Private equity should hold firm on ESG  

Ask any managing partner at a large private equity firm these days and ESG will be cited as a top priority. But 2022 has raised some questions and the wider ESG-investment movement is now under attack from several fronts for doing too much and too little at the same time. While the focus is primarily on public markets for now, it may soon be levied with gusto at private markets, so the industry should decide on its response. 

In the U.S., populists are criticising businesses that look beyond profits. In recent months, Florida senator Marco Rubio introduced legislation to let investors sue companies that don’t maximise shareholder returns, while former presidential nominee Mitt Romney has signed a letter saying ESG scores are “politicising” S&P’s credit ratings.  

Elon Musk, this era’s most prominent CEO, recently labelled ESG a “scam”, while Tariq Fancy, BlackRock’s former chief investment officer, paints it as mere “greenwashing” or even a dangerous “placebo” that prevents real action.  

Governments and regulators too are asking questions, as highlighted by the recent raid at Deutsche Bank’s offices in Germany. With a potential recession looming large, governments, companies and investors may also focus elsewhere.  

In other words, should private equity firms still seek to become sustainability leaders? Is it worth the hassle and will it still carry a reputational premium? The answer to these questions is a firm ‘yes’. In fact, when others are asking questions, private equity has a chance to show substance and lead.  

Public markets had a head start when it came to integrating ESG, but a lot of things have gone wrong. Private markets have all the attributes of being able to charge ahead faster and better, especially during downturns. This includes direct influence over companies, a long-term focus, an affinity for data, significant resources, non-bureaucratic organisations, and young, hungry and extremely motivated employees.  

The backers of private equity, namely pension funds, sovereign wealth funds, insurers and increasingly wealthy individuals, are for the most part long-term investors that have a genuine stake in the issues that the ESG movement has set out to solve. Other key stakeholders, including employees and management teams, are also believers. 

All of this makes it easier to create alignment, measurable results at scale and invest when others are holding back. The smart thing for private equity management teams is therefore to continue the journey they started while ensuring that it can stand up to scrutiny.  

Each firm should identify and understand the issues that matter most to its stakeholders (have you asked your LPs, management teams and employees what ESG factors they actually care most about?), the strengths it has as an organisation and use this to set out a clear and differentiated strategy. Ensure you are making progress and be careful not to overclaim. If you get caught out, credibility is quickly lost.  

To reap the reputational dividend and avoid criticism, it is important not to slip from objective assessment around risk and opportunity to more subjective, case-by-case value judgements. Of course, context changes, and with it so should your policies and approach. But you need to be able to point towards a coherent framework.  

It is equally important to have focus and commitment. As with political campaigns, it works best to identify a few key themes and over time build momentum and credibility by campaigning on these issues by both acting and collaborating. 

If the industry gets it right, it will not only be an opportunity to address two of its biggest challenges – attracting a diverse base of motivated talent and the best investee companies – but also help it get some long-overdue credit for contributing to society. The individual firms that stand out in doing so are likely to reap outsized returns, with higher capital flows from LPs, access to the very best talent and an edge when bidding for the most innovative and ambitious companies of the future.