Private Equity: Investor Expectations Accelerate Companies’ ESG Transition

Investors’ expectations act as an accelerator of the sustainable transition for private equity (PE) companies. An improvement that is reflected in the performance of portfolio companies. In 2023, the use of renewable sources among PE companies increased, bringing the median share to 30%, compared to 28% the previous year, although geographical differences remain – for example between Europe, where companies obtain an average of 22% of their energy from renewable sources, and North America, where the percentage drops to just 1%.

Furthermore, 77% of investee companies have at least one woman in the C-suite , exceeding 64% of listed companies, while those that have a decarbonization strategy are 22%, compared to 29% of listed companies, but on the other hand the progress of the former is faster. These are some of the findings of the annual Sustainability in Private Equity report by Boston Consulting Group (BCG), which shows that the PE sector is proving to be a key player in the transition to sustainability.

With over $8.7 trillion in assets under management, the sector’s influence on environmental and social issues is growing and this is because, according to the report’s findings, investors are demanding tangible results in the ESG field and in the integration of asset managers into investment strategies.

“The growing focus on sustainability is not only a response to environmental challenges, but also a reflection of investors’ new priorities. A survey reveals that for 70% of Limited Partners (LPs), i.e. investors in private equity funds, companies capable of effectively managing sustainability issues can obtain higher valuations and it is no coincidence that 40% of them have already earmarked specific funds for climate investments,” explained Elisa Crotti, Managing Director and Partner at BCG, “Sustainability is important, both for General Partners (GPs), i.e. fund managers, and for limited partners. In fact, 85% of investors interviewed by our analysis expect to give greater priority to sustainability issues in the next three years.”

For private equity investors, sustainability is essential because it helps reduce risks and increase profits

According to the analysis, the sustainability conversation in private equity has continued to progress rapidly over the past year. “We have seen an acceleration in the number of climate-focused funds and a growth in sustainability-focused value creation efforts among portfolio companies.

The ESG Data Convergence Initiative (EDCI), the consortium of private equity fund managers (GPs) and investors (LPs) aiming to create a critical mass of sustainability performance data from PE firms, has rapidly expanded its coverage of the private equity universe to include more than 450 leading managers and investors.

With more than 150,000 data points collected from approximately 6,200 private equity-backed companies, we now have a significantly deeper understanding of sustainability outcomes in private markets,” said authors Benjamin Entraygues , managing director and senior partner in BCG’s Paris office, and Vinay Shandal , managing director and senior partner in BCG’s Toronto office.

Many of the managers interviewed in the report are committed to sustainability, with half of respondents saying it is central to their company’s mission.

An even larger share, two-thirds, said sustainability is important because it helps reduce risk in portfolio companies. Attracting capital from limited partners and increasing portfolio company revenues were cited significantly more frequently than historically relevant drivers of ESG activities, such as regulation or compliance. This further reinforces the belief that sustainability efforts are critical to overall value creation and capital formation. As with investors, the sustainability themes that PE fund managers place most importance on are climate change, reporting, and diversity, equity, and inclusion (DEI).

The high importance placed on reporting and transparency by both managers and investors is not surprising, the report says, as many investors are preparing to respond to demands for several new sustainability reporting standards, such as those of the Corporate Sustainability Reporting Directive (CSRD) or the International Sustainability Standards Board (ISSB). However, managers are also placing significant emphasis on a broader range of topics, including cybersecurity, supply chain risks and employee value proposition, which are considered material social and governance issues and are likely to be more tangible for GPs involved in the day-to-day management of their portfolio companies.

Sustainability and Net Zero: The Gap Between Ambition and Reality

Yet the road to Net Zero remains fraught with obstacles: only 22% of private equity-backed companies have a decarbonization strategy, compared to 29% of listed companies. Where such strategies are in place, results are achieved more quickly: private companies are reducing emissions at a significantly faster rate than listed companies. The adoption of renewable energy is a case in point. Among the private companies analyzed, the use of energy from renewable sources rose in 2023, bringing the median share to 30%, compared to 28% the previous year.

Furthermore, the narrowing gap between private and public companies in adopting this type of energy is promising. The share of private companies that have increased their use of renewable energy by at least 25% has increased from last year (2%), reaching 12%, compared to 6% of public companies in the same period. Furthermore, there are still large geographical disparities: private companies in North America are still far behind their European counterparts. On average, European companies (including those that do not use renewables at all) get 22% of their energy from renewable sources, compared to just 1% in North America, which recorded 0% last year.

Diversity and Work: A Gain for Private Equity

In addition to the environment, the BCG report also highlights progress on the social front . 77% of investee companies now have at least one woman in leadership, compared to 64% of listed companies. However, the gap in boards of directors remains evident (61% versus 89%).

Private equity also stands out in job creation: despite the impacts of global economic pressures on the labor market, in 2023 PE firms generated four new hires for every 100 employees, compared to just one among listed companies.

A Call to Action for the Future

Private equity is at a crucial point in its sustainability journey: integrating sustainability into corporate strategies is no longer an option, but a necessity to create value and maintain competitiveness.

As sustainability initiatives within the sector continue to mature, improved data collection and transparency will provide valuable insights for allocators, managers, and portfolio companies to maximize their impact and turn sustainability into a competitive advantage.

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(Featured image by Scott Graham via Unsplash)

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