You could not go far in the investment world in 2019 without hearing about environmental, social, and governance management (ESG). According to Bloomberg, global sustainable investments grew by 44 percent to US $30.7 trillion over the past two years. Similarly, many more funds in the U.S. added ESG management to their prospectus, bringing the total up to about 500 firms. In 2019, considering climate change in the investment process and making diversity a priority were key ESG considerations. Now, here are five trends to watch for in 2020:
Higher Standards for Diversity in PE
Amidst an evolving climate of social responsibility, 2019 was a tipping point in the cultural shift towards increased emphasis on diversity and inclusion in the private equity space. Notably, the vice chairman of the Oregon Public Employees Retirement Fund voted “no” on an allocation to TPG after voicing his concerns around a surprising lack of female diversity amongst its leadership team. As LPs increasingly take diversity into account in allocation decisions, specifically keying in on minorities and women in senior positions, GPs will have additional incentive to improve representation. In many cases, this will mean a refresh of resources available to particular groups such as mentorship programs, retention efforts directed at underrepresented demographics, and innovation within legacy recruiting methods to increase the pipeline of diverse talent.
We have seen a slow rise of the narrative around diversity in private equity. At an institutional level, the ILPA has been engaged in a years-long endeavor to address the racial and gender inequality present in private equity, including augmenting its due diligence questionnaire to cover GP diversity back in 2018. But increased pressure around diversity will call for more innovative approaches and tangible progress. One example of this exists in KKR’s partnership with Harlem Capital, which utilizes a referral system of Harlem Capital’s interns and entrepreneurial candidates, funneling them to KKR internships and full-time positions. Thus, in 2020, it is reasonable to expect this trend to continue to proliferate, creating an environment where higher standards for diversity and inclusion efforts are the rule rather than the exception.
Impact Investors’ push to disclose and measure actionable impact strategies
After impact investment strategies surged in 2017 and reached an estimated worldwide total of $502B in 2019, impact investors are now looking to standardize their disclosures of positive social and environmental impact. Since the release of the UN Sustainable Development Goals in 2015, impact investors have used the SDGs to align their investments to global goals. However, with increased awareness of impact investing and concern from investors and fund managers alike of “impact-washing,” the impact investment industry has moved toward standardization. The International Finance Corporation (IFC) established standards for impact managers and the Impact Management Project’s framework (IMP) has helped align limited partners’ expectations for a fund’s measurable impact performance. Through a global consensus, the IMP incorporates five dimensions to measure: 1- scale, 2- duration, 3- target population, 4- adverse risk, and 5- additionality of impact.
These drivers have led to some precedent-setting moves in the industry, including from firms like KKR and TPG, which have designated $1B and $2B to impact strategies, respectively. These firms have committed to assessing and verifying their impact funds through the World Bank’s International Finance Corporation, which will consist of an independent verification of the fund’s annual impact investment report.
Given mounting political pressure and public scrutiny on private equity firms, industry-led initiatives to demonstrate tangible and measurable impact outcomes aligned to LP expectations will continue to be an emerging area of focus for impact investors.
Increasing Concern about AI Bias
Artificial intelligence capabilities continue to evolve in their sophistication and the scope of their applications at a remarkable rate. As this trend accelerates in the new year, AI hygiene—practices to reduce discriminatory tendencies of AI algorithms—will continue to become a central focus in the development of these technologies. As witnessed in recent years, many AI platforms currently exhibit an alarming propensity for bias. In 2018, researchers at MIT discovered widespread racial disparities in facial recognition technology effectiveness, including in products made by IBM and Microsoft. In 2019, high profile instances of AI bias included allegations of discriminatory credit limit assignments that favored male users of the Apple Card, which implicated both Apple and Goldman Sachs. In recent years, Google’s image search results have been scrutinized for providing skewed results (e.g. underrepresenting women in image searches for “CEO”).
Studies show the underlying data with which an AI algorithm is trained is usually the culprit, rather than the contents of the algorithm itself. When models are fed data that contain human decisions or reflect second-order effects of societal or historical inequities, those biases are internalized and inadvertently reinforced via feedback loops. As AI continues to be applied to potentially sensitive areas such as hiring, criminal justice, and healthcare, it will be expected for companies in 2020 to be more conscientious of their development practices, in some cases leveraging third-party algorithm consultants to audit and certify their products as free of bias.
Despite ample research highlighting the financial and societal benefits of pay parity, discrepancies in wages between men and women in similar roles continue to persist. As it stands, women around the world are paid only ~68.6% of the total earnings of their male peers, and recent findings by the World Economic Forum (WEF) estimate that true global pay parity will not be achieved for another ~200 years. Clearly, although the wage gap has been widely recognized, little progress has been made to close it.
However, new regulatory developments and highly public pay gap scandals at organizations such as the BBC will likely prompt companies to take action to address wage discrepancies—both in 2020 and in the ensuing decade. Within the US, states such as California and Massachusetts lead the charge for pay-parity legislation, recently implementing regulations requiring wage disclosures to increase transparency and banning salary history questions in interviews which protects employees from receiving starting salaries that are tied to low past salaries. Internationally, the United Kingdom’s recent changes to the Equal Pay Act require all companies with more than 250 employees to report gender pay gap data publicly and to the government, introducing the potential for public scrutiny.
Beyond regulatory requirements around pay parity, reputational scrutiny around pay gaps and the demonstrated benefits of pay parity for companies will prompt action to address pay gaps in 2020. Key steps to be taken at the company level include providing more extensive parental leave benefits, increased transparency around pay brackets, implementing hiring practices to prevent gender bias, and professional development programs aimed at increasing numbers of women in senior roles. Although awareness of the pay gap has been widespread for years, changing regulations and demonstrated benefits of pay parity will prompt companies to take action to identify and address pay discrepancies in 2020 and the coming decade.
The Rise of Employee Activism
Employees are taking an active role in dictating the direction of the companies for which they work. In 2018, 20,000 Google employees staged a walk-out in response to corporate mismanagement of credible sexual harassment allegations, and the following year, Walmart employees staged a walk-out to protest the sale of guns in company stores. Employees’ empowerment in interjecting their voices into company practices is becoming widespread. An online survey among 1,000 employed American adults by Weber Shandwick and KRC Research found that the majority of Americans believe that employees are right to speak up about decisions made by their employer, whether they are in support of those decisions (84%) or against (75%).
While company strategy has generally been geared towards handling potential reputational problems originating from the public, company executives and investors should also consider employee concerns. Employees have a more intimate relationship with company operations than consumers, giving them increased insight into potentially problematic practices. Furthermore, when employees do take action, it can cause disruptions to business operations and exacerbate public reputational scrutiny as well. Wayfair made national headlines after employees walked out to protest the company’s selling of furniture to migrant detention centers; the Company lost more than $1 billion in market value at the end of that quarter. Executives should attempt to make company processes more transparent and in line with public and employee sentiments in order to mitigate opposition from their workforce; employees are increasingly conscious of the impact their employers have on the world.