Sustainability Investing in European Mid-Market Private Equity: A Lasting Opportunity

How would you describe the growing opportunity of sustainability investing in the context of the European mid-market Private Equity segment?

Ambienta was founded almost two decades ago on the firm belief that sustainability drives investment value. We recognised that the world must transition approximately US$100 trillion¹ of economic activity toward sustainable practices in order to support current levels of global economic and population growth.

Our vision was anchored in the conviction that as environmental resources are strained by economic expansion and increasing global population, sustainability-driven businesses that address resource efficiency and pollution control will have a clear long-term competitive advantage.

This philosophy has not changed. We continue to believe that sustainability creates strategic value, drives growth and delivers long-term performance. More importantly, we recognise that sustainability is a theme. It is not a sector - environmental challenges are multi-layered and are not constrained to specific sectors. We are witnessing the biggest revolution in the history of the economy, which is reshaping all industries. Despite politics, this industrial revolution will not reverse – the food and beverage sector will not start moving back from natural to chemical ingredients, LED won’t be replaced by traditional lighting, nor will heat pumps revert to gas boilers.

Based on a scientific understanding of sustainability dynamics across the entire sector spectrum, we see opportunities present across all industries. Currently, we have a portfolio of environmental champions that spans established companies with over 130 factories across 5 continents² , all of which have grown at double-digit rates, with over 20% profit margins³. These are mature companies driving the economy towards a more environmentally sustainable footprint. In the last 18 years, we have executed 80 transactions, of which 71⁴ were primary. This proves that with a strategy based on industrial value and real sustainability drivers and the ability to build deep relationships with entrepreneurs to grow their companies in partnership, there are vast opportunities in the European mid-market Private Equity segment.

Are sustainability and ESG losing momentum in the current political landscape?

Regardless of policies, politics, lobbyists and greenwashing, which are to some extent diverting attention from ESG and sustainability, it is indisputable that environmental trends have reshaped and are continuing to reshape the competitive dynamics of all industries.

Ultimately, and despite this shift in attention, it remains indisputable that those companies that have found a way to address human needs with a business model that has a lower environmental footprint, but still makes sense economically, are gaining market share and winning clients over traditional business models. Ultimately, companies reducing resource use and pollution have a long-term advantage. We see these companies, which we term “environmental champions”, continuing to grow three times faster than the market.

But let us take a closer look at why we are witnessing governments, public opinion and investors backtracking or reducing their focus on ESG considerations, goals and policies.

The drivers are twofold. For one, this is largely because it is becoming recognised that unfortunately many so-called ESG and impact players are not applying an authentic investment approach. And this is good news for genuine players in the market like Ambienta, who already back in 2007, before sustainability was even on the agenda for mainstream players, invested exclusively in this space. Authenticity will prevail as we go through a period where superficial market players, who jumped on the ESG and sustainability bandwagon for the wrong reasons, fall away.

The noise we are seeing currently does not impact our conviction that, simply put, companies that have found a way to use resources more efficiently and/or pollute less will, given the ever-increasing pressures on natural resources that we are already witnessing today, enjoy growing and long-term competitive advantages. On the flipside, companies that do not take this trend into consideration when evolving their businesses will be heavily penalised.

Secondly, ESG and sustainability are often used interchangeably, causing confusion and diluting the essence of their meaning. Ambienta is very clear on this – sustainability and ESG are two very different things. Our approach distinguishes sustainability as the “what” and ESG as the “how” in the context of analysing companies and investment opportunities. Sustainability means: “What is the business model?” It looks at whether the services or products of a business improve resource efficiency and pollution control in a way that is meaningful and measurable for the long term. ESG, on the other hand, means: “How is this business managed?” It is effectively a risk management tool assessing good governance and sound business practices.

Logically, both the “what” and the “how” must be considered together because a sound ESG framework alone, without the essence of a business model (the “What”) being sustainable, cannot drive long-term performance.

Let’s look at an example – any oil and gas company can have the best ESG credentials: solar panels installed on their roofs, social engagement, good governance, great diversity metrics. The company would satisfy the “How” it operates question. But on the “What” it clearly falls short.

It is for this reason that reservations arise when we talk about ESG – people recognise that ESG is being misused. ESG does not equate to being sustainable. And it is for the same reason that we still see funds labelled and bucketed as green or sustainable losing momentum - because investors recognise that these funds invest in companies that are not fundamentally related to environmental sustainability trends even though they tick all the boxes on best-in-class ESG implementation. ESG is not a sustainability differentiator, in fact it is no longer a differentiator at all. It may be a good indicator of how well a company is run and governed, but it must not be confused with providing any indication of whether a business model is ultimately environmentally sustainable.

Where does this leave us?

Sustainability and ESG are two entirely different concepts. It is the sustainability of the underlying business model of a company that determines and drives its value and competitive advantage, not its ESG scores, which are a metric for whether it is run well or not.

So, while recent noise around nomenclatures and ESG/sustainability/impact will prove a significant headwind and pose challenges for investors and businesses that do not have a fundamental and well-established footing in their conviction around the meaning of parameters in this space, the increased scrutiny will play in favour of businesses that differentiate themselves with authenticity. For Ambienta, being synonymous with authenticity in sustainability investing, we see this as a tremendous opportunity to stand out.

Fabio Ranghino, Partner and Head of Sustainability & Strategy, Ambienta

¹ World Bank data.
²Ambienta internal source.
³Ambienta internal source.
⁴Ambienta internal source.