRock shows that PE outperformed the S&P 500 and MSCI World indexes by 2.8 and 4 percentage points a year, respectively, between 2002 and 2020.
While the PE industry has been slow to dive into ESG, there are signs that PE investment is starting to align with global ambitions for a sustainable economy. But where to find those signs? “Follow the money,” says John Ruffolo, the founder and managing partner at Maverix Private Equity. “The finance industry is changing, and private equity is now responding to a whole range of new factors, including pressure from [limited partners] to consider ESG.” A 2020 INSEAD study called Green Shoots: Can Private Equity Firms Meet Responsible Expectations of Their Investors? found that 90% of limited partners factor ESG into their investment decisions, and 77% use it as a criterion in selecting general partners.
As of May 2022, the Net Zero Asset Managers initiative (an international group of asset managers committed to net-zero) had grown to 273 investors who collectively manage US$61.3 trillion. PE funds that invest solely in renewable energy assets raised about US$52 billion last year, a record, according to Bloomberg, and the available capital for such funds is about 25 times more than the amount flowing to fossil-fuel-asset funding. InBC Investment Corp. made its first investments in 2022, choosing a trio of Vancouver-based funds focused on entrepreneurs driving climate change action, advancing reconciliation efforts, and innovating for the future. Two years prior, in 2020, KKR announced an investment in Q-Park, a leading European parking garage operator. The investment’s intent was to support Q-Park’s transition to a more sustainable business model, including the adoption of electric vehicle charging stations and the implementation of energy-efficient lighting and heating systems.
In 2019, TPG announced an investment in Cibus, a plant-based food company that uses biotechnology to develop sustainable food products. With this investment, Cibus has been able to scale its operations and expand its product line, including the development of a plant-based alternative to meat. PE’s ownership model and flexibility could be transformative for climate; however, “most funds focus on climate-related technology and enablers, less so on decarbonization of heavy-emitting assets,” Ruffolo says.
However, while you would think that increased adoption of ESG into investment cycles would lead to increased ESG expertise within investment teams, it’s not the case. The real potential for disruptive innovations can be found at the intersection of ESG data and analysis and financial data and analysis. For now, taking a lead on ESG seems to consist of embedding ESG into the investment cycle: due diligence, on-boarding, holding periods, exits and reporting. The few players in the industry that are meaningfully stepping up on ESG are examining material issues through the lens of value creation and moving past the compliance checklist to identify opportunities that disrupt the status quo while generating healthy returns.
To hear more about how private equity is well positioned to lead on ESG, join us at noon (ET) on March 8 for a panel discussion on the topic. Click here to register.
