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The state of private markets sustainability in five charts

Investors have focused more on ESG over the past year, will prioritise social issues as a result of the pandemic and use a wide range of frameworks to establish their goals and measure their performance in sustainable investing.

Investors’ focus on sustainability has intensified over the past year, but they’ve been tackling responsible investment in a variety of ways. Here are some key charts from recent LP surveys by investment consultancy bfinance and market analytics provider MSCI to illustrate these trends.

How investors are approaching sustainability

ESG has continued to be an important consideration for investors through the pandemic, as this chart from bfinance shows. Although private equity investors are widely believed to have lagged behind other asset classes in implementing ESG factors, we can see similar trends between private equity and real assets investors.

Investors are increasingly integrating ESG considerations into their investment decision-making processes across their entire portfolios, rather than having distinct funds to apply ESG. This illustrates that investors are increasingly viewing ESG and sustainability risks as potential financial risks. However, this is “a work in progress”, says Kathryn Saklatvala, head of investment content at bfinance. “To really do ESG in an all-portfolio way that’s really credible and professionalised, ideally it’d be great to have more consistency in the kinds of data available for different asset classes and areas.”

Investor frameworks

Investors rely on a variety of frameworks to guide and measure their ESG performance, as demand persists for industry-wide ESG standards.

The UN Principles for Responsible Investment, launched in 2006, are the most commonly used framework. Many investors require managers to be PRI signatories. Eight of the 10 largest private equity GPs are signatories – Blackstone and Carlyle are the two exceptions – as are six of the 10 largest private equity LPs.

Climate concerns are a significant priority for many investors, with 57 percent now using the Taskforce on Climate-Related Financial Disclosures in some way. MSCI also reported that 54 percent of private investors surveyed said that climate risk was very or somewhat significant for their investment strategy.

This is not an exhaustive list of the frameworks and guidelines for ESG and responsible investing. Several frameworks have emerged to dominate the industry in specific and sub- asset classes, such as GRESB in real assets.

Mapping to the SDGs

The UN’s Sustainable Development Goals, launched in 2015, are 17 global environmental, social and human rights objectives. The UN intended for governments, NGOs, individuals and global companies, organisations and institutions to collaborate to achieve these goals by 2030. The SDGs are not specific to private investors, and the chart below appears to show limited direct implementation of the goals by investors.

However, the SDGs have been incorporated in other, more commonly used frameworks such as SASB. Although the SDGs do not include a framework for measuring progress towards achieving the goals, there are tools that provide ways of doing so. These include the Global Reporting Initiative, the UN Global Compact, the World Business Council on Sustainable Development and the International Standards of Accounting and Reporting. In 2020, PRI released a framework for investors to map their sustainability outcomes against the SDGs.

Investors pivot to ‘S’

The pandemic appears to have instigated an increased focus on social issues within ESG across Asia-Pacific, the Americas, and Europe, the Middle East and Africa. MSCI suggests that although the data show a similar increase in the importance of social issues across all regions, the specific forms of social issues may vary by region. In the US and UK, racial diversity has become more important as covid has drawn attention to health inequalities based on race. In Japan, there has been a greater focus on gender diversity.

“As a crass generalisation, European LPs tend to be more focused on environmental issues, and American LPs tend to be more focused on social issues,” says Jeremy Smith, head of impact at placement agent Rede Partners.

Playing catch-up on carbon

Carbon reporting is one way for LPs to assess their underlying portfolio companies’ environmental performance through the use of emissions data, and is becoming more common across all asset classes.

Publicly traded equity clearly leads the way in carbon reporting, says bfinance’s Saklatvala, but carbon reporting will soon become more common in private markets too. “When investors are looking towards carbon reporting, they’re usually looking to go systematically through the portfolio, starting with what’s going to be easiest,” she says.

“They’ll often start with [public] equity, just because the data there is richer. A lot of the index providers now carry the carbon data. There are more specialist providers of data. And investors then tend to progress through the portfolio and tackle the more challenging asset classes later.”

Stephen Barrie, deputy director of ethics at the Church of England Pension Fund, told delegates to a Private Equity International event in November: “I expect that asymmetry to be addressed because, as LPs, we want to be able to say at the portfolio level – covering both private and listed assets – that we are, for example, net zero aligned.”