Private credit and growth equity/venture funds are lagging behind private equity investors on several major ESG fronts, including portfolio engagement and monitoring – even as private market investors continue to embrace ESG.
- Private equity investors are taking ESG seriously- 100% of PE investors incorporate ESG into their investment process, but this drops to 86% for growth/venture funds and 64% for credit funds.
- In the survey, 98% of general partners (GPs) who responded cited limited partner (LP) demand as a primary reason for ESG integration.
- Tracking is key to measurement of performance – 84% of private equity funds say they monitor portfolio companies on ESG issues, while 60% of growth/venture funds and 11% of credit funds do.
These numbers are from Malk Partner’s inaugural survey – The State of ESG: 2022 – which queried 51 private equity, credit, growth equity/venture capital, and hedge funds, provides an update on general partners’ attitudes and their adoption of ESG.
The vast majority of the survey’s GP respondents, who have a combined AUM of $750 billion, say they have already integrated ESG considerations into their investment process.
What really stands out in the survey though is that as general partners focus on ESG, private credit and growth equity/venture capital funds continue to lag private equity on key ESG practices.
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.
This 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%).
ESG integration varies by asset class
While the integration of ESG into private equity fund processes seems to be moving apace, 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 was that investment integration varies widely by asset class. 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 remains a primary focus for private equity funds at 84%, but this falls rapidly in other types of fund. Only 60% of growth/venture funds monitor their portfolio on ESG issues, and only 11% of credit funds.
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.
The idea of setting targets for performance also seems to remain the domain of private equity. 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. And executive pay still fails to connect between remuneration and ESG performance.
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.
Asset class also affects approaches to climate, DEI and other issues
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.
