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Sustainability Boosts Returns for Private Equity Funds, Part IV

Meeting the Expectations of Limited Partners

Our last installment of this series looked at how private equity general partners can benefit from enhanced consideration of environmental, social, and governance factors during transactional due diligence. In this edition, we examine the evolving expectations of the institutions which invest in private equity as an asset class.

In late March, I had the opportunity to speak about impact investing at the Information Management Network’s 2012 Spring Investment Series, an event attended by managers of pension funds, endowments, foundations, and a wide array of financial advisers.  While the content of the event covered a wide array of industry topics, from capitalizing on rapidly expanding secondary markets to global economic forecasts intended to guide fixed income asset allocation, the importance of environmental, social, and governance management was raised during several panel discussions.

The emerging commitment of this community to responsible investing has a direct impact on private equity general partners (GPs) as these institutions invest in private equity as limited partners (LPs). As LP expectations continue to rise, GPs will need to increase their management of environmental, social, and governance (ESG) issues in order to raise the capital necessary to acquire companies.

To be fair, many attendees still view responsible investing as a nascent rather than established concept. However, institutions are beginning to take action. For example, Linsey Schoemehl of the Illinois State Board of Investment shared her organization’s experiences as a signatory of the United Nation Principles for Responsible Investment (UN PRI). These principles provide benchmark standards and practices for investors to integrate ESG considerations into their activities.

Although less than a decade old, over 1,000 institutions representing approximately $30 trillion of assets under management have signed the principles – that’s roughly double the annual gross domestic product of the United States committed to responsible investing! Participating organizations include institutional investors such as the New York State Local Retirement System and UAW Retiree Medical Benefits Trust, investment managers such as Goldman Sachs and PIMCO, and private equity general partners such as KKR and Darby Private Equity, among others.

Signatories of the principles make a number of commitments which affect the assets in which they invest. These include, among others:

  • Incorporating ESG issues into investment analysis and decision-making;
  • Being active owners which incorporate ESG issues into ownership policies; and
  • Seeking ESG disclosure from the entities in which they invest.

The rapid adoption of the UN PRI is indicative of a rapidly evolving focus on ESG management by investors in private equity. As part of an ongoing study which the Malk Sustainability Partners team is conducting on this subject, we recently had the opportunity to speak with a number of LPs on their views of ESG issues and their relationship to investment performance.

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