In recent years, impact investing has become mainstream and private equity (PE) firms are playing a key role. Despite being dismissed by some as “woke capitalism”, impact investing is a trend that is here to stay. Impact investments seek to create a positive impact by investing in sustainable companies, this includes ethical companies with a social and environmental purpose. The goal is to support organizations with measurable societal benefits.
A shift is reverberating throughout the investment community as it is becoming increasingly clear that investors are being drawn to the enduring quality of impact investments. PEs are changing systems and control processes to accommodate this shift.
To illustrate, BlackRock, the world’s leading investment firm, with more than $7 trillion worth of assets under management, has announced that climate will play a central role in investment considerations. The increasing interest in impact investing is being driven by society-wide awareness of climate change and other sustainability issues. Impact investing is well suited to confront the challenges we face, it can be scaled and adapted to all different types of investors across asset classes, sizes, and geographies. The most sustainable private equity firms possess unique skill sets that enable them to address some of the most serious issues humanity has ever faced.
PE firms have the ability to take tangible action that has a demonstrable effect on key sustainability issues. PEs also provide strategic guidance that includes the implementation of best practices. According to a PwC publication, PE firms have an edge in the effort to drive sustainability. In the face of the “imperative to repair, rethink and reconfigure” PEs help to bring about rapid transformative change, in the words of PwC, “PE funds [have]…the capacity to drive change more aggressively and quickly than other investors.” PE firms are accelerators that help companies to gain scale and drive down costs.
PE firms have helped to grow the popularity of impact investing
The sheer volume of capital on the table is game-changing. According to a report published by Ceres, the Net Zero Asset Managers initiative has grown to 128 investors who collectively manage $43 trillion. PE is a fast-growing industry that has seen tremendous growth with even more forecasts in the coming years. According to Prequin, the size of PE assets under management has multiplied 6 times since 2004 and tripled in the last decade and Prequin predicts that PEs will grow by 30 percent between 2019 and 2025 when PEs are expected to reach $8.3 trillion.
A large and growing share of that investment capital is going towards impact investments. This is driving what Martin Calderbank, the managing partner of Agilitas, called a “sustainability revolution”. The rapid growth of sustainability investing by PE firms is being driven by increasing public demand for climate accountability, political action, and disclosure requirements from regulators.
In an interview with Private Equity International (PEI), Tania Carnegie, the Global Private Equity and Asset Management Leader for KPMG Impact, said she is confident about the future of impact investing. She attributes its growth to broader calls for the evolution of capitalism. She says that PEs are increasingly understanding the intersectionality of environment, climate, and social factors and she expects the understanding of investment opportunities to continue to become more holistic going forward.
Proof that Sustainable Investing Can be Profitable
According to the Ceres report, private equity firms are investing in climate and other sustainability-related domains because investors see the potential for significant returns. As stated by Calderbank, there is “mounting evidence that harnessing the transformational power of private capital to create environmental and societal value also contributes to remarkable risk-adjusted financial returns”.
In addition to creating significant environmental and societal value, investing in sustainability affords strong financial returns. The business community is also acknowledging the growing need to guard against operational, reputational, and legal risks.
Calderbank lauds investing sustainably saying, “the alignment of shareholder value with fundamental purpose, as well as reducing risk for investors, can establish a powerful virtuous circle through which positive fundamental impact and investor returns are mutually reinforcing and thus offer the possibility of exponential performance.”
Interest in sustainability-focused investing is growing while those who fail to meet high standards are vulnerable to value erosion from regulatory and consumer forces.
More Funds Diverted to Sources of Renewable Energy
Fossil fuels are at high risk of becoming stranded assets and PEs have a significant stake in the energy sector. Bloomberg reports that PEs made $261 billion worth of energy deals since 2017, which amounts to around one-fifth of the total transaction. In 2020, U.S. renewable energy investments by private equity firms were more than $23 billion, which represents a four-fold increase and the largest annual amount to date.
As reported by the Green Market Oracle, oil investments are being abandoned by investors as vast sums of money are being moved away from fossil fuels in favor of carbon-neutral climate investments like renewable energy. Big private equity investors like BlackRock, Warburg Pincus, and Riverstone Holdings are moving in this direction. Sustainability is a salient factor in the investment decisions being made by some of North America’s largest pensions funds, and fund managers are responding to the demand for a shift away from fossil fuels to renewables,
Renewables have significantly outperformed conventional energy-focused funds. According to Preqin, conventional energy investments lost 5.6 percent between 2010 and 2021 while renewable-focused funds gained 8 percent in the same time frame. Renewable energy funds raised $258 billion in the decade through 2020 and renewable energy-focused private equity firms raised a record $52 billion in 2020 according to Bloomberg. In the first half of 2021, 80 percent of energy money went towards renewables or 25 times fossil fuel asset funding. Banks are now providing more funding to clean sources of energy than to fossil fuels.
Increased Focus on Environmental, Social and Governance Factors
ESG is emerging as the key locus of value creation and a major competitive advantage. Interest in impact investing is being driven by environmental, social, and governance (ESG) factors*. Sovereign wealth funds, university endowments, public employee pension funds, and mainstream institutional investors are engaged in a range of ESG topics. The Covid-19 pandemic appears to have heightened the importance of ESG and consumers have shown increasing interest in sustainability due to the pandemic.
PE firms are also engaged in a wide range of ESG considerations. According to an article posted by BLG (Borden Ladner Gervais LLP), a leading, full-service Canadian law firm, interest in ESG factors by PE firms has increased substantially of late. This is attributed to data that shows ESG drives value and limits risk. Carnegie says PE is increasingly “going deep” on ESG because of concerns related to due diligence and best practices that prioritize sustainability factors.
Moving Beyond Financial Value
In addition to being a powerful risk management tool and a lever for value creation, PEs have the power to do tremendous good, driving capital where it can offer the most benefit. Private equity firms are leading sustainability investing to drive positive change. PEs are creating sustainable environmental value while promising strong financial performance
PEs are ideally suited to address decarbonization the issue at the core of the climate crises. PEs can apply in-house cost-cutting expertise to create value by reducing the costs of slashing carbon. The same logic can be applied to other sustainability challenges. PE firms can also leverage their position to drive down emissions in their own operations and in their portfolio companies.
Some PE firms are taking their commitment to sustainability one step further and becoming Certified B Corporations. This means such firms meet the highest standards of verified social and environmental performance, public transparency, and legal accountability. B Corps are at the forefront of efforts to build a more inclusive and sustainable economy. One such leader is Generation, with $36 billion under management their investments drive the kind of transformative change required for a net zero, prosperous, equitable, healthy, and safe society. A generation has been a leader in ESG investing since 2004.
Socially Responsible Investing and Sustainable Development Goals
There has been a torrent of corporate sustainability reports, third-party scorecards, and indices, that measure, monitor and quantify companies’ sustainability performance. However, according to Carnegie, PE needs impact standards like the work being done on ISO standards for sustainable finance and the EU is developing green taxonomy for sustainable activities.
The U.N. Sustainable Development Goals offer a standardization framework. SDGs are like a shared set of ESG action challenges that support and reinforce each other. The SDGs are a global mandate agreed upon by 193 countries in 2015. The SDGs are organized into 17 goals** with corresponding targets and indicators. A recent report from the Emerging Markets Private Equity Association (EMPEA) expressed its support for efforts to develop a common approach to SDG investing while saying PE firms can deliver, “important outcomes across key SDG themes”.
The U.N. Commission on Trade and Development estimates that meeting the SDGs will require more than $5 trillion – $7 trillion in annual investment. Only a small proportion of this will come from public funds and development aid, leaving an investment gap in developing countries of around $2.5 trillion. However, the commission cautions that “seizing these opportunities will require innovative thinking, partnerships, and collaboration with non-governmental organizations (NGOs), peers, and regulators”.
There are powerful financial incentives driving investments in SDGs. For example, Morgan Stanley said the unequal access of women and minorities is a $4.4 trillion missed opportunity. There is also evidence to suggest that investing in gender equality outperforms mainstream investments. Data in a research paper from Boston Consulting Group indicates that women receive less than half of the investment dollars compared to their male counterparts, but they have earnings that are twice that of men (78 cents per dollar invested compared to 31 cents for men).
Businesses will play a key role in realizing a more sustainable world and the SDGs explicitly call on businesses to both minimize negative impacts and maximize positive outcomes. According to a report by the Business and Sustainable Development Commission (BSDC), achieving all of the SDGs could create an estimated $12 trillion a year in business savings and revenue.
List of Top Sustainability-Focused Private Equity Firms
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