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Supplements » SFA Report 2022

Private markets roundtable: Breakaway performance

Sustainability and private markets
Investing sustainably is a conversation taking place in both public and private markets. As with investing in public companies and funds, there is no agreed standard on what constitutes as environmentally friendly, sustainable or ‘ESG-friendly’ for private markets. As a result, it is up to asset managers operating in the sector to obtain relevant data and make a judgement.

Raju explains his team’s process: “Our screen for looking at things we’d like to invest in starts with; Is it sustainable or not? Are they interesting businesses that need capital which will grow and give us a great return?

“The question we ask ourselves is, is there something fundamental about the product this company has, or the process by which it develops a product, or the service it provides, that has some implied environmental benefit? And if that’s something that strikes us as being plausible, then we go and carry out due diligence on that company.”

Despite lack of access to standardised documentation and data, it is not a challenge for private asset managers to get their hands on relevant information, Raju says, because the potential investee is motivated to produce relevant information in the hope of obtaining private capital.

“At that point, they are giving us every bit of information they can get their hands on, or hiring consultants to get that information,” Raju continues. “If they want our capital, if they share our vision on where this company needs to go, and if they want to capture some green premium at exit, they’re going to want to do everything we ask of them – and that’s the beauty of private markets.”

The impact investing head suggests, regardless of whether they want to explicitly label themselves as ‘sustainable’, it is to the benefit of private managers to pay attention to sustainability because it can help a growing company and increase returns.

“Recycling reduces the cost of goods sold; it reduces the risk of supply chain disruption,” Raju says. “Weatherproofing your supply chain ensures goods aren’t sitting in a flooded basement, leaving you unable to fulfil orders for two quarters losing market share as a result.”

Considering the revenue part of the equation, Raju notes the premium sustainable products can attract, which can add significant margin.

“I don’t know if this greenium is going to last. But if you don’t have all these things in place, you will trade at a discount. [Sustainability] is becoming mainstream because it’s unavoidable.”

LawDeb’s Porkolab, however, is not as convinced there is appetite to drive sustainability among all private equity investors. “Private equity is an area where owners have the option to influence decisions and drive the business towards sustainability, look at the underlying sustainability characteristics, set key objectives, renumeration and so on, accordingly. But that’s just one segment of the private equity industry and just one segment of private market assets. For instance, if you are a private credit investor or manager, you don’t have the same level of influence about corporate objectives and strategy.”

He continues: “Similarly, certain types of private equity will not necessarily focus on sustainability. If you think about some of the oil majors and energy companies selling some of their brown assets, there is a significant private equity interest in those assets.”

Looking ahead
The CAMRADATA panel on private investing closed by asking panellists what they believe is next for private markets, and how private assets can blend into a wider portfolio.

McNichols concludes investors are likely to look for increased diversification within their private asset portfolio. This would not necessarily or only be to increase returns, but rather to diversify their assets, which would be a good thing for portfolios more broadly.

“Over the past 30 years, the influence of private equity generally has been increasing in the economy,” he says. “As private equity has grown in influence, it has also grown in size and scope. That has all kinds of impacts on the economy and the financing markets as well. Privately owned entities are more likely to source private funding on the credit side, for example.”

For McNichols, the real richness and variety has been – and may continue to be – on this private credit side. “There are attendant benefits, including speed, customisation and cost,” he says. “While you may pay a little more on the interest rate side, you’re going to have other benefits that help you manage your company in a better way.”

A great variety of origination sources that have searched for capital have found partners as investors have broadly accepted private markets into their portfolios.

“Big picture – that’s driving a lot of the growth in the complexity and the size of private markets generally,” says McNichols.

WTW’s Hails agrees, adding: “Why have a private debt mandate focused on just one [area] when it can be broader, with a similar return, but lower risk. Alternatively, specialists could be used in each of these areas.”

He continues: “We have clients that restrict us to private equity, but where they don’t, how we would construct a high-returning private markets portfolio would be between two-thirds and three-quarters private equity, and the rest of it will have high-returning real estate, infrastructure, natural resources, and private debt strategies. These are similarly returning to the private equity funds… but it’s a much broader, more diversified, more robust portfolio.”

Porkolab agrees this strategy could be adopted more widely, but cautions it would depend on the specific circumstances of the investor. He says there may be some pension funds that start with more of a bespoke, ‘do-it-yourself’ approach to private assets, and then gradually shift to more of a total-portfolio approach, and this decision may depend on the lifecycle of the pension scheme, maturity profile and end-game strategy.

Regarding the future of sustainability in private assets, Morgan Stanley’s Raju adds: “I hope three years from now, when we have a panel, we’re not talking about sustainable investments, but just talking about investments because the entire approach is sustainable.”

This discussion took place in March 2022.

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