Demands on private equity (PE) and venture capital funds have gone from “financial returns-only” to include mandates to do good. If these ambitions are achievable, then limited partners (LPs) need to keep a close eye on the promised outcomes and adjust their risk management processes to this new paradigm.
Only then can LPs confidently say that they’re earning a profit and making the world a better place.
In a recent Fireside Chat, Wall Street Journal reporter Simon Clark described the problem covered in his recent book: “When companies and investors sign up for this broader stakeholder capitalism mission, big problems can emerge.”
Co-authored by Will Louch, Clark’s book chronicles how Arif Naqvi, CEO of Abraaj Group – the world’s then-largest emerging markets fund – raised billions in impact investment dollars from governments and institutional investors as he swindled away more than US$660 million. Naqvi was one of the most prominent voices in the impact investing world who promised that there’s “no trade-off between doing good and making money”.
In 2017, Abraaj oversaw approximately US$14 billion in assets under management as Naqvi raised money for a US$6 billion health care fund from investors like the Bill & Melinda Gates Foundation, Bank of America, the International Finance Corporation and the CDC Group. A short time later, the Gates Foundation couldn’t account for a huge sum of its investments; Abraaj filed for liquidation in the Cayman Islands in 2018. A year later, Naqvi was arrested in London based on a warrant from the United States Justice Department. He now awaits extradition to the US where he is facing up to 291 years in prison, if convicted.
The Abraaj story, albeit extreme and rare, requires soul searching from all PE stakeholders. How can investors who trust their capital to PE funds with ESG mandates avoid disappointing outcomes?
ESG is growing in PE, as is the related risk
Impact investing is becoming mainstream in PE. In 2020, PE firms raised more than US$370 billion in funds with ESG commitments, according to Preqin.
Research from INSEAD’s Global Private Equity Initiative on the changing ESG landscape in PE found that 89 percent of LPs consider ESG criteria in investment decisions. But interviews also revealed that LPs have trouble differentiating greenwashing from actual impact.
And they’re not alone. Regulators are also concerned. Last April, the US Securities and Exchange Commission issued a Risk Alert which flagged problems like weak internal controls, compliance issues and misleading marketing among funds that promote impact investing and sustainability. I expect further announcements this quarter.</…….