Here’s Why ESG Investing Is a "Must-Have" for Private Equity

Environmental, social and corporate governance (ESG) investing is now a “must have” for private equity firms, according to a new report by Bain & Company.

While ESG investing is often met with a skeptical eye, particularly in the US, Bain notes that what’s made the private equity industry successful in the past is its ability to predict value creation opportunities and to think broadly about how those moments may reveal themselves. ESG should no longer be viewed as a sideshow, Bain argues—rather, ESG should be a core part of what differentiates companies as competitors. ESG principles should be baked into due diligence, value-creation plans and exit strategies

“Private equity has always focused on governance risk and increasingly sees the value in cutting costs through sustainability,” the report states. “What’s changing is firms’ growing awareness that environmental, social and governance issues are highly interrelated and that the biggest benefits over time accrue to companies that balance efforts between all three.” 

Consumers are taking note: “survey after survey” shows millennials and post-millennials in particular flock to companies they think act with a high degree of social responsibility. Data from Nielsen estimates that in the US, alone, consumers will spend up to $150 billion on packaged goods they view as sustainable in 2021.

But despite that, the US is trailing Europe in these initiatives, according to the report. An analysis of ESG performance among PE firms by EcoVadis shows that portfolio companies owned by US-based firms lag behind those owned by EU-based firms by 12 points. But even in Europe, many of those portfolio companies haven’t launched meaningful ESG initiatives. 

“Proactive private equity players aren’t waiting for return on investment (ROI) studies to pan out before incorporating sustainability and social responsibility into how they invest and operate,” the report states.

With or without ESG, though, private equity firms are stepping up their investments as the rollout of multiple vaccines promise economic recovery. Deal velocity and exit value among private equity investors rebounded sharply in the third quarter of 2020, ending the year 8% up over 2019. Valuations remained high, according to Bain, and returns were solid. And despite the pandemic, the second half of 2020 was as strong as any two-quarter run in recent memory, the firm says.

This year will likely be a standout as well, as a high level of dry powder and robust credit markets will make markets busy as investors look to make up for time lost in the pandemic’s early days.

“Private equity held up well in a most unprecedented and tumultuous context,” said Hugh MacArthur, global head of Bain & Company’s Private Equity practice, in a statement. ”The market absorbed the drop seen in the second quarter, and ended up on a high overall as dealmakers quickly adapted to working in a remote world. With the number of deals down in 2020 from recent levels, we expect to see a lot of pent-up demand returning to the market. Add to that soaring levels of dry powder and robust markets and 2021 is shaping up to be incredibly busy.” It will remain to be seen how much of a differentiator ESG will prove to be among these investments.