ESG Programs At PE firms – Survey by PitchBook
This fourth edition of our Private Equity ESG Survey arrives at a particularly interesting juncture for the industry. As our recent U.S. and European PE Breakdowns have detailed, the buyout cycle is finally slowing. In addition, more than ever, PE firms are being confronted with the importance of sustainable, responsible investment theses. There is still mixed opinion among smaller PE firms—judging by our most recent survey results—as to the best methods of adoption/implementation or the necessary levels of attention paid to ESG topics, but it’s clear they must be considered. More and more companies and firms are embracing transparency as to their business practices, driven by consumer demand for visibility in areas such as farming and energy production. Calls for diversity are growing more strident. Whatever the motivation, cyberattacks or even leaks of clandestine files such as Mossack Fonseca’s are proving that any digital barricade can be penetrated, paving the way for any type of perceived corporate chicanery to potentially be exposed. In short, some firms are already integrating ESG consideration into standard processes. Many still aren’t, testifying to how the PE industry may remain dubious as to the necessity of official programs and implementation. But as further clarity around the value provided by ESG-prioritizing investments is achieved, increasing adoption is likely.
Last year was a banner year for hedge funds in general, as the industry attracted $31 billion worth of net inflows, according to data from HFM. That total included a challenging fourth quarter, in which investors pulled more than $23 billion from hedge funds. HFM reported $12 billion in inflows for the first quarter following Read More
Just one last note: this survey was conducted from January to April 2016, and according to our new reports naming convention, will be titled with respect to the datasets’ timeframe. Hence the lack of 2015 data in the following charts.
Garrett James Black
What is ESG?
Environmental: waste, water, electricity, transportation fuel, toxic chemicals, paper
Social: diversity, human rights, supply chain, employee engagement
Governance: policy, management structure, board-level oversight
CSR: Corporate Social Responsibility
EDF: Environmental Defense Fund
GIIRS: Global Impact Investing Rating System
PEGCC: Private Equity Growth Capital Council
PRI: Principles for Responsible Investment
ILPA: Institutional Limited Partners Association
As our 2016 data skewed toward smaller firms, responses changed dramatically. Accordingly, this report should be considered as representative of smaller firms, not the market as a whole, which is better represented by prior years.
ESG programs at PE firms
Smaller firms have yet to emphasize ESG as much as their larger counterparts
When it comes to survey data, a healthy degree of caution must be noted given how many smaller firms, who may be fairly young, responded. The most recent installment of data, consequently, is more reflective of how smaller PE firms are engaging with ESG issues as opposed to larger fund managers. And, especially during the period when this survey was administered, respondents from smaller firms may well have had their attention colored by the uncertainty that gripped (and still grips) global financial markets. Even in normal environments, smaller firms often simply have different priorities than big PE funds, and when it comes to ESG topics, they appear to not be as engaged as of yet. For example, European respondents with AUM exceeding $5 billion rated ESG issues as much more important. In addition, this edition of our survey garnered a proportionally greater number of responses from North America, which could skew results somewhat.
With those clarifications, our most recent survey results were intriguing relative to prior surveys, which indicated more general GP opinion. Our respondent pool exhibited a reversal of the proportion with ESG management programs. Also, as indicated by the breakdown of ESG initiatives by age, it may not be so much a lack of ESG consideration as a lack of official programs dedicated solely to ESG. Many firms have begun or have already incorporated ESG considerations into typical processes. Hence the still-healthy level of positive responses when it comes to increased heed paid to ESG issues in the future.
It’s clear that in North America, there was a wave of early adopters, dating to around the time KKR and other flagship firms publicized their own ESG efforts and Corporate Sustainability Report, among other initiatives. When firms at the smaller end of the AUM range will follow suit remains unclear, although it’s likely they will sooner or later, given the nature of the pressures to do so.
What is driving PE efforts when it comes to ESG?
Perhaps the most interesting shift in the chart below is how respondents from smaller firms rated the influence of LPs when it came to ESG efforts, relative to what survey takers from bigger firms stated previously. Instead, we saw surges in risk management, government regulation and portfolio companies. It isn’t likely that LPs abandoned their encouragement of ESG consideration wholesale. What’s more probable is that given the makeup of this survey’s population, it’s not giant institutions that are these funds’ LPs, but rather high net-worth individuals or family offices, which may not yet be pushing for ESG consideration as much yet. In addition, it’s not so much the influence of LPs shrinking as the attention paid to managing general risks is relatively weightier for smaller PE firms. This coheres with the existence of an early wave of GP adopters of ESG programs or initiatives that have, by now, incorporated such considerations into standard processes. Hence the prevalence of deliberation on ESG issues occurring during due diligence.
What needs to be included in an ESG program?
Cost becomes a much more significant factor for small firms
One of the more significant challenges facing ESG promoters that was noted in the prior edition of this survey was the difficulty of measuring effective performance. It’s easy to sympathize with that complaint: After all, one can measure the impact of a recycling program, but is there an objective set of criteria for measuring diversity? When it comes to corporate governance, it’s more the absence of problems that testifies to success than anything else. So, it’s unsurprising to see the lack of effective metrics once again account for the largest portion of responses concerning challenges. Cost skyrocketed, however, which is tied to the number of respondents that indicated their firms had AUM of less than $500 million. The smaller the scale of the firm, the more difficult it is to devote resources to consideration of ESG issues, as the type of value that could be added may not be prioritized. Consequently, we have seen an increase in responses indicating outlining ESG philosophy in limited partnership agreements (LPAs) as very important. When resources are limited, expectations must be set at the very start. In line with that increase, there’s still a fairly healthy portion of survey takers highlighting the importance of monitoring the success of ESG initiatives, and the variance between how bigger firms responded last year and current survey takers is significant. That split between emphasis at the LPA and implementation level speaks to how, for many in the PE industry—particularly in North America—the true value of ESG consideration has yet to be proven.
That is, at least, at the investor level. Given the rise in those stating it is important for portfolio companies to develop a CSR, smaller GPs seem to be incorporating ESG consideration at a portfolio level at a considerable rate.
Cynics may be inclined to scoff at firms publicizing their ESG efforts as merely opportunistic marketing, but that’s missing the point. Effective marketing is essential to any business, and for PE fund managers in the business of raising and investing capital, employing consideration of ESG issues as a differentiator among the competition is simply a potentially useful stratagem. Hence the rise in the production of corporate social responsibility reports, which, if used effectively, can prove how important a particular firm’s ESG efforts are and why they set that firm apart. It’s interesting to note that North American GPs seem to produce far more CSRs, relatively speaking,
Examples of CSR Reports
All PE firms will take a different approach when it comes to crafting the CSR report. Some produce it as a standalone publication while others incorporate it with their annual review. Here are some examples of how prominent PE firms or LPs share their ESG stories:
KKR: ESG and Citizenship Report
Carlyle: Corporate Citizenship
CalPERS: Toward Sustainable Investment
but that is more due to differences in documentation and procedures. Regardless, CSRs on the part of firms and portfolio companies can be useful tools, particularly in an era of high transparency. Customers in general are growing accustomed to a higher degree of empowerment, and being able to clearly show to not only multibillion-dollar asset managers but also small investors or even lowly market analysts that one’s ESG programs are effective is well worth the while.
Creating the CSR Report
The audience for a PE firm’s CSR report will obviously vary depending on the firm’s size and level of public visibility, but the most crucial audience for all PE firms will no doubt be LPs. For firms that put in the effort to develop an ESG program, it is imperative to clearly articulate what the program is accomplishing to both current and potential investors. The CSR report is the ideal format for this and should include everything from high-level ESG philosophies to specifics on how ESG performance is measured and how it impacts the firm’s investments.
The actual content of the CSR report will vary from firm to firm, but there needs to be substance. PE firms that include quantitative results in their CSR report differentiate themselves from those that simply have nice photos. Key details all firms should consider in their CSR report include:
- Objectives of the ESG program
- General approach to ESG issues
- How ESG performance is measured
- Updates on specific ESG initiatives at both portfolio companies and the firm itself
When and Where
Most firms produce a CSR report on an annual basis, but LPs appreciate a high level of communication from their GPs—and increasingly demand it, judging by anecdotal evidence and investor sentiment. As such, it would also be wise to include ESG updates in quarterly reports. Making the CSR report easily accessibly online allows potential future investors, acquisition targets, media outlets and other interested parties to see the firm’s commitment to ESG issues.
Staying current with ESG developments
ESG Groups & Programs
PRI: Developed by a group of international institutional investors in conjunction with the United Nations, the PRI is a set of six principles that guide the investment decisions for nearly 1,400 signatories. Currently, the PRI is reviewing its objectives, while its Task Force on Climate-related Financial Disclosures has recently released its first report.
PEGCC Guidelines for Responsible Investment: PEGCC, the main lobbying group for the PE industry, developed its Guidelines for Responsible Investment through a collaboration with institutional investors around the world and the PRI. The Guidelines serve as a starting point for PE firms that are developing ESG programs.
ILPA Private Equity Principles: Endorsed by more than 240 investors, the ILPA’s Private Equity Principles provide a blueprint for GPs and LPs to align their ESG efforts. ILPA has also recently released its Fee Reporting Template, which only testifies to increasing emphasis on transparency.
ESG Disclosure Framework: Over the course of 16 months, a group that included 20 PE associations, 10 prominent GPs and dozens of LPs from 11 countries came together to create the ESG Disclosure Framework. Published in March 2013, the document is centered around ESG disclosures in PE investments, outlining five objectives relating to fund due diligence and three pertaining to disclosures during the life of the fund.
PEI Responsible Investment Forum: The forum, which is cohosted by the PRI, informs PE firms on ESG strategies that can be employed to develop better portfolio companies.
See full PDF below.