Institutional investor increased pressure to take environmental, social, and governance (ESG) factors into account in investing has soared, prompting greater transparency on ESG policies and performance, as well as a rise in dedicated impact funds within private markets, according to McKinsey Global Institute (MGI) 2020 annual review of global private markets, A New Decade for Private Markets.
The firm’s research shows that six global private equity fund managers have committed to raising about $9bn (€8.2bn) on impact investing, described as “the highest-conviction approach” to ESG principles.
“Prior to 2017, these same six firms had no impact-focussed funds whatsoever,” the study revealed.
A relative newcomer to the fund management industry, impact investing has built its entire strategy around ESG-related objectives.
“Several leading GPs [general partners] have now launched impact-focussed funds as extensions of their burgeoning product lines,” the study showed.
MGI said that, while private markets investors still lagged public markets in implementation of ESG policies, they had, in recent years, taken strides in adopting ESG factors.
As public awareness of and activism relating to ESG-driven investing had soared, many prominent allocators to private equity had taken up the cause.
“They now require GPs to pass an ESG screen as part of their vetting process, and demand more transparency into ESG policies, procedures, and performance of portfolio assets,” MGI said.
The MGI review cites as an example what is known as the Investor Leadership Network, formed in 2018 to co-ordinate ESG efforts among institutional investors. The collective now represents more than $6trn in capital.
“In some regions, regulations have become a forcing mechanism. Europe recently adopted a sustainable finance action plan that requires asset managers to disclose how they account for ESG factors,” the review added.
An increasing body of evidence indicates that the inclusion of ESG criteria is positively related to corporate financial performance, it said.
MGI noted that the positive relation between ESG and financial performance was typically attributed to reduced levels of risk. It added that though there was not yet consensus, several studies estimated that the presence of ESG concerns could increase an asset’s cost of capital by up to 1.5%.
In a sample survey of investment professionals and C-level executives, MGI found they were willing to pay 10% more for a company with a positive ESG record than for a similar company with a negative one.
“At the leading edge, some PE firms had begun pointing artificial intelligence at media events and other reports to flag ESG risks during diligence”
“It [AI] could help identify future winners in screening and diligence, investing in companies that stood to benefit from growing awareness and more stringent (ESG) requirements.”
ESG integration could also help drive value creation during a GP’s holding period. But, said MGI, most GPs had yet to shift their investment processes or value-creation playbooks in a substantial manner to focus more on ESG impact.
“One exception is infrastructure GPs, which are at particular risk from rising sea levels, more violent and frequent storms, and other manifestations of climate change.
“Many of these firms are moving actively to manage the risks and invest behind the larger trends.”
The report said that, in 2019, private markets had raised $900bn. They had some $6.5trn in assets under management, with dry powder of up to $2.3trn.
The US-based research institute said that, as private markets settled into their newfound status, three strategic issues for the next decade had come to the fore. ESG was on top of the list.
Source: impact investing