Does Sustainability Affect Private Equity Asset Class?

Abstract

In private equity industry ESG (Entrepreneurial, Social and Governance) metrics are gaining room, passing from the risk management process to influence the orientation of investment strategies. Motivations refer both to a firmer performance of the invested portfolios during the overall investment cycle and to a growing interest of fund subscribers in sustainable investments. Referring to the investment period from 2006 to 2015, we considered a sample of 126 PE investment vehicles. Amongst them 70 are ESG compliant (the main sample) and 56 are non-ESG. In terms of geographies we covered both Europe and North America. We have found that ESG funds generated more stable returns, in terms of net IRR standard deviation, in comparison with non-ESG vehicles, even if the latter showed a superior net IRR. This evidence is in favour of ESG funds as a more stable asset class in the medium-long period. Moreover, we have found that ESG funds contributed to a better portfolio diversification inside large institutional investors. In fact, their average Treynor Ratio is better than that figured out for non-ESG funds. The better performance didn’t depend on absolute returns, in fact the Sharpe Ratio was lower, but on a weaker dependence on the systematic risk as well as on a lower value for their total risk ratio. Finally, we have found that ESG funds were able to pursue a better risk hedging against sources of operating volatility, through a superior stability of their portfolios composition. Evidence was obtained comparing their average total risk ratio with that for the non-ESG funds. This research offers a valuable contribution to the literature on sustainable finance with a specific focus on private equity asset class.

Keywords: sustainable finance, private equity, diversification benefit

JEL Classification: G11, G23, G24, Q56