Investing strategies centered on environmental, social, and governance outcomes have faced criticism by those who believe they deliver inferior returns. That criticism has extended to the private markets, which, by their nature, are far more opaque than the public markets.
But enough historical performance data now exists for a variety of ESG and impact-related private funds that Preqin, a private markets data-and-analysis firm based in London, has recently published financial benchmarks to track the sector.
The initial findings: ESG-related funds perform just as well as other private-market funds.
“What we see is it really just follows the market—it’s just a smaller slice of it,” says Jaclyn Bouchard, Preqin’s head of ESG solutions and corporate responsibility.
According to the firm, a lack of “standardized and comparable ESG fund performance data” has contributed to anti-ESG sentiment and criticism. Despite that backlash, global investors have continued to clamor for these funds. The firm’s data from November 2023 shows more than 20% of private-market investors have turned down fund opportunities out of concern they didn’t have adequate ESG standards, while another nearly 40% say “they would” turn down investment options if they had concerns.
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For private-market fund managers, “we’re starting to see that similar momentum that you saw maybe seven, 10 years ago in public markets, where you can no longer not talk about ESG or kind of put your best foot forward with ESG,” Bouchard says. Managers want to be able to say to investors: “Hey, we have ESG funds in the market, we have policies, we have a team that’s dedicated to ESG across our firm.”
ESG-related fund managers are also finding that the companies they’ve invested in are worth more to the market, or to a potential acquirer, when they seek to exit their investments via an initial public offering or acquisition, Bouchard says.
“The data for this is more anecdotal,” she says, but it is part of why investors and fund managers have become increasingly interested in the sector.
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Preqin has long sought to provide financial performance benchmarks for ESG-related funds, but to do so required each category to include at least four funds that had been in the market for at least three years.
“It was kind of an exercise in patience,” Bouchard says. “We hit this critical point earlier this year.”
The data the firm can now provide covers eight categories of funds, including those with a specific impact objective, that is, the investments are intended to achieve measurable, positive economic or social outcomes. It also includes “sustainable development goal” funds—which are aimed at addressing one of 17 U.N. goals such as “no poverty” or “clean water and sanitation”—and climate-focused funds.
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Also included are so-called ESG-integration funds, which are those that consider the quality of each company’s environmental, social, and governance practices before investing, in addition to two categories of funds that meet specific European Union regulatory guidelines. These are Sustainable Finance Disclosure Regulation Article 8 funds, which are similar to ESG-integration funds, often tilting toward a theme such as climate or housing. SFDR Article 9 funds are strictly designed to have a specific, positive environmental or social impact, and have to comply with a lot of regulatory reporting, Bouchard says. There are currently 751 Article 8 funds and 394 Article 9 funds in existence, according to the firm.
Preqin’s financial performance data also covers Sharia-compliant funds, which make investments consistent with Islamic law.
The scope of this data could have a global impact on investor choices. With these benchmarks, investors have figures to show ESG-related funds can perform as well as others.
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For example, an analysis of Article 8 vehicles finds the funds “deliver returns in a narrower range, with less likelihood of large losses than the average private-equity fund.” The median net internal rate-of-return being reported for a pool of 15 funds created in 2020 is 16.3%, according to recent data. For the bottom quartile of funds in this group, the lowest performing have an IRR of 8.4%, while the best performing ones in the top quartile have an IRR of 26.6%, Preqin said.
A comparable pool of 517 private-equity funds found the worst performers in the bottom quartile have an IRR of 7.9%, while the best performers in the top quartile have an IRR of 25.1%. Similar results were found for funds created in 2021.
Also, the number and size of ESG-related funds continues to grow. There are now about 2,800 private-capital ESG-related funds with a total of US$1.1 trillion in assets. Fundraising for these vehicles slowed last year, but that was true throughout private capital, Bouchard says.
Today, there’s also growing interest for investing in clean-tech technology in the U.S. through funds that may or may not carry an ESG or impact label, in response to the climate incentives in the Inflation Reduction Act, she says.
“There’s a lot of private capital being pushed to this, so that’s a huge opportunity,” Bouchard says. “We’re still seeing it, just maybe through a different lens.”