It can be daunting to take the first step towards incorporating sustainability principles into your investment process, but there’s no other way around it. ESG (Environmental, Social, and Governance) considerations are no longer optional. They’re essential. 

Why is that? Easy. Sustainability is profitability! 

In other words, the PE firms who reap the rewards are the ones that seize the opportunity to truly embed sustainability principles into every aspect of their business operations. They’re proactive about taking necessary actions to make that happen—aka ESG operationalization. 

Or, as we like to say around here: ESG is Business Intelligence.

In this article, we’ll explore why ESG investing makes plain sense for the PE industry, as well as what ESG operationalization looks like in practice.

The ESG - PE link

Last year, total private markets AUM swelled to $11.7 trillion, the result of steady increases at an annual rate of nearly 20% since 2017. Dry powder exceeded $3 trillion. Those assets are projected to hit $13 trillion by 2027. The 10,000 or so PE firms in the space collectively oversee more than 20 million employees at across 40,000 portfolio companies. In other words, PE has proven itself a formidable player in the world economy.

Given its immense size the PE industry and therefore the broader economy have headwinds stemming from ESG:

• A significant majority (81%) of executives have reported the establishment of new roles and responsibilities specifically designed to support potential ESG disclosure requirements. (Deloitte)
• Across >2,000 studies, ESG propositions had a positive impact on equity returns 63% of time. (McKinsey) 
• ESG-mandated assets totaling $35 trillion could make up half of all professionally managed investments by 2025. (Deloitte) 

Doing well by doing good is not the only goal for PE investors. They are also seeking to generate profit alongside purpose—it’s increasingly being proven to be the smart way to do business. But unlike their public peers, PE investments have more leeway when it comes to setting and attaining their ESG targets. 

What does successful ESG operationalization look like? 

Top-performing PE firms recognize the profound impact that successful ESG integration can have on long-term value creation. These firms seek to ingrain sustainability considerations into the heart of their business strategy. Here are examples of how ESG might look like in a PE firm committed to operationalization:

Operationalizing “Environmental” factors

As a demonstration of their commitment to ESG integration, XYZ Capital, a private equity firm, has embedded environmental factors into the core strategy of one of its portfolio companies in the manufacturing sector. Recognizing the materiality of environmental risks and opportunities, XYZ Capital launches a wide range of initiatives to reduce the company's carbon footprint and promote sustainable practices. This includes optimizing resource consumption, implementing waste reduction programs, and transitioning to renewable energy sources in their production facilities. By actively integrating ESG considerations into its decision-making and operations, XYZ Capital boosts operational efficiency by 20%, reduces costs by 30%, and strengthens the company's brand reputation enough to significantly boost profitability upon exit. 

Operationalizing “Social” factors

XYZ Capital is investing in a manufacturing company. To operationalize ESG from a social standpoint, it’s prioritizing the creation of quality jobs. During due diligence, the firm assesses the target company's employment practices, including worker safety, fair compensation, and employee development programs. It engages with management to understand their approach to job quality and identify areas for improvement. Based on their findings, XYZ Capital develops an action plan that focuses on improving worker safety protocols, implementing fair wage policies, promoting diversity and inclusion, and providing opportunities for skill development and career advancement. They actively communicate these plans to the company's leadership and employees to build a culture of transparency and employee engagement. Through these efforts, XYZ Capital can quantifiably improve the portco’s ESG metrics around job quality and employee well-being.

Operationalizing “Governance” factors

XYZ Capital prioritizes investments in companies that exhibit robust governance structures and ethical practices, recognizing the material impact of governance on long-term performance. It actively supports the integration of strong governance principles throughout its portfolio operations. This includes building in rigorous governance protocols such as independent board oversight, comprehensive risk management frameworks, and transparent reporting practices. By embedding these practices into their portcos’ DNA, XYZ Capital helps protect shareholder interests while building trust with stakeholders and ensuring sustainable, long-term growth. 

By embedding E, S, and G factors into the heart of the investment process, PE firms get the opportunity to create value for shareholders while driving positive change for stakeholders and beyond. Commitment to ESG integration goes beyond a mere compliance exercise—it should be a fundamental part of the business approach, guiding decisions and actions to deliver both financial returns and sustainable impact.

Next steps

^For more insights on what exactly “ESG integration” entails, as well as methods and practices to up your firm’s competitive advantage, be sure to check out the following articles: 

• ESG in Private Equity: From Due Diligence to Exit
• ESG Isn’t About Compliance. It’s About Competitive Advantage.