As more governments mandate climate disclosure reporting, and stakeholders, in general, become more concerned with how an organization is managing ESG risk, private equity firms are increasingly recognizing the value of comprehensive ESG reporting.
Currently, government mandates only apply to publicly traded companies, but as we approach the UN’s deadline for reaching net-zero emissions by 2050, more private companies are receiving increased pressure from their stakeholders to operate with sustainability in mind. PE firms can’t wait for it to become a requirement and instead should embrace ESG reporting to take advantage of its many benefits.
Here are three ways private equity firms benefit from incorporating ESG into their operations and reporting:
Reduce Financial Risk
As more individuals, communities, and governments prioritize sustainable living practices to help reduce human impact on the environment, more organizations will need to address these concerns held by their stakeholders or face potential financial consequences.
- ESG Performance of Portfolio Investments- According to a Bank of America analysis, ESG-related controversies cost large US companies more than $500 billion in a five-year span.
- Profitability of Investment Companies – A McKinsey study found that executing ESG effectively can help companies combat rising operating expenses, which can affect operating profits by as much as 60%.
- Sanctions, Fines, and Lawsuits – More countries are mandating climate disclosure requirements such as the U.S. SEC’s proposed climate disclosure rules, Canada’s climate disclosures for federally regulated institutions, the UK government’s climate-related financial disclosures for companies and LLPs, and more sure to follow.
For the moment, the above-mentioned mandates don’t apply directly to most private equity firms, however, they may have investors that do fall under the realms of these sanctions. These investors could withdraw their funds if the PE firms cannot satisfy their reporting requirements.
With comprehensive ESG reporting across their entire portfolio, private equity firms can reduce the chance of the many financial implications that can occur by enabling them to monitor the ESG performance of portfolio investments as well as ensure compliance with all federal and international disclosure requirements.
Improve IPO Pricing and Valuation
One of the many concerns for private equity firms is the IPO valuation of the investments in their portfolios. With a need to ensure portfolio ROI, private equity firms utilize multiple metrics and analytics to forecast potential IPO pricing and valuations. ESG data offers PE firms another means by which to measure and predict an investment’s valuation.
A SSRN study, “ESG and the Pricing of IPOs: Does Sustainability Matter,” found a significant relationship between ESG communications and IPO pricing and valuation. The study concluded that the disclosure of ESG information led to higher corporate financial performance, in terms of lower underpricing and more precise firm evaluation.
When PE firms implement ESG reporting across their investment portfolios, they can monitor the ESG performance of the organizations they’ve invested in to identify low performers at risk of underpricing and other potential ESG-related risks.
With the right ESG reporting platform, private equity firms can also utilize ESG risk management to identify companies in their portfolio with ESG programs at risk of not meeting ESG-related goals, commitments, or KPIs. This allows private equity firms to work with these organizations to create action plans to improve ESG performance and in turn lower the chance of underpricing and perform more precise firm evaluations.
Generate Higher Portfolio Returns
Most investors are not willing to let ESG affect their ROI, a PwC Global report found 81% of global investors surveyed expressed reluctance to take a hit on their returns exceeding 1% in the pursuit of ESG goals. Despite this, there is growing evidence that organizations pursuing ESG goals experience growth in stock price and higher returns.
- The Morgan Stanley Institute for Sustainable Investing found 80% of investors still believe that companies with strong ESG practices can generate higher returns and make better long-term investments.
- This Morgan Stanley Institute analysis shows that sustainable U.S. equity funds outperformed traditional peer funds by a median total return of 4.3 percentage points in 2020.
- State Street Global Advisors found in their ESG Institutional Investor Survey, 68% of global institutional investors say that integration of ESG has significantly improved returns.
- The survey also found 69% of respondents said pursuing an ESG strategy has helped with managing volatility and 84% are satisfied with the financial performance of their ESG strategy.
The evidence is clear that PE firms only stand to benefit from implementing ESG reporting across their operations as well as their portfolio investments. The insights gained from collecting ESG performance data provide private equity firms with a more informed decision-making process, improved risk mitigation capabilities, and much more.
Need help with investor-grade data collection across your portfolio companies? The FigBytes ESG Insight Platform helps private equity firms to manage and maintain a sustainable and profitable investment ecosystem with accurate and engaging ESG reporting.