ESG policies becoming more sophisticated

Some private equity firms now consider responsible investment issues across all phases of the investment cycle in a trend that has been well received by investors.

More private equity firms have moved past the discussion stage of how to manage environmental, social and corporate governance (ESG) risks and are now developing actual policies. A fraction of those that do are even customizing their ESG programs and tools by sector and investment strategy.

Malk Sustainability Partners recently interviewed a blend of private equity investors and fund managers of various sizes across the US, Europe and Middle East. The consultancy group discovered 63 percent of general partners have adopted policies to develop their ESG management processes. A total of 31 institutions were interviewed, 19 of which were private equity firms. 

In a similar study last year the comparative figure was 54 percent, underscoring a sharp rise in the industry’s treatment of ESG management over a short 12 month period.

GPs ahead of the ESG curve are tailoring their strategies by industry, says Malk managing partner Andrew Malk. “Some examples include social risks in apparel supply chains, compliance with conflict mineral regulation in electronics businesses, or big-box retail suppliers with insufficient capabilities to meet growing sustainability requirements of their enterprise customers.”

“Opportunity checklists” are being developed by GPs who want to methodically test portfolio companies’ on ESG value creation potential, measuring their energy consumption for example.

LP ESG interests are being driven more than ever by the desire to enhance risk management and protect reputations

The industry appears to be following the lead of Kohlberg Kravis Roberts, the Blackstone Group and a handful of other ESG trailblazers in the industry. KKR for example has built a “Green Portfolio Program” that incorporates ESG considerations throughout the due diligence and investment process of select companies.

The research said firms primarily in the range of $2 billion to $10 billion in assets under management have begun to adopt similar approaches. “[A] greater portion of 2013 participants include ESG considerations in materials for senior management decision-making, like investment committee memorandums and slides in investment review presentations.”

Recently PE Manager explored the various ESG strategies being used by firms, noting some general partners have found it best to use third parties like the Environmental Defense Fund (EDF), for example, or bring an ESG expert in-house. Some GPs have done a blend of both.

Investors' interest in responsible investment can help explain the industry’s growing commitment to ESG. “LP ESG interests are being driven more than ever by the desire to enhance risk management and protect reputations, translating into greater expectations for action and disclosure from GPs,” the Malk report said.

A strong majority (75 percent) of LPs inquire about a GP’s approach to ESG management during fund manager selection, according to the research.