Pension funds and other institutional investors are increasingly putting ESG principles at the core of their business practices and they have a key role to play in keeping up the momentum. If portfolio managers and their managers feel they are too busy to develop their own responsibility guidelines and practices, the pressure to do so from institutional investors will simply increase.
In the U.S., for example, the California Public Employees' Retirement System and California State Teachers' Retirement System, among others, were instrumental in prodding the Private Equity Council to develop responsible private equity investing guidelines that were announced in February. The PEC has said that its members, which include 13 of the world's largest private equity firms, will consider applying these guidelines prior to investing in companies and during their period of ownership.
In the past, companies themselves typically instigated change in taking more responsibility for their actions. Now, though, private equity firms are taking the initiative by devising plans to build sustainable, competitive businesses, working in close co-operation with the management teams of portfolio companies on ESG issues.
Let's look at some examples:
• An aircraft leasing company switches to more fuel-efficient aircraft, not only bringing environmental benefits but contributing to higher future returns thanks to reduced fuel costs.
• A manufacturer of glass packaging that is promoting the consumption of recycled glass converts its production facility to natural gas from electricity, also resulting in cost savings.
Beyond environmental issues, responsibility concerns can and should stop a private equity fund from investing in the first place if, for instance, due diligence reveals unethical behavior or even corruption on the part of management.
If pressure from pension funds and enlightened self-interest on the part of private equity groups is not enough to push the industry toward responsible investing, the final straw will take the form of legislation.
In Europe, increasing clamor for change from politicians, the media and trade unions has persuaded the European Commission to promise legislation. In February, Internal Market Commissioner Charlie McCreevy announced that the commission was committed to bringing forward an appropriate legislative agenda on private equity, although the original April 2009 deadline was subsequently pushed back.
The directive is now being discussed in council working groups with the expectation that views will be exchanged with the commission at the end of August.
If the private equity industry doesn't change by itself, it will be forced to do so. The rules of the game are changing. The days are over when a general partner could say “leave it with me, I'll get you a good return.” Indeed, this is only the beginning. In 10 years — or maybe sooner — responsible investing will be mainstream in our industry.
Ad van den Ouweland is managing partner and chief investment officer of Robeco Private Equity, a unit of Robeco Groep N.V., Rotterdam, Netherlands. The views expressed in this commentary reflect those of the author and not necessarily those of Robeco.