DE&I gains in private equity firms despite being rare deal-breaker – EY

Dive Brief:

The largest private equity firms are more focused on prioritizing diversity, equity and inclusion (DE&I) initiatives than moderately sized firms as (87%) of private equity firms with over $15 billion in assets under management identified it as their most important talent management priority, compared to 81% of firms with AUM of $2.5 billion-$15 billion, and 56% of firms with AUM under $2.5 billion, according to a EY’s 2022 Global Private Equity Survey of more than 100 private equity CFOs, COOs and financial executives and over 50 institutional investors.
The increased focus on diversity is starting to trickle down to impact private equity hiring. Since 2020 the percentage of PE firms where women comprised more than 30% of the front office workforce rose to 23% from 12% while the share of companies with the same proportion of women in back office positions ticked down, albeit from a higher level, to 74% from 78% over the period. The percentage of PE firms where racially and ethnically diverse workers comprised more than 30% of front office workers has risen to 11% from 7% since 2020 while the percentage of firms with that level of diversity in their back offices rose to 17% from 11%.

However, the lack of a "consensus on a global framework" for environmental, social and governance (ESG) issues remains an obstacle that leaves some PE managers reluctant to offer specific investment products in the space, the report stated. Only 42% of the largest companies say they consider ESG risks and opportunities seriously or very seriously as part of their investment decision process, 39% view it seriously for certain risk areas and 19% say they consider it on an ad hoc basis but investment returns are still the most important factor, the survey found. Only 2% of managers said they have turned down an investment opportunity because of a portfolio’s DE&I policy.

Dive Insight:

Attracting and retaining talent has risen toward the top of C-suite risks cited by many firms this year. It’s also weighing heavily on the private equity sector, which is experiencing a period of fast-paced growth that is challenged by one of the worst labor shortages in decades.

The combination of growth and labor challenges “has kept talent management a priority,” Kyle Burrell, U.S. FSO Assurance Partner at EY, told CFO Dive. "Firms are only getting bigger," and at the same time they're not immune to the labor pressures other firms are facing, he said. Sixty-eight percent of the largest PE firms surveyed identified talent management, followed by (52%) product/strategy expansion and (52%) ESG initiatives as the top strategic priorities aside from asset growth.

The survey findings also underscore a shift by investors and PE firms to ESG product offerings. The share of investors who put money in ESG product offerings rose to 39% this year from 33% in 2021 and the share of large managers who currently offer ESG products to investors rose to 35% from 26% from 2020, according to the survey.

The push for ESG has in turn impacted hiring decisions as private equity firms focus on their own DE&I initiatives, typically viewed as being part of the "social" component of ESG. Sixty-eight percent of the largest PE firms identified increasing gender and racial/ethnic representation as tied for the top two priorities in hiring followed by 52% who cited instilling the firm's culture in a hybrid or work-from home environment, according to the survey. “Outside of just believing it’s the right thing to do there is some pressure from limited partners to have DE&I,” said Burrell.

Still, obstacles remain for the firms looking to launch ESG funds, with 49% of respondents citing a lack of standardized means of rating a program’s effectiveness, 47% the need for an appropriate risk-return profile, 15% the lack of investor interest and 14% the difficulty of finding ESG investment expertise. While many companies are looking for more guidance from regulators such as the International Accounting Standards Board, the report stated that many PE managers "have turned to creating custom scorecards to rate just how effective their portfolios are with respect to ESG."

The report also noted that it was surprising, given the sector's focus on ESG, that so few respondents said that DE&I policies had caused them to walk away from a deal. However, the report recommends that firms work with portfolio companies that do net yet have DE&I policies to create one and that PE managers build out a formal investment review process that has "deal-breaker" potential based on whether companies meet certain guidelines.

The survey was conducted from May through October of 2021 using telephone and online interviews with CFOs, COOs and heads of finance at 107 private equity and venture capital firms and with 54 institutional investors.