Stewardship Surge Predicted in Private Equity
ESG is an increasing factor in deal flow and value creation, but regional variations persist across markets.
General partners (GPs) of private equity (PE) will hold even more stewardship discussions with portfolio companies following a recent rapid acceleration, according to speakers at the International Corporate Governance Network’s Global Stewardship Forum.
“We’re going to have a lot more discussions around corporate governance and stewardship in the PE space,” said Walter Viguiliouk, Managing Director of Sustainable Investing, Private Markets at Manulife Investment Management, speaking on the forum’s Stewardship in Private Equity panel.
“PE is a massive part of a lot pension plans and institutional investors’ allocations. That growth brings new expectations, transparency, and conversations with it.”
Alternative assets and insights provider Preqin’s ‘Future of Alternatives 2029’ report forecast the global alternatives industry to rise from US$16.8 trillion in AUM at the end of last year to reach US$29.2 trillion by 2029. According to the report, PE is on track to more than double in AUM by 2029, from US$5.8 trillion in 2023 to US$12 trillion.
Last month, LGT Capital Partners’ ESG Report 2024 found that 73% of the more than 300 assessed PE managers have robust ESG processes in place, a jump of 46% from 27% in 2014. In the past year alone, 33 PE managers significantly improved their ESG efforts, which resulted in a higher rating for their firm.
This week, a report released by financial data provider Pitchbook underlined that PE is a good fit for ESG implementation for reasons including GPs’ ability to conduct extensive due diligence on potential investments. In total, 527 respondents completed the survey while 1,158 provided at least one answer, with 26% being fund managers and 14% being asset owners. Survey respondents suggested that PE and venture capital are the strategies in which the most GPs utilise ESG factors within the private markets universe.
“Stewardship is business-model agnostic,” said Susanne Stormer, ESG and Sustainability Services Leader at PwC Denmark. “It’s the gel that ensures understanding of what drives value and helps making business decisions. I don’t see any business operating without stewardship.”
A report released by the Principles for Responsible Investment earlier this year claimed a “natural fit” between stewardship and PE. The research highlighted that GPs reported experiencing significant benefits from effective stewardship, including enhanced client relationships and a positive impact on company earnings. Several GPs even shared that strong ESG stewardship capabilities had helped them with deal flow or closing competitive deals.
Stormer said there have been cases where ESG was the “deal breaker” behind potential new owners or investors walking away from transactions. “ESG is a lever of value creation, but its absence can lead to value erosion,” she added, “ESG due diligence is now a de facto part of deals when it wasn’t just a couple of years ago.”
In the private markets, GPs create and manage the fund, while limited partners (LPs) are investors – either institutional or private – that commit finance to such projects.
Earlier this year, S&P Global Market Intelligence analysis found 344 global pension funds’ median PE allocation stood at US$272.8 million. Meanwhile, research from investment manager Downing found a quarter of public pensions were looking to increase their PE allocations by 50% or more over the next three years.
Regional differences
Stanley Kwong, Principle for Sustainable Investing at investment company KKR, said challenges had begun to emerge from regional differences, in terms of incorporating ESG factors into the PE sector’s investment decisions and processes, with some regions pushing ahead while others are stalling.”
According to the LGT Capital Partners’ report, 87% of Europe’s PE managers were rated either ‘excellent’ or ‘good’ for their ESG practices, ahead of Asia at 76% and the US at 53%.
Europe’s direction of travel, being driven by the LPs and regulatory environment, is fairly clear, said Kwong, with ESG processes increasingly forming a baseline for firms in Europe.
“On this side of the Atlantic, it’s easier to have conversation about stewardship or sustainability,” said Viguiliouk. “However, it can be more challenging due to there being a lot more regulation, as well as uncertainty around the direction of some of that regulation.”
He added that Manulife has faced challenges on accessing ESG-related information from non-European companies, saying there have been “really low reporting rates from North American and even Asian companies”.
“With approximately 30% of companies reporting, it is challenging to make conversations with investment teams meaningful as you don’t have enough of a basis to start comparing and drawing insights and conclusions between firms,” said Viguiliouk.
“In North America there’s a complicated conversation happening politically,” he added. “The way forward for investment teams is to really be very focused on the issues they’re going to zero in on, and have a good thesis to articulate how that connects to creating value for that business.”
In addition to regional differences, data remains a challenge for stewardship. In Pitchbook’s survey, 35% of respondents said the subjectivity and lack of standardisation around ESG contributed to their decision not to utilise it in their investment process, an issue which data could help tackle.
“Data is very limited in the in the private market,” said Kwong. “That doesn’t mean we don’t do ESG assessments, but it makes the challenge much more difficult because we’re working in an uncertain environment where we’re also trying to price seven years or so ahead.”
Collective efforts
Pitchbook’s report also found that 36% of nonpractitioner respondents said use of ESG factors in investment processes constitutes a breach of fiduciary duty.
Speaking on an earlier panel at the event, Valeria Piani, Head of Stewardship at UK-based asset owner Phoenix Group, expressed concern about sentiments that collaboration between investors to address ESG factors such as climate risk contravenes legal obligations or fiduciary duty.
Investor initiative CA100+ has increasingly become a target for anti-trust allegations from US politicians seeking to characterise investors’ climate-related engagements as detrimental to jobs and prosperity. While Europe and the US have similar guiding principles fiduciary duty the two regions diverge on ESG, with the US lacking formal federal-level laws and regulations specifically mandating ESG investing.
“We feel very strongly that collaborative engagement is a part of the future [and this] should not even [be up for] debate,” she said. “We need to have a conversation with companies on climate change or inequalities. We’ve spent years demonstrating this is not against the law, and it’s actually something that companies can get a lot out of as well as investors.”
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