ESG Integration Dilemma: Bridging the Divide Between Aspiration and Action

There is no doubt that awareness of environmental, social, and governance (ESG) factors has flooded mainstream investing. As of Q1 2023, the Principles for Responsible Investment (a framework and set of principles for ESG incorporation in investing) had over 5,300 signatories, representing more than $120 Trillion in AUM¹, who have publicly committed to implementing the 6 principles of ESG-integrated investing.

Separately, a robust ecosystem has emerged to support both corporate ESG disclosures and investor ESG integration. Publicly available sustainability frameworks such as SASB/IFRS, GRI, and TCFD, promote the transparent management of ESG factors through standardized disclosures. Prominent investor groups have organized industry initiatives (e.g., the ESG Integrated Disclosure Project and ESG Data Convergence Initiative) aimed at streamlining fragmented and onerous approaches to ESG data gathering and reporting, and niche market efforts – ranging from ESG ratings providers to software platforms designed for collecting, synthesizing, and reporting ESG data – have been established to help interpret ESG data.

However, the combination of peak ESG awareness and exogenous field-building has not translated to widespread or consistent implementation of ESG practices for most investors. The intention to achieve this is evident– according to Morgan Stanley, 85% of asset managers and 83% of asset owners already implement or have plans to implement sustainable investing strategies². Yet, ESG assets are expected to only constitute 21.5% of total global AUM in 2026³, meaning 78.5% of global AUM will not be ESG aligned in 3 years’ time.

Implement or plan to implement sustainable investing

Source: Morgan Stanley

What is causing the disconnect between current investment processes and investors’ own predictions of future ESG integration? If ESG is truly about risk management, why isn’t it being considered more widely for de-risking investments? Are there flaws in current ESG integration processes or are investors suffering from ESG malaise? 

The Way Forward for ESG 

For most PE firms, the original catalyst for ESG integration was (and still is) LP demand. This reactive but defensible approach leads to a sustained “check-the-box” orientation, where GPs seek to satisfy LP considerations but don’t advance ESG practices beyond those requirements. In other words, ESG is a parallel path distinct from traditional investment analyses. 

Several leading PE firms have, however, progressed their ESG practices to an advanced state. Apollo and Carlyle, for example, have established comprehensive sustainability platforms grounded in their conviction that proper ESG integration in action serves not just as a risk mitigator, but also as a catalyst for opportunity and growth, leading to enhanced outcomes. They have firm-wide “ecosystems” supported by teams that oversee ESG issue identification, data collection, portfolio company engagement, and reporting across the entirety of the investment lifecycle. 

Sustainability Ecosystem at Apollo

Source: Apollo

As “best practice,” many of these firms also utilize third-party ESG consultants to provide impartial assessments of their internal analyses or to complement internal teams. This access to specialized knowledge and additional resources significantly bolsters the larger PE firms' capacity to keep abreast of and implement optimal ESG integration practices throughout due diligence as well as post-acquisition. 

However, for most of the market, achieving this level of ESG maturity is a distant prospect. Mid-market and growth equity segments are unlikely to view establishing full teams of dedicated internal ESG resources as financially beneficial, and the degree of work required for existing (non-ESG focused) deal teams to perform ESG analysis is unrealistic given the specialized knowledge and time required. 

Considering the extensive scope of ESG considerations, mid-market firms have tended to concentrate their ESG efforts on the processes highly valued by LPs (as evidenced in LP DDQs⁴): foundational fund-level policies and overarching firm-level governance practices. Creating a new business case for the adoption of more strategic ESG practices is needed to inspire these firms to take bolder action on ESG. In our view, we see a shift into more widespread ESG integration amongst mid-market PE managers occurring when they: 

1. Can access the same ESG integration strategies as market leaders but without the more onerous operational aspects 
2. Recognize and can benefit from the interconnectivity of ESG across the investment lifecycle 

To get mid-market PE to reach that level, these business case requirements have to be satisfied. This starts with the seamless integration of ESG practices into service offerings they currently access through third-party experts. This would allow them to start operationalizing their ESG programs by unlocking the following efficiencies: 

• Embedding ESG due diligence (ESG DD) into commercial due diligence (CDD), leveraging insights gained from CDD to inform and enhance a more strategic and complete ESG DD 
• Value creation plans that include an analysis of material ESG risk factors against key financial metrics and provides recommendations on how to create value from ESG risks 
• Sell-side/exit planning that benchmarks ESG performance, communicates the ESG business case, and streamlines buy-side ESG DD 

Advancing ESG integration practices across the ownership lifecycle allows PE firms to move past awareness to meaningfully demonstrate that financial performance and sustainable practices are interlinked. For mid-market PE, combining ESG analysis with traditional financial analyses already sourced through 3rd-party partners allows them to achieve similar ESG integration capabilities as the market leaders and contribute to positive societal and environmental outcomes. This strategically positions them for long-term success in a changing business landscape. 

At Stax, we founded our ESG and Impact Advisory practice to bridge the intent-reality gap experienced by investors. By integrating ESG into our core offerings, we enable our clients to shift their internal conversations around ESG. Our solutions help to operationalize ESG across the full investment lifecycle – from buy side diligence to value creation and exit planning – advancing client maturity and steering investees towards better outcomes. 

Leverage a 30-year track record of delivering value to clients and elevate your ESG strategy with us – contact Stax to learn more. 

Anuj A. Shah

Managing Director | ESG & Impact Advisory

1. “Quarterly Signatory Update.” PRI, July 10, 2019.
2. “Sustainable Signals.” Morgan Stanley, November 2022.
3. “ESG-Focused Institutional Investment Seen Soaring 84% to US$33.9 Trillion in 2026, Making up 21.5% of Assets under Management: PWC Report.” PwC, December 2022.
4. “ESG Roadmap and Resources.” ILPA, September 28, 2021.