ESG in Alternatives 2023: A Growing Landscape of Opportunities for CFOs

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Explore the rapid growth in capital raised, the impact on dealmaking, and the rise of impact strategies.

Preqin, the global leader in alternative assets data, tools, and insights, has released its annual environmental, social, and governance (ESG) report titled “ESG in Alternatives 2023.” The report unveils key insights within the private markets, focusing on the developments, fundraising trends, and fund sizes in the ESG space across different regions. As the landscape of ESG investing continues to evolve, CFOs are presented with new opportunities and challenges in navigating this dynamic field.

Rapid Growth in ESG Capital Raised

The report highlights a remarkable three-fold increase in annual capital raised between 2020 and 2022, surging from $29 billion to $92 billion. Europe-based ESG funds emerge as the prominent frontrunners, securing over three-quarters (79%) of the aggregate capital, followed by 14% in North America and 7% in the APAC region. Moreover, average ESG fund sizes have grown from $400 million in 2017 to nearly $600 million in 2022, signaling increased investor appetite for sustainable investment opportunities.

ESG Impact on Dealmaking

While the debate on whether ESG drives longer-term returns remains ongoing, the report reveals that investors’ views lack a strong consensus. However, what is evident is that ESG considerations significantly influence investors’ willingness to engage in deals. In a recent investor survey conducted by Preqin, 29% of respondents reported turning down a deal due to ESG concerns, and an additional 43% expressed their likelihood of doing so. This suggests that investors view ESG as a vital means to manage downside risk.

Private Equity and Infrastructure: Leading the ESG Charge

Private equity funds have historically dominated ESG fundraising since 2014. However, the strong growth experienced in 2021 and 2022 resulted in infrastructure funds securing nearly as much capital as their private equity counterparts. Infrastructure’s unique position in delivering societal and environmental outcomes through essential services contributes to its appeal. Furthermore, infrastructure fund managers exhibit high levels of transparency, reflecting their need to engage multiple stakeholders in infrastructure project development.

The Rise of Impact Strategies in North America

Within the ESG landscape, impact funds have gained significant traction, particularly in North America. Unlike conventional ESG funds, impact investing deliberately embraces a trade-off between financial returns and the pursuit of specific societal or environmental goals. Consequently, positive external outcomes are central to the investment decision-making process. Notably, impact fundraising across alternative assets surged from $2.6 billion in 2019 to $33.6 billion in 2022. North American impact funds lead the way, capturing 59% of the aggregate capital raised, while Europe and APAC secured 37% and 2%, respectively.

Key Additional Findings

Increased Impact Funds in Venture Capital – Impact funds hold a prominent position within the venture capital space, accounting for 40% of funds across the 2013-2023 vintages, compared to 18% for ESG integration funds.

ESG Funds by Industry Exposures – Energy and utilities dominate ESG funds in Europe and North America, constituting 14% and 19%, respectively, based on fund vintages from 2013 to May 2023. In North America, information technology (IT) plays a more significant role in ESG funds, accounting for 13% compared to 8% in Europe.

Opponents to ESG’s Rise – Some political representatives, including the Governor of Florida and state representatives from Kentucky, North Carolina, and Texas, have expressed opposition to ESG-risk-management standards. They have threatened divestment from fund managers embracing ESG policies. However, the majority of private capital investors across asset classes have either implemented or plan to implement active ESG policies within the next 12 months, with 52% of Infrastructure investors already having active policies in place.

ESG-related Litigation – Corporate ESG litigation has witnessed a notable increase in recent years, particularly targeting companies involved in fossil fuel extraction and sales. Preqin’s ESG Risk Exposure Estimates rank the oil and gas industry as the second-highest risk exposure, closely followed by the chemicals industry.

Amidst new challenges and the focus on performance, the ESG landscape is diversifying and becoming increasingly sophisticated in what it can offer investors. Impact investing has emerged as a distinct market within ESG, attracting growing interest. As CFOs navigate this evolving landscape, they must recognize the expanding opportunities for sustainable investments while mitigating associated risks. By staying informed and leveraging the insights provided in reports like “ESG in Alternatives 2023,” CFOs can contribute to their organizations’ long-term success and sustainable financial performance.

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