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Private equity for positive change AND competitive returns

A new paper from researchers at MIT and EBS Business school 'ESG Footprints in Private Equity Portfolios…' looks at the relatively understudied area of responsible investing in private equity (PE), which is on the spectrum of impact investing, its implications for investment performance and the most effective methods.

The results, in terms of impact on performance, are highly notable, and very helpful for you as investors.

The authors follow 206 buyout funds (focused on owning controlling stakes in established companies) from the US and Europe, representing over 2,000 companies over the period of 2010 through 2022, with fund level ESG metrics from RepRisk and data on PE manager ESG methods from UNPRI surveys.

Overall their findings show---

A significant positive impact on performance from responsible investing in PE:

  • '…fund-level financial returns are positively correlated with ESG portfolio footprints'. With fund net internal rate of return (IRR – a common performance measurement for private investments) increasing by 'up to 12.4%' in the presence of a 50% increase in fund-level ESG score.

A focus on action versus reporting by the PE manager had the biggest impact on ESG scores:

  • Specific ESG management practices and ESG 'value enhancement plans' by the PE Manager had the biggest impact on fund-level ESG score, while additional ESG reporting and 'ESG impact controlling' (essentially fund ESG monitoring reports) had minimal effect.

Overall they found no difference in results based on the location of the manager (US or Europe), or by size of fund.

The authors theorize on reasons for the notable performance boost:

  • '…it could be easier for PE investors to obtain financing for target companies that are more ESG-compliant'.

  • '…it can also be a way of managing the risk exposures of the underlying portfolio or as a move of establishing regulatory compliance…'

Additionally, shareholder advocacy can be far more impactful on companies, as PE buyout investors use their controlling stakes to directly 'enhance the organisational performance of their portfolio companies, fostering innovation and enhancing their societal and environmental contributions'.

There are some issues with the study, including limited sample size and just 12 years of data – with a narrow focus on one type of PE strategy, along with the use of fund level ESG 'footprints' which combine the effects of all companies in the fund, versus more granular company level measures.

Yet overall, the authors nicely summarize --- 'These findings emphasize the potential for impact investing in PE to not only contribute to positive societal and environmental change but also generate competitive financial returns, making it an attractive strategy for investors seeking to align their capital with their values and impact objectives'.

The research contains a superb and brief literature review of notable 'responsible investing' investment research, with a focus on the nascent area of private equity.


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