Private Inequity: How the Private Equity Industry Needs to Improve When Addressing Systemic & Systematic Risks

According to a new report about the private equity (PE) industry, the majority of PE firms are not doing enough to take systematic risks seriously in both their business operations and investment portfolios. The report, “Private Inequity: How the Private Equity Industry Needs to Improve When Addressing Systemic and Systematic Risks,” analyzed how PE firms responded to the ongoing triple crises of climate change, the COVID-19 pandemic, and racial injustice.

A research team analyzed 100 of the largest PE firms according to eight different categories or response types for a total of 2,400 potential responses (or 800 responses per crisis) that PE firms could have made between June 2019 and July 2020. Out of this total, researchers found publicly available evidence for only 264 responses (11.0%), suggesting a significant and urgent need for improvement. More than a third (38%) of reviewed PE firms took no public action of any kind in response to the crises.

The eight categories that were evaluated included two types of non-systemic responses (i.e., those unlikely to lead to systemic change and systematic risk management) and six types of systemic responses (i.e., those which would meaningfully contribute to systemic change and systematic risk management).

Non-systemic responses included:

  • Public statement – A PE firm recognizing there is a problem by issuing a public statement about a particular cause or issue
  • Donation – A PE firm giving back by donating to a nonprofit working to address one or more of these issues

Systemic responses included:

  • Internal changes – A PE firm self-reflecting on how it may be contributing to these issues and making changes to its internal business practices by (1) improving hiring and procurement practices, (2) improving employee training and resources, or (3) improving public reporting and disclosures
  • External changes – A PE firm acknowledging its role relative to systematic risks and making changes to its external investment processes by (1) launching new funds, committing more capital or engaging with portfolio companies to manage systematic risks, (2) aligning incentive and investment structures with stated ESG goals or targeted outcomes, or (3) aligning lobbying and political spending practices with ESG goals

The most common responses, as a percentage of the potential response total (with 100% representing a perfect response rate), included: public statements (84/300, or 28.0%), donations (45/300, or 15.0%), internal changes (73/900, or 8.1%), and external changes (62/900, or 6.9%).

However, the frequency and types of responses varied greatly across the three crises. The COVID-19 pandemic elicited by far the most responses overall (114/800, or 14.3%), significantly outpacing both climate change (74/800, or 9.3%) and racial injustice (76/800, or 9.5%). COVID-19 is also unique in that it only surfaced as a crisis in late 1Q 2020, while both climate change and racial injustice have been recurring themes that seem to slip in and out of the public consciousness.