What investors really want on ESG

LPs are struggling to gauge managers’ ESG work post-commitment, leaving it up to the GP to communicate the work being done. 

Allow us to throw some quick ESG stats out there, all from this year: 71 percent of investors said they would reject your fund on ESG grounds (PwC); 85 percent of big firms say they’re under more pressure from LPs to work ESG into their everyday practices (London Business, Adveq); and 76 percent of LPs have ESG on their list of criteria when choosing a fund manager (LGT Capital Partners, Mercer).

The one, clear takeaway is that LPs really, really care about environmental, social and corporate governance matters; and managers that don’t express the same can quickly lose their interest.

But here’s something else to chew on, from the same PwC survey: only one in five LPs ask to receive quarterly reports on ESG from their underlying managers; and only 18 percent of LPs have actually gone ahead and withdrawn from an investment or withheld capital on ESG grounds. This kind of conflicting data needs reconciling.

The simple answer is that LPs have limited manpower and resources to review managers’ ESG efforts post-commitment. What is also true, however, is that LPs and GPs are still struggling how to communicate about ESG effectively.

Part of this comes down to the diverse mix of ESG strategies being adopted by firms: a GP wholly dedicated to oil and gas companies, for instance, may take a holistic approach to ESG whereas a manager scoping deals in less risky sectors may apply in-depth ESG reviews on a company-by-company basis – which makes it difficult to standardize ESG best practices that could be used for any kind of formal reporting.

In fact, PwC says there is limited evidence LPs are extracting much value from these reports, which tend to be more qualitative than quantitative in nature. LPs are unsure of what type of ESG information to ask from managers, and “are reluctant to impose costs on GPs by requiring onerous reporting,” PwC said in its study. Meanwhile some GPs suspect ESG information requests are more of a box-ticking exercise for LPs rather than an attempt to better understand their ESG management.

Clearly this is a problem, but what industry ESG consultants like Ryan Miller of Malk Sustainability Partners expect to happen is for LPs to use more non-traditional channels like email and ad-hoc phone conversations in addition to more formal communications such as due diligence questionnaires to keep abreast of (and keep the pressure on) managers' ESG efforts.

And while ESG reporting still needs improvement, LPs appear to trust managers' ability to manage ESG and, at least for now, “don't prescribe a method for managing specific issues,” says Miller.

Happily, initiatives such as the EVCA’s ESG Disclosure Framework launched in 2013, and a United Nations-backed brain trust of LPs and GPs are looking to solve the ESG reporting problem, but LPs remain skeptical that it can be done. Almost half (47 percent) of LPs in the PwC survey said they never used the ESG Disclosure Framework, and appear to appreciate that a firm’s specific ESG policies and procedures will be tailored to its investment strategy and size, based on what makes sense.

The bottom line is that ESG reporting (for now) is of limited value to LPs, but they still want GPs to clearly communicate their responsible investment plans from the outset and make themselves more available for phone calls and other informal channels to receive an update on how those promises are being delivered. The new ESG surveys may not make that perfectly clear, but investors certainly will during your next fundraising. 

PS: Interested in hearing more candid LP views on ESG? Join us later this month at the PEI Responsible Investment Forum in London.