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Building ESG into private market portfolios

Fidelity International

Fidelity International - Investment Team


Navigating challenges, seizing opportunities


Environmental, social and governance (ESG) trends present investors with one of the most meaningful sets of challenges and opportunities across private markets. According to PwC, in the base case scenario, sustainably managed assets are estimated to reach about US$34 trillion by 2026. Of that amount, private market ESG assets under management is estimated to reach US$2.7 trillion during the same period (see chart below). Reinforced by regulation, the reasons for this remarkable shift are threefold: 

  1. Changing preferences. Consumer, investor, and societal attitudes are creating demand to incorporate a stronger focus on sustainability in capital allocation, influencing investment decisions at every level.
  2. Changing materiality. The magnitude and likelihood that sustainability issues affect financial performance have become more apparent, thanks to increasing data transparency and new technology that enables analysis at a more granular level.
  3. Changing opportunities. Evolving preferences and the materiality of sustainability issues have helped foster the rapid development of ESG solutions, creating potentially attractive opportunities for investors.

Global ESG assets under management (US$trillion)

Global ESG assets under management (US$trillion)

Source: PwC, 2022. Data are based on analysis by the PwC Global ESG and AWM Market Centre, which conducted surveys involving about 250 asset manager respondents with global AUM of US$50 trillion and about 250 institutional investor respondents with global AUM of US$60 trillion. The analysis also includes data from Lipper, Preqin, and ESG Global. Figures include retrofitted funds.

Materiality materialising

Evidence that ESG has a material impact on an issuer’s risk-adjusted return is strengthening, with ESG return drivers transmitted through three key channels:

  • Cash flow (higher rated ESG companies may benefit from efficient use of resources, robust human capital development and innovation to support earnings growth).
  • Systematic risk (companies with higher ESG profiles tend to have lower cost of capital, which can translate to higher relative valuations).
  • Idiosyncratic risk (companies with stronger risk management practices and regulatory preparedness may have more downside protection).

However, it is important to note that the materiality of individual ESG issues is often dynamic and can change over time. This can be driven by ESG factors interacting with traditional return drivers or the risk associated with an issue shifting in response to varying external conditions.

Differences between public and private market ESG implementation

ESG investing should be applied across public and private markets, though it is also vital to consider some crucial differences. First is the information environment. Private companies typically face fewer obligations to disclose information publicly, so direct engagement is often a critical source of data gathering. Second, investments in private assets may involve larger ownership stakes or effective control, which is less common for investors in public markets.

Third, private market investors are presented with a different set of risk-return characteristics, including more extended holding periods, additional liquidity constraints, and more complex exit strategies. Arguably, this makes ESG considerations even more relevant in the origination stage because ESG issues are typically more likely to impact business performance or valuations over longer time horizons. ESG considerations also can be significant during the exit process. There is a strong incentive to work with management and other stakeholders to demonstrate and report ESG characteristics and improvements at the end of the investment cycle (see chart below).

Fidelity’s view of ESG in public markets vs. private markets

Fidelity’s view of ESG in public markets vs. private markets

Source: Fidelity International, March 2024.

ESG investing in private markets is expected to accelerate in the coming years. We know the pace of change will be swift and uncertain. Building a robust foundation will help enhance the ability to respond quickly to changes, based on our public market experience and its practical application to private markets. Furthermore, ESG standards must be applied just as rigorously whether assets are in the public or private sector. Otherwise, we risk regulatory arbitrage, whereby asset owners can sidestep public scrutiny by shifting into the private sphere - undermining investors’ long-term sustainability goals along the way.

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