If the evolution of Environmental, Social, and Governance (“ESG”) spanning more than a century was indicative of the future, there would be little hope that one day we’d see ESG frameworks (or forms of it such as CSR or SRI) become a benchmark for successful private equity investing. But, with Limited Partners (LPs) increasingly in the driver’s seat on these and other issues, and given General Partners’ (GPs) need to more effectively differentiate themselves with investors, the dynamics all indicate that a paradigm shift in private equity investing is underway.
What does this mean for GPs? As one industry expert commenting on paradigm shifts quips, “When does one realize when the ice is melting around them? Generally when it’s too late.”
Admittedly, a broad perspective is needed to see this gradual shift as the private equity class continues to mature. According to a 2014 Global Sustainable Investment Review, Socially Responsible Investment (SRI) still hovers around 30 percent for all regions combined. And while GPs’ integration of ESG framework differs starkly by region due to respective regulatory environments, recent industry data strongly support the notion of a paradigm shift. For example, a 2015 ESG and Private Equity Survey looked at 2012-2014 growth of SRI relative to total managed assets. It found that all regions registered high single digit increases, with Europe leading the pack. There are numerous other industry studies and surveys that attest to the continued adoption of ESG frameworks, indicating that an ESG focus is slowly but surely becoming critical to GP differentiation.
Clearly, many obstacles remain to ESG integration on a global scale, especially for smaller private equity funds that likely don’t have the in-house capacity or expertise for added levels of due diligence or reporting needs. Overall, the lack of established track records and metrics available on ESG as well as the dearth of experienced managers present issues for LPs, facing decisions of how to effectively diversify and allocate funds to alternatives. Perhaps that’s why it’s so important for GPs to keep the broad perspective on ESG in mind when raising their first or next fund. LPs are aggressively embracing ESG, and have been driving the development and implementation of guidelines for ESG at a global level.
Sounds like ESG is here to stay, and GPs may want to take note. There is a distinct opportunity for market differentiation in the crowded alternatives space. What’s needed is for GPs to effectively market their ESG capabilities and respective investment approach. By telling their story and why ESG matters, and demonstrating commitment to the ESG cause via enhanced reporting and improved metrics, GPs can build recognition, credibility and awareness with LPs.
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