Preqin, the global leader in alternative assets data, tools, and insights, has published its annual Environmental, Social, and Governance (ESG) report: ESG in Alternatives 2022: The Transparency Tipping Point. The report provides the latest insights on developments in what is becoming a necessary competency for private markets managers that want to meet the growing expectations of investors toward evidencing ESG integration. ESG has risen to the fore in recent years, and regulations are becoming more prescriptive in what is expected of managers in private capital markets. Many investors and managers are still developing their expertise and are increasingly demanding data to evidence how ESG is being incorporated into strategy formation, deal sourcing, and execution.
Investors key to pushing the ESG agenda
Investors are a key push factor in ESG uptake in private markets, as managers look to deliver against Limited Partner (LP) preferences for ESG adoption. Preqin’s most recent 2022 H1 Investor Outlook – which was informed by more than 350 LPs investing across alternative assets – found a quarter (25%) of those surveyed reported having turned down an investment opportunity because of ESG standards, with a further two in five (39%) saying they would be prepared to do so.
The H1 2022 Investor Outlook also revealed that nearly three-quarters (72%) of investors believe fund managers are adopting ESG policies because of pressure from existing and prospective LPs. This factor is well ahead of alternative drivers such as industry standards or best practices (cited by 48% of LPs), political pressure (36%), regulatory demands (25%), or outperformance (14%). Although political pressure was only at 36%, this driver climbed from seventh most important factor to third over the past year.
The survey also found that 37% of investors in alternative asset classes have an active ESG policy in place. Private equity investors are in the lead, at 43%, followed by private debt and infrastructure, at 39%. Hedge fund investors (30%) trail the field for the second successive year.
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Infrastructure and private debt lead the pack
As of October 2021, Preqin has tracked $4.37tn of private capital assets under management (AUM) managed by firms that report being committed to ESG investing. * This represents 42% of total private capital AUM ($10.3tn).
Infrastructure boasts the highest share of AUM within ESG-committed funds, at 64%, driven by the longer social contract required to develop and operate public infrastructure. Private debt is close behind in terms of AUM share in ESG committed funds, at 59%. This high result is partly down to its relatively recent emergence as an asset class, just as attention on ESG was growing. At the other end of the risk spectrum, private equity and venture capital (PEVC) has the highest aggregate value of AUM in ESG-committed funds at $2.26tn, but the lowest share of any asset class, at 34%.
Looking at our growing mandates data, we see that infrastructure ESG applicable mandates are overrepresented. Whereas infrastructure has less than 15% of the AUM of PEVC ($955bn for infrastructure vs. $6.6tn for PEVC), of mandates applicable to ESG, infrastructure accounts for just over 20% of the total, vs. 26% for private equity.
Investors are asking General Partners (GPs) to report their ESG commitments, and driving demand for higher quality, more granular data to demonstrate how their portfolios are delivering on their own commitments towards delivering ESG outcomes.
- Private Equity and Venture Capital: AUM of funds reporting as ESG committed is at $2.26n, and the percentage of AUM under ESG commitments is 34%
- Private Debt: AUM of funds reporting as ESG committed is at $0.73tn, and the percentage of AUM under ESG commitments is 59%
- Real Estate: AUM of funds reporting as ESG committed is at $0.66tn, and the percentage of AUM under ESG commitments is 51%
- Infrastructure: AUM of funds reporting as ESG committed is at $0.61tn, and the percentage of AUM under ESG commitments is 64%
- Natural Resources: AUM of funds reporting as ESG committed is at $0.11tn, and the percentage of AUM under ESG commitments is 50%
Jaclyn Bouchard, Executive Vice President, Head of ESG Solutions and Corporate Responsibility, at Preqin, says: “As ESG continues to embed into private capital markets, tracking managers’ commitments is essential to inform investors who to select to achieve more sustainable portfolios. As GPs consider ESG risks and opportunities in their investment decision-making, and LPs feel pressure from regulations and client expectations, private markets are at a transparency tipping point. High-quality and reliable ESG data is essential to move from vision to reality. From our perspective, the more transparent the industry is on ESG reporting, the better our data and analysis can be for the whole private markets lifecycle – it is a symbiotic relationship.”
- Globally, 232 impact funds have closed, 66% of these since 2017. Last year, 2021, saw 64 impact funds close, the highest annual figure yet. These are a specific set of funds that intend to generate measurable positive impact alongside financial returns.
- Among all impact funds, including those closed, raising, and otherwise, 62% are within the private equity and venture capital asset classes – with half of these based in North America. More broadly, the ESG agenda is bedding in across asset classes in Europe. Managers in the region are showing the highest levels of transparency around the policies and procedures adopted alongside Australian managers who are the leader of the APAC region.
- ESG in Asia-Pacific (APAC) is perceived as less developed than in more mature private capital markets in Europe and North America. According to Preqin ESG Solutions data, the average transparency metric† in APAC, at 4.7%, is much lower than other regions, such as Europe (13.1%) and North America (8.4%). There are a few reasons for Asia’s lack of progress on ESG adoption. Among them is the lack of well-established ESG frameworks that span key markets. Many fund managers and investors in Asia are still in the process of establishing ESG teams and ramping up the talent pool to overcome challenges around the lack of expertise. This has resulted in a measurement gap that makes collecting quality, comparable ESG data across an investment portfolio a big challenge.
- The Australasian private capital industry, in contrast to the rest of Asia-Pacific, is excelling in its commitment to ESG with an average transparency metric of 13.6%.
Sectors driving the ESG charge
- Cleantech – predominantly driven by infrastructure funds, this maturing sector is seeing the roll-out of new innovative technologies that could rapidly change energy market dynamics. As deployment in renewable energy generation continues, grid-scale battery technology is gaining traction in some developed markets such as the UK. This technology helps do away with the intermittency challenge of wind and solar, reducing the need to invest in alternative baseload sources such as gas and nuclear.
- Sustainable food – a sector that has seen several highly successful firms delivering returns for early-stage venture capital investors. As consumer habits change toward embracing more sustainable goods, this is one sector where innovation is providing a credible threat to incumbents. These innovators have shown that reliance on established, carbon-intensive supply chains create risks as consumers seek options for limiting their environmental impact.
- Agriculture – a focus on the carbon intensity of energy generation misses the challenges in other sectors that need attention if we are to meet carbon reduction targets. The carbon used to generate fertilizers and to rear cattle is increasingly acknowledged. While opportunities to decarbonize the production of ammonia from renewable energy sources do exist, these will always compete with other demands for clean energy.
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