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Sustainability Boosts Returns for Private Equity Funds

Part I: Introduction to Environmentally-Driven Value Creation for General Partners

With the recent presidential campaign attention paid to Bain Capital, it seems likely that 2012 will be the year that Americans become better acquainted with the private equity sector.  Despite managing hundreds of billions of dollars of capital, the practices and often the very existence of fund managers such as TPG and the Carlyle Group are largely unknown to the general public.  However, as election buzz ramps up in a year where the economy is the primary focus we can expect this to change.  As Charles Riley of CNNMoney noted, “…The new hot-button campaign issue is private equity.”

As private equity fund managers or general partners (often referred to as GPs) become better known to the public, now is an opportune time for these investment professionals to consider sustainability initiatives as a driver of value creation.  But while private equity sustainability strategies will improve the public image for the sector, more importantly these actions drive returns for GPs and have the potential to accelerate deployment of sustainability practices.

Private equity fund managers strive to be savvy active investors, unlocking value that may be hidden to others.  In an era where resource constraints, climate change, and other environmental issues are already redefining competitive advantage, sustainability is another lens through which private equity funds can focus on boosting returns.  Leading funds such as Kohlberg Kravis and Roberts have actively embraced sustainability as a driver of cost savings; the firm’s Green Portfolio program has helped many of its portfolio companies including Dollar General and Sealy Mattress to avoid costs of over $365 million during the past 3 years.  Elizabeth Seeger, who helps manage KKR’s initiative commented that, “We are encouraged by the enthusiasm which our portfolio companies have shown for the Green Portfolio Program.  They see this as a way in which owners and management can collaborate to create shared value.”  Other well-known funds such as the Carlyle Group and Apax Partners are pursuing similar strategies.

Additionally, pension funds, university endowments, and other large institutional investors which provide capital to general partners are increasingly concerned about climate change and resource management as drivers of risk – in fact 570 institutions have become signatories to the United Nations Principles for Responsible Investing.  As massive institutional investors such as CalPERS act to manage new environmental exposures and to profit from growth in the low carbon economy, they will expect more in the way of sustainability management from their private equity general partners.

As we explored in our last series of articles about green banking, lenders and investors are finding ways to generate strong returns from funding more sustainable projects and companies.  Despite temporary setbacks in certain cleantech sectors, this trend will accelerate.  Toward that end, our next series of articles will showcase specifically how sustainability strategies help private equity GPs to improve returns.  We will look at:

  • Maximizing Earnings – Resource savings identified through the lens of sustainability have resulted in hundreds of millions of dollars of cost savings in recent years and have proven to be a meaningful boost to earnings at a time when growth in the economy has slowed.  Private equity funds, which own substantial interests in their portfolio companies, are well-positioned to guide these companies toward more sustainable practices, and to reap the benefits of doing so.  As general partners exit investments at valuations which are generally calculated as a multiple of earnings, the efficiency and waste reduction cost savings they’ve driven create even stronger returns for funds;
  • Managing Exposure – By training investment professionals to understand and act on the scientific, technological, and policy implications of the major environmental challenges facing our planet, fund managers can minimize exposure to resource scarcity, cost of additional compliance, and other risks.  Environmental due diligence can also identify cost saving and other value creation opportunities, as fund managers focus on green initiatives as an area where performance improvement will create value;
  • Satisfying Investors – As noted above, major institutional investors in the U.S. and abroad are encouraging the funds they invest in to meet new environmental standards.  Private equity funds should meet these increasing demands and can in some cases benefit from exceeding them.  At the end of the day, these institutional investors are the GPs’ most important stakeholders and private equity fund managers who want to demonstrate skilled adaptation to a changing world should engage their limited partners on sustainability issues.

We expect to see more about private equity funds in the media during the coming months.  We also hope to see much more about how these investment managers are leveraging environmental sustainability to drive returns while supporting a more sustainable future.

Andrew Malk is the Founder and Managing Partner of Malk Sustainability Partners (MSP), a specialty management consultancy, which guides businesses in developing profitable corporate environmental sustainability programs.  MSP has particular expertise in engaging private equity funds to unlock value through shifts in thinking about sustainability.  This article was written in collaboration with MSP Partner Zach Goldman. If you have enjoyed this series so far, we invite you to also download a complimentary Malk Sustainability Partners white paper outlining our case for green banking. It is available online here.

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