The overwhelming majority of respondents to our Private Funds Leaders Survey 2022, conducted in partnership with MUFG Investor Services, believe that a stronger ESG vision and culture will create value in their business.
“ESG is hugely important at many levels,” says Silverfleet Capital managing partner Gareth Whiley. “We need, as investors and as businesses generally, to demonstrate to society that we are a force for good and that pursuing commercial interests is not to the detriment of everyone other than shareholders.”
Livingbridge chief investment officer Shani Zindel adds that your approach to ESG is critical to recruitment and retention today. “It is a way of engaging with your team, your community and your environment that people care deeply about,” she says. “It is hard to believe that that doesn’t make for a better business.”
Phoenix Equity Partners CFO Steve Darrington, however, sounds a word of caution. “ESG has definitely gained momentum over the past five years, but it has done so in a relatively benign environment,” he says. “I think the real test of ESG’s mettle will be whether that momentum can be maintained against a more challenging macroeconomic backdrop.”
Meanwhile, notable differences also persist between geographies. While 58 percent of European managers and 56 percent of Asian managers resolutely agree that a stronger ESG vision and culture creates value, this falls dramatically to 22 percent for North America.
Mirroring 2021’s results, meanwhile, LP pressure is the predominant driver of greater ESG monitoring and reporting, reflecting a heightened awareness among the general population. “I think it is a perfect coming together of people understanding that their actions can make a difference, coupled with increased demands from LPs, customers and consumers, that is driving a relentless increase in the focus on ESG matters,” says Whiley. “I worry that monitoring can risk becoming an end in itself, rather than a tool to help achieve a goal but, equally, we know the power of monitoring things to effect change.”
There has also been an uptick in regulatory influence, however, up from 19 percent to 34 percent. This increase was particularly evident among European respondents, as SFDR takes hold.
“The ESG agenda has moved from a nice to have to a need to have, with the introduction of the new EU directive on ESG disclosures for funds marketed in the EU as well as the EU taxonomy requirements,” says IK Partners CFO James Yates. “Any fund manager that is unable to demonstrate it is best in class from an ESG perspective in how it manages its investment process and deals with its portfolio company will be at a huge disadvantage to those that can.”
Nonetheless, less than a quarter of respondents claim to be fully prepared for the EU regulation and its principal adverse impacts reporting, with a similar number admitting that they are not prepared at all.
Approximately two thirds of those surveyed believe that ESG considerations are critical or very important to both value creation plans and due diligence at a portfolio level, and over half of participants are able to demonstrate a positive correlation between ESG and investment performance – again, falling to 40 percent for North America.
“Proving the link between ESG and performance is an ongoing project for many managers,” says Yates. “There has always been the ability to demonstrate anecdotal evidence linking ESG to portfolio performance but with the level playing field that EU regulation is trying to introduce it should be easier to demonstrate how portfolio companies are delivering value through their ESG agenda, or indeed not as the case may be.”
Diversity remains the most tracked ESG metric, but there has been a marked increase in the percentage of respondents tracking more challenging KPIs including energy consumption, carbon footprint and waste.
“Tracking is essential because you have to have the data in order to know if you are making a difference,” says Zindel, pointing to industry-wide efforts to track D&I. “That data collection exercise has focused attention on the issue and made people more aware. I am sure we will see similar outcomes in other areas.”
The majority of firms collect ESG data directly from portfolio companies, with an overwhelming 90 percent indicating that the process is challenging. A further three in 10 respondents supplement that information with data from external providers. Only 5 percent report having a highly automated ESG data gathering process, while for 60 percent the exercise is fully manual.
Meanwhile, over half of those surveyed have an internal ESG team, while 40 percent are also outsourcing some ESG-related functions. Yates, for example, says that IK manages ESG inhouse and has invested in technology to assist in data capture and reporting. “We also use external advisers to assist our portfolio companies where they may not have the resources to help them manage their ESG agenda,” he adds.
Darrington adds that the scope of work has changed dramatically, meaning that external support is now required. “Up until around 2015, I was able to craft a relatively robust narrative around ESG. I had a body of collateral so that I could respond to enquiries when they came in,” he explains. “But then LP information requests became significantly more granular. It really was a case of show and tell. At that point I brought in a consultancy in recognition that these custodians of capital are wanting more.”