Over the past few years there has been a seismic shift in the private equity industry’s stance towards ESG. There is now clear evidence to demonstrate the correlation between responsible investment and enhanced long-term financial returns. GPs are waking up to the fact that having a robust ESG policy in place is no longer a ‘nice-to-have’, but increasingly vital if they want to attract top LP investors to their fund.
Friede, Busch & Bassen analyzed over 2,200 studies on the link between ESG and corporate financial performance and found 90 percent of them there was relationship between ESG and financial performance – and a large majority found a positive relationship.
LPs themselves are increasingly committed to responsible investments and therefore expect their investee entities to share this stance. Institutional investors, in particular, are facing growing pressure from regulators and third-party stakeholders, such as pensioners, to be fully ESG compliant.
How not to do it
It’s all very well hiring an agency to produce a well-written, beautifully designed report, but it’s not just the language and the look that matters. LPs generally can see through the all-singing, all-dancing reports that are more style over substance.
Brackendale’s recent Private Equity ESG LP sentiment survey explores what makes for a poor ESG Report, and “superficiality” came top of the list of criticisms. LPs complained of too superficial statements on intent or philosophy, and “all talk and no data.” They also criticized greenwashing (making people believe that your company is doing more to protect the environment than it really is) and whitewashing (deliberating concealing incriminating facts), and funds which lacked a top management member responsible for ESG.
Key ingredients for an ESG report
There has to be evidence of a clear ESG policy in place, with either a committee, or at the very least someone, responsible for making sure investments are carefully vetted according to ESG best practice criteria as part of the investment due diligence process. And these criteria should be well documented in the report.
Examples of ESG-friendly investments are good to see, but equally important are examples of how a private equity house has improved a company to make it both ESG-friendly and more profitable at the same time.
In order to benchmark what progress has been made with portfolio companies, key performance indicators are a must-have. There need to be specific criteria and reporting based on concrete measures, rather than just generic policies. LPs want to see tangible and evidenced improvements being made by the GP, with examples in action, rather than simply explaining what good business practice should be.
For example, one of our clients, a Spanish buyout firm, acquired a supermarket equipment firm which it helped to create a shopping trolley range made out of recycled fishing nets. In doing so this reduced ocean pollution, as well as appealing to growing numbers of environmentally conscious customers. Another of its portfolio companies, a boiled octopus producer, made the switch from using bottom trawlers to artisan fishers, which resulted in job creation in the local fishing community, better quality products and protection of marine life and the seabed.
In addition to including details of ESG-friendly investments made or how companies have been improved to become champions of sustainability, ESG reports should also include information on investments that have been rejected or failed due diligence owing to their non-ESG friendly approach. This does not mean stating the blindingly obvious – such as deciding not to invest in a weapons manufacturer. It is better to choose less conspicuous examples of company wrongdoing that progressed to later stages of due diligence before they were unearthed.
Practice what you preach
It is not enough to purely display good ESG awareness at investment level, fund managers also need to be doing so at company level too. The head of ESG’s role should also include being in charge of reviewing the effectiveness of measures put in place companywide and seeing how they can be improved.
Examples include implementing waste, paper and plastic reduction, maintaining gender diversity, joining relevant industry bodies, setting up corporate ESG initiatives, and tracking and reducing unnecessary travel (when travel is allowed again). Carbon usage can be also offset by investing into emission-reducing projects through nonprofit organizations.
While some of the larger private equity firms stand accused of greenwashing with lavishly fancy reports lacking in credible content, on the flipside there are many smaller private equity funds that have had effective ESG policies in place for decades, but not necessarily had the time nor resources to dedicate towards producing an ESG report.
LPs won’t necessarily expect their investee funds to be perfect – but it is important for them to see documented evidence that fund managers are taking matters seriously, taking steps to improve and aligning ESG objectives with investors, portfolio companies and society as a whole.
Fay Margo is CEO of UK-based marketing, branding and communications agency Brackendale Consulting.