Sustainability in private equity

The private equity industry has finally stepped onto the unstoppable train that is the sustainability movement. There is rarely any debate nowadays as to whether environmental, social and governance (ESG) considerations can be powerful drivers of value creation. The key challenge lies in execution.

In this white paper, we shed light on how sustainability practices of private equity managers are evaluated using our assessment framework. In addition, we hope this paper can be a useful resource for private equity managers who have only recently embarked on their own sustainability journey and are now looking for guidance. We are doing this not only because we believe the influence of the private equity industry, which has enjoyed tremendous growth in the past decades, can be channelled into addressing systemic challenges facing global communities.

We are also a firm believer that properly incorporating ESG considerations ultimately delivers strong financial returns for investors, in a long-term sustainable manner.

Sustainability is now mainstream in the private equity industry

In a survey of 117 private equity managers, 100% of respondents believe that sustainability is relevant to investment decision-making (Figure 1)¹. In another 2020 survey of over 50 private equity managers, over nine in 10 respondents (93%) believe that focusing on ESG themes will generate good investment opportunities².

Sustainability is now mainstream

Private equity is well-positioned to take the lead in sustainability

• Long investment horizon
  While private equity is far from immune from short-termism, the average holding period for portfolio companies is around five to six years³. That allows private-equity-owned companies to operate on a longer time horizon than most publicly traded companies, whose executives often feel compelled to manage the business to meet quarterly guidance. An adequately long time frame is often required to realize ESG objectives such as reducing greenhouse gas emissions and for the benefits of successful sustainability initiatives to be reflected in the financial value of the business.
• Control-oriented approach and greater access to information
  Private equity firms are often well-placed to exert significant influence, if not outright control, over their portfolio companies. This can include encouraging for stronger sustainability practices. The information advantage, coupled with its control-oriented ownership model, can put private equity firms in a powerful position to drive changes in corporate behaviours.

WTW private equity sustainability assessment and engagement framework

At WTW we believe that properly incorporating sustainability considerations, including both risks and opportunities, is central to successful long-term investment outcomes. This foundational belief spurred the development of a structured and disciplined process for integrating ESG considerations into our manager research decisions.

In evaluating the sustainability practices of a private equity manager, we use a six-dimensional framework to assess the overall commitment to sustainability and the sophistication of ESG integration (Figure 3). The key is to pinpoint clear evidence that ESG integration has gained collective buy-in and become institutionalised, supported by a clearly defined governance structure and a fit-for-purpose resourcing model.

How WTW assesses sustainability credentials of a private equity manger

1. 01

   Overall commitment to sustainability

   • An evolving sustainability policy that reflects collective beliefs on why sustainability matters and details how ESG considerations are embedded in the entire private equity investment cycle including deal origination, due diligence, deal structuring, portfolio management and exit
   • Demonstration of commitment to industry standards/guidelines/best-practice frameworks and evidence of actionable learnings from participating in these initiatives 
   • Evidence of contractual commitments related to sustainability (e.g., in side letters or limited partner agreements)

2. 02

   Sustainability resources

   • A clear governance structure outlining sustainability oversight responsibilities within the organisation
   • Evidence of senior leadership buy-in and involvement, supported by dedicated ESG specialists and/or third-party consultants
   • Evidence of regular and firm-wide efforts to provide sustainability training, assistance and external resources to investment and operational teams as well as portfolio companies

3. 03

   ESG integration: pre investment

   • Evidence of in-depth and consistently conducted ESG due diligence, led either internally by the manager itself or assisted by external ESG consultants
   • Documentation in investment memos of materiality-based assessment of ESG risks and opportunities and evidence of material ESG findings influencing investment decisions, including pricing decisions and downside protection structuring, and ESG objectives and milestones as part of the value creation plan

4. 04

   ESG integration: post investment

   • Embedding of a sustainability action plan in the portfolio management and value creation process
   • Evidence of incorporating ESG responsibilities in leadership roles at portfolio companies, including remuneration measures related to sustainability
   • Evidence of ongoing monitoring and management of ESG considerations at portfolio companies

5. 05

   Reporting

   • Qualitative and quantitative updates on ESG considerations/KPIs featured in regular communications, ideally quarterly
   • Established disclosure framework in action to material ESG incidents
   • Reporting on engagements with portfolio companies, including the entity engaged with; the objectives/topic and rationale of the engagement; actions taken; outcomes and next steps

6. 06

   Sustainability impact

   • A transparent approach to measure, assess and report impacts of investment holdings on the wider environment and society
   • Evidence of decreasing carbon footprint and other environmental improvements, at portfolio companies and at the private equity business
   • Evidence of aligning portfolio companies and the private equity business with net-zero goals
   • Evidence of increasing diversity and other societal improvements, at portfolio companies and at the private equity business

Footnotes

¹ “ESG and the SDGs: Insights from private equity managers”, LGT Capital Partners, 2020.
² “Eyes on the prize: unlocking the ESG premium in private markets, ERM, 2020”.
³ “Prolonged Private Equity Holding Periods: Six Years Is the New Normal”, Joenvaara et al, The Journal of Alternative Investments Summer 2022

For the full report and analysis, download the paper below.

Contact

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Liang Yin, PhD, CFA

Director, Private Equity research

email Email

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