As GPs Deepen ESG Focus, Private Credit and Growth Equity/Venture Capital Funds Lag Private Equity on Key ESG Practices
While private markets investors continue to embrace environmental, social, and governance (ESG) factors in their investments, private credit and growth equity/venture funds lag private equity investors on several fronts, including portfolio engagement and monitoring, according to The State of ESG: 2022, Malk Partners’ inaugural annual survey on general partners’ attitudes and adoption of ESG.
Malk Partners (“Malk”), the preeminent advisor for creating value through ESG management and impact investing, launched its inaugural ESG survey to capture the evolving perspectives of GPs. The report—which queried 51 private equity, credit, growth equity/venture capital, and hedge funds with a combined total assets under management (AUM) of nearly $750B —found that the vast majority of GPs have already integrated ESG considerations into their investment process.
The widespread ESG integration has been driven largely by LPs. An overwhelming majority of respondents (98%) cited LP demand as one of the primary reasons why they are integrating ESG into their processes. Other drivers included risk management (67%), alignment with peers (53%), value creation (51%), and regulatory pressures (40%).
However, the adoption and integration of ESG in the private markets still varies widely based on asset class, as well as by firm size. Among the other key findings in The State of ESG: 2022:
- Investment Integration: While 100% of PE investors surveyed already incorporate ESG into their investment process, the figure drops to 86% for growth/venture funds and 64% for credit funds.
- Portfolio Monitoring: More than eight out of 10 PE funds (84%) monitor their portfolio companies on ESG issues, while only 60% of growth/venture funds and 11% of credit funds do.
- Portfolio Engagement: A majority of private equity funds collect KPIs on ESG from their portfolio companies and engage in ESG discussions. Yet 56% of credit respondents say they do not engage with portfolio companies to improve ESG issues, and only 33% hold informal ESG discussions with management.
- ESG Targets: While a majority of PE funds set ESG targets for their portfolio companies, 89% of private credit funds and 80% of lower middle market PE firms do not.
- Executive Compensation: While 20% of upper middle market PE firms surveyed link ESG performance with executive pay at portfolio companies, none of the lower middle market respondents have taken this step.
“As the largest and most seasoned dedicated ESG advisor in the industry, we are proud to present this survey’s unmatched perspective on evolving GP sentiments,” said Julia Lamorelle, Head of GP Advisory at Malk. “This survey’s findings help us to stay ahead of key ESG trends and deliver the exceptional level of service and expertise that our clients have come to expect.”
Asset class and firm size also affect how investors approach key issues, such as climate change and diversity, equity, and inclusion (DEI). For example, climate-related issues were cited as a priority among 62% of GPs surveyed. That said, adoption of net zero commitments is still relatively nascent, with one-third of upper-middle market PE investors committing and just 20% of lower-middle market firms. One-quarter of private equity investors who responded to the survey track greenhouse gas (GHG) emissions at the portfolio company level; that figure drops to 10% for private credit investors.
On DEI topics at the firm level, the survey found that all GP respondents track gender internally, and most track race and ethnicity, as well. Furthermore, DEI priorities have begun to trickle down to portfolio companies. Presently, 70% of PE firms track gender and 63% track race/ethnicity in their portfolios, while only 30% of credit investors do.
Given the rapidly evolving ESG landscape, Malk plans to survey GPs annually in order to identify shifts among private market investors on their sustainable investing practices and policies. Going forward, this year’s findings will provide a baseline from which to measure ongoing change.