A regular briefing for the alternative asset management industry.
Investors, regulators and stakeholders increasingly require sustainability issues to be integrated into investment decision-making. In many cases, such issues are financially material, and private fund managers already have powerful incentives to consider them – although, of course, they need good data, and sometimes specialist support, to assess them. In fact, alternative asset managers are particularly well-placed to take account of financially material issues, generally having an intensive pre-acquisition due diligence process and a multi-layered investment approval process. Long-term prospects often translate directly into exit value, and effective corporate governance during the ownership phase can ensure that strategy and risk management responds to sustainability opportunities and risks.
It is also clear that the financial drivers for a focus on environmental and social issues will continue to increase. The climate emergency is catalysing technological change and policy decisions that will have a dramatic effect on the profitability of certain economic activities, even many that are not themselves exposed to the physical risks. But other environmental issues – loss of biodiversity and the need to move towards a circular economy, for example – as well as several pressing social concerns, will change the business models of a wide range of companies in the decade ahead. Firms that respond quickly to those changes will likely benefit. Once again, the private markets can thrive in such a world – having a financial imperative to be ahead of change, given the need to find a sophisticated buyer for an illiquid asset in, say, five years from now.
However, the financial case for responsible investment is only part of the story. As has become clearer in recent years, investors are concerned about the impact of the activities they are financing – and are increasingly asking about non-financial outcomes. Even where the financial case for "doing the right thing" is not fully made out, companies and financial intermediaries are being implored to do it anyway. (This thought-provoking piece by the London Business School's Professor Alex Edmans from 2018 suggests that, in some areas, attempts to make out a financial case can crowd out the more compelling moral one.)
...As has become clearer in recent years, investors are concerned about the impact of the activities they are financing – and are increasingly asking about non-financial outcomes...