How entrepreneurial governance gives PE the edge

Private capital will continue to deliver outsized returns thanks to its unique governance approach, while meeting growing demand for more sustainable and renewable investments, according to the co-founder of one of the industry's largest managers.

"Private markets have really developed from a leverage play to an operational improvement play today," Urs Wietlisbach, Co-Founder and Partner at private markets asset manager Partners Group, said at the AIC 2019 Conference.

"For this you need 'entrepreneurial governance', you cannot have this 'governance of correctness' of public firms."

Public companies are driven to focus on short-term oversight and controls, he said. Their boards also become bogged down in compliance discussions and don't know how to remunerate their executives, turning to external consultants for advice.

"It's actually not the fault of the public companies – it's the fault of the regulators who have forced them. Today in the US a board member has to expect a suit against him almost every day."

PE-backed companies take a different path – they don't focus on whether a director is independent but rather appoint operating directors that can create value. Their interests are then simply aligned by asking them to invest the bulk of their wealth in the company.

"You need to get the public companies entrepreneurial again," Wietlisbach said. "Maybe you have to put up regulation that every board member has to put up $2 million to be voted on to a public board…. if he has to put money in then he will also look after what the company is doing."

While private markets are growing to include new sectors and assets, the number of US publicly-listed companies almost halved from slightly more than 7,300 to 3,600 over the two decades to 2016, he said.

Private markets at the forefront of sustainability

Wietlisbach said the rise of environmental, social and corporate governance (ESG) factors was not just a passing fashion and had been embraced by large institutional investors.

However, public markets are forced to evaluate ESG factors as passive investors compared to private markets, which can actively manage their companies for sustainability or even limit their investments solely to sustainable businesses. Private market impact investment funds, which deliver strong financial returns with a positive social and environmental impact, include Bain Capital Double Impact, KKR Global Impact Fund, and Partners Group LIFE.

Private markets also now support deep impact investing, which aims to deliver profits while helping the severely disadvantaged.

"Charity is a big business, but it's not sustainable. Impact investing is really sustainable."

Wietlisbach said Partners Group had made a substantial investment in a large canteen company that supplies food to schools and other organisations. It was able to cut food waste by implementing AI software that predicts how much food and what type is required each day.

"It's a great example of yes, you do something good for the world; yes, it's good for the company… but you have to do pre-investments. And sometimes public firms don't like pre-investment because they have the quarterly figures to deliver."

Public companies are currently re-evaluating their core purpose. The Business Roundtable recently released a statement signed by 181 CEOs that states the purpose of a corporation is to benefit all stakeholders including customers, employees, suppliers, communities and shareholders.

Wietlisbach said one of the biggest issues around sustainable investing is how to measure its impact, so that investors can assess its impact alongside earnings. Non-sustainable businesses might disappear if investors no longer support them.

"I'm convinced that in five to 10 years from now, you will have two accounts… you will have the financial accounts and you will have a sustainability account."

The renewable energy opportunity

Renewable energy presents a huge opportunity as governments encourage greater investment in the sector and new technology makes the sector competitive against fossil fuels, Wietlisbach said.

"Our new wind park off the coast of the Netherlands is now so efficient that we can compete with the normal market… and that's going to be a big shift. As soon as you are competitive with coal or gas turbines, then why not take wind if it's cheap?"

He also pointed to supportive countries such as Taiwan, Japan (where there are strong subsidies as the country shifts from nuclear power after the Fukushima disaster in 2012), and Germany (which is encouraging investment in wind but not solar).

Wietlisbach said private capital can help fund the estimated $14 trillion-plus of new investment the renewables sector needs out to 2050.

While local regulatory support for Australian renewables remains mired in politics, Partners Group (with CWP Renewables) has continued to invest locally, recently adding a third Australian wind farm to its portfolio.

"We are building up wind farms, we are building up solar plants, and at the end we will also build up some storage."

The cost of renewable energy continues to plummet but storing that energy via more efficient batteries remains the next frontier.

"Today's batteries are not yet good enough to actually store the size that would be needed if we will get to the 62% renewable target for a whole country like Australia, so that's going to be the big hurdle. But people are doing research on this… I'm convinced over the next 5-10 years, we will find new ways to store electricity."

Investment by PE and VC funds offer a way to fuel a greener future and sustainable returns.