Should Private Equity Firms Integrate ESG?

A recent Forbes article explored the opportunities that private equity (PE) firms could take advantage of by integrating environmental, social, and governance issues (ESG integration).

Considering the ideal position of PE firms to improve the world around us, it’s certainly an interesting suggestion that the writer makes about the role PE firms can take in developing ESG initiatives within the firm’s portfolio.

To explain how ESG integration could benefit PE firms, Forbes presents a compelling outline of the many social and financial boosts that could potentially happen. And there’s other research that suggests a similar positive influence.

According to this report, the PE industry possesses huge assets, somewhere around $2.4 trillion. Because of the size of the industry, it indicates the stage is set for PE firms to take a huge leadership role in ESG integration. Another reason PE firms are in such a good position to improve ESG integration is the most recent holding period for those companies in a PE firm’s portfolio. The holding period of a company’s stocks for a PE firm in 2015 was 5.5 years, while on Wall Street, it’s a mere 8.3 months. That short time period is not nearly long enough for a company to properly conduct ESG integration because it’s necessary to have a longer period of time to see concrete results.

Another possible benefit for PE firms? These entities are not held to many of the same regulations as listed companies, so PE firms can more freely check up on a portfolio company to ensure it’s being properly managed. In the case of evaluating ESG integration, this could mean determining how much value the company is creating, which could in turn influence future investment decisions.

Notably, a recent survey cited that businesses say risk management is their largest reason to begin ESG integration. Some experts argue that integrating ESG values is a first step to mitigating risk and helping companies appeal to their shareholders and potential investors who need greater assurances.

European PE firms are also honing their focus on ESG investments. In the last month, Invest Europe–a trade association for European PE, venture capital, and investors–published a due diligence questionnaire for private equity firms interested in ESG so that the firms can better assess potential ESG investments. That questionnaire is available here.