Taking the ESG discussion into uncomfortable places

Are there important aspects of investing responsibly that we are just too afraid to discuss? The Predistribution Initiative wants us to discuss the elephant in the sustainable private markets room.

Current investment management practice – even when it is ESG- or impact-flavoured – contributes to systemic social injustice and long-term investment risk.

That’s the view put forward by The Predistribution Initiative, a project started in 2019 that seeks to move thinking about responsible investment forward, so it encompasses not just portfolio company activities, but also the more fundamental elements of investment structures and asset allocation.

In other words: current ESG and impact discussions dwell mainly on how, for example, a private equity-owned company might be encouraged to improve its culture of safety or reduce carbon emissions. The Predistribution Initiative, meanwhile, highlights how an investment model that relies, say, on high levels of corporate debt, or one that concentrates wealth among a small number of individuals at investment management firms, is introducing longer term instability into the system.

In its latest paper, ESG 2.0: Measuring and Managing Investor Risks Beyond the Enterprise-Level, the Predistribution Initiative examines how increased corporate indebtedness – and the short-term incentive for asset owners to allocate assets to higher risk strategies – is creating vulnerability in the real economy. It is also flowing capital towards a smaller number of ever-larger funds – in the hands of a smaller number of firms – which gets invested into larger companies. This in turn creates “monopsony dynamics,” at the same time squeezing out “diverse and emerging fund managers, as well as innovative and potentially more regenerative investment structures.”

The concentration of wealth among successful private equity managers, notes the report, contributes to inequality “as well as disproportionate influence of the largest fund managers over their investors, stakeholders and public policy”.

PE’s (dis)comfort zone

The work of the Predistribution Initiative essentially involves taking the ESG discussion – one that the private markets ecosystem is just starting to get comfortable with – and pushing it into uncomfortable new spaces. Its founder and executive director, Delilah Rothenberg, tells me there is “a real fear” when it comes to opening up a conversation about such issues. Perhaps this fear stems partly from an idea that these issues are not easily addressed in such a way that doesn’t fundamentally undermine the private equity model.

And yet, the paper – which invites stakeholders of all stripes to come forward to collaborate – does offer up 11 areas in which action can be taken to create a more stable system (and they don’t involve the extinction of the buyout).

When I suggest to Rothenberg, whose career has spanned private equity, investment banking and consulting, that these are the ESG issues we might be discussing at conferences in three or four years’ time, she points to the rising enthusiasm for employee ownership as evidence that they are actually being considered already.