Finding the right ESG solution

It’s no secret that investors have become increasingly vocal about fund managers’ need for a framework that addresses environmental, social and governance (ESG) issues throughout the investment process.

Better, stronger companies and an improved public image are two core reasons why fund managers ought to be establishing ESG programs as part of their overall investment strategy. That was the message Volkert Doeksen, chief executive of AlpInvest Partners, delivered late last year to a standing room only audience at Private Equity International’s Responsible Investment Forum.

Doeksen encouraged his fellow LPs to push for wider adoption in the private equity industry: “We need to remain very vocal on it at all levels – please keep pushing, be more specific so GPs will respond.”

Just last month a first of its kind collection of 41 limited partners, 20 private equity trade bodies and 10 buyout firms did just that, releasing a set of eight specific responsible investment objectives for GPs to consider. 

For some private equity firms, this may be the sort of push they needed to consider enhancing their in-house ESG strategy. But should they partner with third parties, like the Carlyle Group or KKR has done successfully with Environmental Defense Fund (EDF), for example, or bring an expert in-house? Some mix of both?

Hiring an in-house ESG specialist has a few inherent advantages. By virtue of being embedded at the firm, they have the leverage to make improvements happen and complete initiatives quickly, says Adam Black, who has experience as both an outside ESG consultant with KPMG and in-house specialist as head of sustainable development at UK private equity firm Doughty Hanson. With the support of management, a full-time ESG employee is best placed to communicate the logic and appeal of responsible investment to colleagues during investment committee meetings or even water cooler chats. Sources say an in-house ESG guru lends a certain kind of credibility to a firm’s message on responsible investment, and can serve as the point person in answering investors’ ESG-related enquires.  

Third party organizations can also offer GPs unique advantages. Consultants can provide specific areas of expertise on ESG issues, for example carbon emissions or labor union disputes. By working with multiple clients, consultants can see firsthand what ESG solutions have worked at similar companies and flag ESG-related challenges others might miss during due diligence.  

In a similar vein, advocacy organizations like Transparency International and the American Heart Association offer private equity firms high-level guidance on ESG issues, often at no cost. EDF for example has developed a free ESG management tool, tailored for the private equity industry, available for download. However firms that enter into a direct relationship with advocacy groups should be prepared to provide a high level of transparency and commitment to the group’s mission, says Lee Coker, who manages EDF’s partnerships with private equity firms.   

Of course there’s nothing preventing GPs from using a mix of all the available options to enhance their ESG work. Elizabeth Seeger, who oversees KKR’s environmental and social responsibility initiatives, says part of her job is identifying the right external resources needed to help understand and manage ESG issues.

In the end GPs will need to decide for themselves what ESG approach works best for their firm, both from a cost and a culture perspective. Private equity recruiters say the trend for in-house ESG specialists began a few years ago with large-cap firms like The Blackstone Group, Carlyle Group and KKR, but that it was now trickling down into the mid-market. Considering investor demands, it’s not hard to imagine why. 

P.S. In our May edition PE Manager will explore other human capital-related issues, including our annual look into the average compensation figures of private equity professionals.