Carlyle Breaks From Pack, Plans Impact Investing Across Firm

It was a curious moment last year when Carlyle Group Inc., once famous for bold bets on defense contractors, hired one of the more prominent names in socially responsible investing.

Megan Starr is a Goldman Sachs Group Inc. alum known to appear on stages at gatherings like the SXSW film festival to proselytize the virtues of environmental, social and governance investing. Now she’s at a firm with no plans to join the rush of private equity titans launching impact funds.

Instead, Carlyle says, the 32-year-old is going to help reshape its broader portfolio.

Carlyle Group is wading into the ESG movement with a markedly different strategy than rivals such as KKR & Co., TPG and Bain Capital, which have set up dedicated funds to make impact investments. As wealthy families, pensions and sovereign wealth funds ratchet up pressure on private equity firms to make more conscientious decisions, Carlyle is embracing the idea that ESG principles can burnish long-term returns across the board.

“We’re taking a much more thematic approach to areas like energy and climate change,” said Starr, who helped build the ESG and investing business at Goldman Sachs before joining Carlyle. “It’s no longer possible to generate high rates of return unless you invest for impact. It reflects the economic reality.”

It’s a striking pledge for a firm that installed former U.S. Defense Secretary Frank Carlucci as its chairman and spent much of its first decade making outsize bets on related companies, investing in military communications and electronic warfare systems. Carlyle also has a history of involvement in the fossil fuel sector. Today, in a sign of shifting times, its remaining investment in Liberty Oilfield Services Inc. is dwarfed by a stake in a supplier of renewable biomass fuel.

And then there’s Carlyle’s investment last year in Spanish denim manufacturer Jeanologia SL. Part of the appeal was that the business uses about 85% less water than its rivals, a lure for shoppers interested in more sustainable goods. After making the initial investment, Carlyle helped Jeanologia get a loan with pricing linked to targets for conserving water. Hitting those goals will keep borrowing costs down.

“If you make businesses better, they will perform better,” Carlyle co-Chief Executive Officer Kewsong Lee said in an interview. “Impact is not a product or a way to grow assets. It should exist in everything we do. We often have control, we have influence and we have the ability to make these changes happen.”
Climate change dominated talks at the World Economic Forum in Davos last month. Asset managers from BlackRock Inc. to Amundi SA have said they are steering cash to firms that emphasize ESG criteria. Some big investors, like the New York State Common Retirement Fund, are even threatening to pull out of companies that don’t do enough.

For years, many heavy hitters in private equity reacted to such pressures by edging away from industries, like coal or certain gun manufacturers, blamed for harming the planet or society. A number of firms issued ESG reports, showing the positive ways their holdings stack up. The latest approach is much more active, tailoring deals to a company’s progress on ESG metrics — such as the financing for Jeanologia — or pursuing strategies with a broad impact theme.

“You’re looking at sectors that do well and align with sustainable development goals, like water and renewables,” said Anna West, an independent consultant in Denver focused on ESG issues. “But firms are still prioritizing returns.”

Positive change and strong returns don’t have to be mutually exclusive, Lee said. Firms can drive cultures that are more inclusive and figure out how to be friendly to the planet without sacrificing profits, he said in an interview Wednesday on Bloomberg TV.

A Carlyle report from this month noted that portfolio companies with two or more board members who are female, black, Hispanic or Asian typically generated annual earnings growth over the past three years that was almost 12% greater than at companies lacking such diversity.

Starr sees an opportunity to help companies that might be considered on the “wrong side” of a more sustainable economy by shifting their practices over time. Since she joined Carlyle, colleagues have been pulling her into conversations with investors or asking her for advice on how ESG measures could play a larger role in the bets they’re making across its portfolios.

Some rivals are still taking a more bifurcated approach.

KKR said this month that it raised $1.3 billion for its first global impact fund, and it has already bought stakes in an Indian recycling company and a Singapore-based energy-efficiency business. But just a year ago, KKR also teamed up with BlackRock on an agreement to invest $4 billion in Abu Dhabi’s oil pipelines, securing two decades of guaranteed returns. KKR has told investors that it’s taking what it learns from the impact fund and applying it more broadly.

“As investors, we can have a significant impact through the activities of the companies in which we invest,” said Ken Mehlman, co-head of KKR Global Impact. “Over the last 12 years, we’ve worked to incorporate best practices for managing ESG issues into our investments across the firm.”

Many private equity firms are taking similar approaches. Still, some investors would like to see them go further.

“It makes no sense at all to raise a dedicated impact fund that’s at odds with what’s happening at the rest of firm,” said Matthew Weatherley-White, co-founder of multi-family office Caprock Group. “There’s a logic chain that breaks when you’re trying to solve problems with one part of the portfolio that the other part is causing.”

Source: Bloomberg

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