Insights
Pictured: Jennifer Flood, Dr Serge Younes, Claire Sullivan and Nicole Sledgh from Investindustrial.
How can the Net Zero Investment Framework help private equity investors to decarbonise their portfolios and create value? These are two sides of the same coin, argues Dr Serge Younes of Investindustrial.
When Serge was invited to a series of discussions on a new private equity component for the Net Zero Investment Framework (NZIF) he was met with the fundamental question: how can we ‘foolproof’ the guidance for private equity?
“We put our beta tester hats on,” the Head of Sustainability for Investindustrial said: “Bringing together Limited Partners (LPs) and General Partners (GPs), of different sizes and from different continents to structure the component and reporting, helped to make it credible and actionable.”
The mission was to give managers very clear expectations and a process for aligning their portfolios to net zero.
Led by Misa Andriamihaja, IIGCC’s Private Equity Lead, this investor-led approach produced a resource which has been welcomed by the industry since publication in May 2023. It focuses on aligning ambition across LPs and GPs, with the decarbonisation of portfolio companies as the overarching goal.
“It gives you urgency”
Investindustrial's sustainability credentials were already well established. The European-based group, which specialises in mid-market industrial, services and healthcare companies, first measured its carbon data in 2007 and first made public its portfolio carbon data in 2016.
It became a signatory of The Net Zero Asset Managers initiative in 2021 and has since set science-based targets, earning widespread recognition on climate action in private markets. This includes B Corp certification as well as several industry ESG awards over the past 10 years. It was also one of the first private equity investors to use NZIF as part of its reporting in 2023.
“NZIF gave us a timeframe element which is really clear,” Serge explained: “It gives you that urgency. From when we acquire a company we have, say, two years, within which it needs to be at a certain net zero alignment stage. That really focuses the attention on what needs to be done to achieve that.”
The guidance suggests a four-stage assessment of a portfolio company’s alignment with net zero, which considers various stages alongside fund vintage milestones. Investor progress is measured through four clear targets which vary by scenario, including whether the investor is a GP, LP, or by asset class and fund type.
Serge explained that this time-bound focus, together with how NZIF can be used alongside other existing guidance, such as The Science Based Targets initiative (SBT) for PE and the Private Markets Decarbonisation Roadmap, helps PE managers demonstrate a decarbonisation path to investors:
“[Using NZIF] Any firm can go and explain to its stakeholders what it is doing and where it is going. It’s not your own definition – here you have a clear set of data for comparison.”
Value creation
Aligning investment strategies with net zero is part of risk management, but Serge points out that senior leaders at Investindustrial take more notice of the benefits doing so adds to the value creation process: “You also start to measure the business opportunity and the competitive advantage for each portfolio company.”
“Sustainability should be part of the discussion and action plan in relation to risk, governance, in growing the top line and improving the bottom.”
He listed several examples, including a portfolio company where close attention to the European Union Emissions Trading System (EU ETS) reduced costs significantly over the holding period as the regulated carbon price increased.
In another case, a portfolio company was invited to tender by its biggest customer, a large multinational which was asking for unreasonable price reductions. During the tender process, it became clear that the portfolio company was the only vendor with a credible climate transition plan - a mandatory requirement for the contract. Suddenly, it was the portfolio company with the negotiating power.
Serge believes that these competitive advantages are especially relevant in private equity. PE investors often have longer holding periods and majority control, allowing them to support their portfolio companies in implementing long-term sustainability and decarbonisation programmes. Focusing on these benefits is the advice he would give to other firms considering decarbonisation:
“You don’t have to make a climate commitment now, but there are steps you can take. Understand your portfolio, make it part of your internal process,” he said: “Sustainability should be part of the discussion and action plan in relation to risk, governance, in growing the top line and improving the bottom line. These are core to the private equity value creation model.”
A missed trick
Reflecting on the guidance, Serge is certain that NZIF can be a shortcut for new adopters in the industry: “Our journey started in 2007, with a comprehensive decarbonisation plan which has been ongoing now since 2016. What took us close to 10 years shouldn’t take other firms the same length of time. We have shared what we have learnt through NZIF so other firms that are later adopters can benefit from this.”
"Behind new 'green' companies, with higher valuations and uncertain futures, there are many established companies primed for a pivot."
He also highlighted a particular area of interest where some European-based LPs are looking to increase their allocation to net zero-focused funds:
“I think there’s a missed trick in the transformation of industries – I call it grey to green,” he said, explaining that behind the new ‘green’ companies, with higher valuations and uncertain futures, there are many established companies primed for a pivot:
“There are great opportunities if you look at infrastructure, industrial manufacturing and their value chains. Companies that have competence but have not been able to enter into sectors such as solar panels, wind farms and EV components, as examples, may now be extremely well positioned to service these high-growth sectors. It would be a missed opportunity not to allocate capital to those businesses.”
Translating sustainability requirements into the language of opportunity and risk is core to Serge’s ethos and one which will ring true with IIGCC members. Now, it is hoped that the Net Zero Investment Framework Component for Private Equity will drive more progress towards net zero and competitive advantage for those that use it.
Misa Andriamihaja, IIGCC’s Private Equity Lead is offering one-to-one support meetings for private equity investors to help them understand and implement the component. Please get in touch if you would like to know more.