Navigating Climate Risk: How Private and Public Equity Impact Pension Funds
Private and public equity are vastly different regarding access, strategy, and regulation. But how do private and public equity relate to the role of public pension funds, and why is it important to think about both in the context of climate change?
Let's explore this by using an analogy that clarifies the distinction: the exclusive club versus the community pool.
Private Equity: The Exclusive Club
Private equity is like an exclusive club. Membership is limited; only a few (private equity firms, venture capitalists, institutional investors, or wealthy individuals) can invest in these funds. The key characteristics of private equity are that it's more hands-on and often involves a controlling interest in a company. The goal is to improve operations, increase profitability, and sell the company for a return. But because it's exclusive, it's less liquid and requires a long-term commitment from investors.
Private equity has been on a rapid rise. In the U.S., the number of private equity-backed companies has surged from around 2,000 in 2000 to more than 11,500, a 400% increase. The private market is expected to reach more than $15 trillion this year and $18 trillion by 2027, up from $10 trillion in 2021, and private equity accounts for over half of the total.
For public pension funds, private equity investments can be beneficial to diversify portfolios and pursue long-term growth. However, with growing concerns around climate change, these investments need to factor in the emerging risks tied to sustainability. A private equity firm looking to build long-term value should prioritize sustainability and climate resilience. They need to ask: How is the company addressing climate risk? Is the company prepared for the long-term challenges of a rapidly changing environment?
Public Equity: The Community Pool
On the other hand, public equity is like a community swimming pool. It's open to everyone, and anyone can buy or sell company shares at any time based on the current market conditions. Public equity is more liquid and subject to market fluctuations, meaning that it responds quickly to public perception, company performance, and overall economic conditions. For pension funds, investing in public companies can offer an easier entry and exit point, with a broader spectrum of options for diversifying the fund's portfolio.
However, public equity is shrinking. The rise of private equity has been accompanied by a decline in the number of publicly traded corporations over the past 20 years in the U.S. Publicly listed U.S. businesses have declined from about 7,000 in 2000 to about 4,500, a 35% decrease. This means pension funds have fewer public equity options and must be more strategic in selecting companies committed to climate resilience.
Public equity investments face the same climate-related risks that private equity funds do. As public companies are scrutinized more heavily by regulators and the public, pension funds need to assess how these companies are addressing climate change. Investors should look for proactive companies in their climate strategies, both in terms of mitigating risk and seizing opportunities that arise in the transition to a low-carbon economy.
The Intersection: Public Pension Funds and Climate Strategy
So, what does this all mean for public pension funds, and how does it tie back to climate change?
In the context of climate change, both types of investments carry potential risks to long-term value. Extreme weather events, shifting regulations, and changing consumer preferences due to climate concerns can affect private and public companies. In response, pension funds must:
Integrate climate risk into both private and public equity investments: This means evaluating the climate resilience of companies in which they invest, understanding exposure to climate-related risks, and ensuring investments align with long-term sustainability goals.
Push for transparency and accountability: Whether investing in private or public equity, pension funds can use their shareholder power to hold companies accountable for their climate impacts, demanding comprehensive reporting and climate action plans.
Diversify with sustainable investments: As the world shifts toward a low-carbon economy, pension funds can invest in private and public companies leading in sustainability, such as green infrastructure and sustainable agriculture.
Why This Matters for Workers
Ultimately, pension funds are responsible for securing the financial futures of workers and retirees. With the growing risk of climate disruption, pension funds must make investments that account for the best interest of the millions of workers invested for retirement. Whether swimming in the community pool of public equity or participating in the exclusive private equity club, pension fund managers must remember that climate risk is real, and addressing it is essential for safeguarding tomorrow's financial security.
Note: The analogy used was developed with the support of AI.
