Five things investors need to know about the future of ESG in private markets 

Mercer’s head of alternatives for EMEA and Asia Pacific, Garvan McCarthy, on how sustainability is evolving across private markets and why the sector is well placed to lead the way on ESG investing

Back in November last year, at Mercer’s Private Markets Global Conference, we fired out a bold prediction to our delegates – that environmental, social and governance (ESG) investing is set to become a mainstream approach across private markets over the next few years, despite much of the asset management industry just finding their feet in the space.  

Investors across the alternative asset classes increasingly have a razor-sharp focus on all matters ESG-related, including diversity, equity, and inclusion (DEI) considerations. Certainly, at Mercer, we have seen how quickly sustainability has become a prominent framework through which investors consider our own allocation decisions. 

But I want to make an even bolder prediction – yes, ESG is becoming mainstream and wholesale across all private assets, but this is happening at a much faster rate, and far sooner, than perhaps many people in alternatives had foreseen. Supply and demand factors are driving fully integrated ESG factors into all decision-making, both at investor-allocator and asset manager level.  

So, what might ESG look like in private markets?  

From a client perspective, institutional investors need to demonstrate to their stakeholders, and to regulators, how they are considering ESG and DEI in their investment portfolios. As an industry, this means how we collectively report on ESG is going to be crucial. 

Sustainability has been at the core of Mercer’s outlook since 2014. In that sense, it is by no means a new focus area for our business. Much of our portfolios have been shaped by themes such as population growth, resource scarcity and energy efficiency, as well as by net-zero emissions targets.

Yet sustainability is evolving rapidly and that presents new challenges. Pressure from clients to achieve results is ramping up further every year, for example. And there is a growing body of regulations and reporting requirements to get our heads around and adhere to. We need to consider and assess the long-term impact of the choices we make, while also learning to accept the potential short-term impact that sustainable investing might have on portfolios. It can all feel like a bit of a balancing act.  

Challenges can sometimes feel more like obstacles, but the very structure of private markets mean they are well placed to meet them and lead the way on sustainability. 

Private markets managers have direct ownership over their portfolio companies. This means they can play a leading role in shaping the ESG journey of the assets they own, integrating and demonstrating ESG best practice. 

Timeframes are also a factor. Managers tend to own companies for relatively long periods of time.  So, they are better able to drive change on key ESG issues.  

Private market managers are competitive beasts too, constantly seeking to differentiate themselves from their peers. ESG and DEI will be key areas they’ll look to excel in and prove to investors they are best in class. 

My five take-aways about ESG in private markets, which every investor should keep in mind:    

1. ESG will rise to even greater prominence in 2022. ESG momentum will continue to build, becoming mainstream across wholesale and private markets sooner than expected.  
   
   
2. Private markets will find it easier than traditional assets to integrate ESG. Private market managers have the advantage of direct ownership when integrating ESG into their decision making, as well as relatively long timeframes to improve in key ESG and DEI-related areas.  
   
   
3. Demand factors are driving ESG integration. Stakeholders now expect institutional investors to better demonstrate how they consider ESG and DEI in their investment portfolios.  
   
   
4. Supply factors are driving ESG. As private market managers try to differentiate themselves, ESG and DEI are becoming key areas to excel and prove their positions.  
   
   
5. ESG is here to stay.  ESG and DEI are no longer niche areas. They are now integrated across the investment management industry with the potential to drive real-world change and long-term performance growth.