How Private Equity Can Create Value Through Purpose

Related Expertise: Principal Investors and Private Equity, Portfolio Acceleration, ESG in Private Equity

How Private Equity Can Create Value Through Purpose

By Meagan AndrewsShrinal ShethVinay ShandalGreg FischerTariq Nanji, and William Lubega

As businesses become more proactive in tackling environmental and social issues, the private equity industry has an opportunity lead the way. With full ownership control over portfolio companies and relative freedom from short-term pressures to deliver results, PE firms can create value for investors by incorporating sustainability into their broader financial objectives.

BCG recently interviewed more than 30 leading general partners, limited partners, and industry experts. Those discussions point to five immediate priorities for private equity firms:

• Invest in institutional capabilities and organizational culture.
• Focus on a long-term plan for change.
• Communicate the plan to all stakeholders, along with measurable milestones en route.
• Don’t just divest; transform gray assets into green ones.
• Collaborate with other PE firms to address key barriers.

Expectations about sustainability are evolving rapidly, but that shift presents an opportunity that investment firms should seize. Read the full publication here.

Pressure is growing on private equity firms to address environmental and social issues—as well as to generate financial returns. Failure to activate a critical mass of general partners (GPs) and limited partners (LPs) committed to such impact could expose the industry to heightened reputational and regulatory scrutiny. The industry must act now. Sustainable investing need not be a burdensome requirement, however. In fact, the industry has clear advantages in generating results. With full ownership control over portfolio companies and relative freedom from short-term pressures to deliver results, PE firms can lead the way in generating value through sustainability.

To assess the current state of sustainable investing in the PE industry, we conducted interviews with more than 30 leading GPs, LPs, and industry experts. Although no one-size-fits-all playbook emerged, these interviews highlighted five immediate priorities for private equity firms that want to make faster progress—and unlock more value—in sustainable investing.

Invest in capabilities and culture. Many LPs and GPs face a critical gap in the institutional capabilities necessary to act on sustainable investing opportunities. Installing leaders who have the right experience to straddle the worlds of traditional investment and sustainability is a critical first step in building these capabilities. At the same time, however, it is critical to avoid isolating operational responsibility under these champions. LPs and GPs must intentionally shift their organizational culture, too, creating a sense of ownership for sustainability initiatives at all levels.

Focus on a long-term plan. Building capabilities and driving cultural change to develop value proofs will take time and likely entail overcoming missteps along the way. To stay the course, private-equity LPs and GPs should take advantage of the greater time-horizon flexibility in private markets to optimize for long-term outcomes, not just quick wins.

Communicate the plan, along with measurable milestones en route. Because creating value through sustainability takes time—at both the individual asset level and the portfolio level—communicating the long-term plan to all stakeholders and marking progress along the way are vital to securing and maintaining buy-in. Communicating progress requires use of standardized metrics (to enable comparisons) and customized reporting (to accommodate the unique aspects of each investment). Asset-level transparency is critical, since different considerations attach to different assets and since portfolios turn over approximately every five years.

Don’t just divest, transform. Individual investors can progress toward their portfolio sustainability targets by divesting heavy-emitting assets and avoiding specific sectors. But this approach does not remove problematic assets from the global mix—it just moves them to another owner. For that reason, PE should not simply divest its way to sustainability. Instead, firms need to address the sustainability challenge head-on, by deploying capital to transform gray assets into green ones. This is an area where the private-equity industry as a whole can have a disproportionate impact, and where individual firms can develop differentiated capabilities.

Collaborate to address key barriers. Investors acting in isolation cannot effectively address such key sustainability challenges as standardization of measurement and reporting, and establishment of the right incentives to transform gray assets. Instead, LPs and GPs across the industry must continue to collaborate to set appropriate standards and policies. The current momentum and relative maturity of measures to combat climate change can serve as a testing ground for action on these ecosystem challenges, providing templates for system-wide collaboration across a broader set of sustainability topics.

The private equity industry is at a critical inflection point that requires participants to respond to rapidly evolving expectations about sustainability. This presents not only financial, reputational, and regulatory risks for investment firms to navigate, but also opportunities for them to achieve long-term value creation. Private equity must take action to seize this opportunity.

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