ESG-linked capital triples during past decade
Private debt fastest-growing segment, greater focus on returns, social impact
8 Feb 2021 | The Asset

Environmental, social and governance (ESG)-committed capital has tripled within private markets, from US$128 billion in 2011 to US$468 billion in 2020, with private debt the fastest-growing segment, according to recent report.

Asset owners, according to the report by Broadridge Financial Solutions, are making a more conscious effort to select responsible investments, with opportunities aligning with investor and enterprise ESG commitments becoming an important factor in portfolio construction.

“On the surface, many private market strategies possess similar investments to impact strategies –  such as renewable infrastructure and social housing debt – but the primary objective is returns rather than generating impact,” says Nabeel Ansari, Broadridge’s associate director, global insights. “The data showed that private equity remains the largest recipient of total raised private capital for ESG-committed assets, followed by real estate.”

With the adoption of responsible investing slower in private markets compared to public markets, 2021 is likely to be a year of growth for ESG investments in the private markets.

This is partly attributed to growing evidence that supports value creation through ESG, and test cases of long-term return generation within private capital.

While environmental issues like climate change will continue to dominate investment flows, social considerations are expected to be an increasingly important driver too. “Private market investors will begin to focus more on the ‘S’ in ESG as the risks associated with ‘S’ failures are magnified in a post-Covid-19 world. Stakeholders will place greater emphasis on social factors affecting investments. Social bonds rose to 15% of total bond issuance in FY20, up 10% from FY19, a trend we expect to translate into the private markets,” notes Yoon Ng, Broadridge senior director, APAC insights.

There is a growing interest from investors for private debt investments to account for ESG, particularly in Europe, the report states. Key challenges include the lack of objective, consistent and timely publicly available data on private companies, which tend to be small to medium-sized firms. There is also less pressure from the public eye to “do good” due to the relative lack of transparency in the private loan space compared to its public peers.

However, efforts are ongoing to improve ESG application within private debt. There has been headway in rectifying the issue of a lack of transparent data, via a combination of private and public data sources. In the private space, external rating firms have been used by companies to estimate the carbon footprint of smaller firms. In the public domain, unifying frameworks have been set by United Nations’ Principles for Responsible Investing, the Sustainability Accounting Standards Board, development finance institutions, and regulators around the world.

Data show that direct lending forms the bulk of private debt strategies, with a 37% share of assets under management. It is also the fastest-growing strategy within private debt at 19% compound annual growth rate over the last five years. With senior debt, Europe and North America have been attracting the bulk of the flows in direct lending.