The fourth in our in-depth series looking at Sweden’s AP funds features Sjätte AP-fonden. For an outline of the law changes discussed, see here.
Having heard from AP1, AP2 and AP4 so far in this series, the first thing to note about AP6 is that it’s a very different beast to its predecessors. In fact, to call them predecessors is misleading: AP6 was created by the Swedish Government before the first four funds, despite what the numbers suggest, to help revive investment into unlisted assets after the economic downturn of the early 1990s. Within this mandate (for which it was given SEK10.4bn in 1996), it has chosen to focus on private equity – both through direct investments and through general partners (GPs) or private equity firms. Now with more than SEK30bn under management, it has gradually widened its regional focus, first to the Nordics more widely, then to Europe, and most recently to the US where it completed its debut deals in 2017.
But private equity’s reputation for secrecy, asset-stripping and brutal cost cutting measures means it is often dismissed as fundamentally incompatible with ESG. So how is it possible for AP6 to keep up with its public-equity focused peers?
“It’s true that private equity has lagged on sustainability in the past,” admits CEO Karl Swartling. “Partly because ESG regulation, and transparency expectations, have been centred on public equities, so the pressure has been lower in the private markets.” But this is changing, he claims, and “there is a very different, much faster rate of momentum in this area right now”.
It makes sense, he adds, because – contrary to popular belief – private equity has intrinsic qualities that lend themselves to strong stewardship and ESG.
“It’s an asset class normally characterised by few owners, who normally know each other and have long-standing working relationships. That concentrated ownership means transparency is high for an investor – we tend to have a completely clear line into the boards and management teams, and are often active on the boards ourselves.
“The time horizons are usually a bit longer, too [AP6 has an average holding period of five to seven years]. Put all that together, and it’s clear that private equity is an ideal structure for ESG.”
ESG is an explicit part of AP6’s due diligence process and its legal documentation, as well as its monitoring process and reporting.The fund splits its investments 50:50 between direct investments and fund investments. On the latter, it uses 30 external private equity teams to invest in 80 funds, which give it exposure to some 450 companies. It has no official sector-based exclusions, but has “certain types of operations [it] will always avoid due to the fact that the operations themselves are not compatible with sustainable development and responsible investment”, according to its sustainability report. These include fossil fuels, pornography and weapons.
“Feedback that provides insight into peer behaviour is vital, because it’s rare, and people are super curious” — Sustainability Manager Anna Follér
Swartling believes the active nature of the investment process removes the risk of exposure to many of the controversial firms and sectors owned by other, similar-sized pension funds with large passive allocations.
It doesn’t always leave AP6 unscathed, though. “We did have one really severe ESG incident in a portfolio company,” concedes Swartling, refusing to be drawn on which firm. “But because we know our companies well, we got early warning calls from management and high-quality information about what happened and what they were going to do about it. ‘Shit happens’, as they say, but at least we don’t get headlines out of the blue.”
To avoid the issues in the first place, AP6 uses an ‘ESG scorecard’. “We interview each GP annually, and look at ESG-related documentation and data,” explains Anna Follér, AP6’s Sustainability Manager. “Based on that, we score a number of things under three buckets: ESG integration into the investment process; ESG integration into ownership; and ESG reporting – both what they expect from companies, and what they provide to us.” These scores are included in the investment decision-making process and well as being used as the basis for engagement.
“We discuss the GPs’ results with them each year, and point them in the direction of others that are doing exemplary things around ESG or have scored more highly in certain areas. Feedback that provides insight into peer behaviour [anonymously, in this instance] is vital, because it’s rare, and people are super curious to understand what others are doing, so they can learn from it.”
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Follér points out that this approach can be a useful counter to ESG’s fixation with data. “Data is great. You can do a lot with data, but there are other approaches that can be just as effective.” And in a space like private equity, where regulatory disclosure is limited, this understanding is vital.
“You can do a lot with data, but there are other approaches that can be just as effective” – Follér
The new ESG requirements brought in for the AP funds this month don’t apply to AP6 (which is governed by different laws), but Swartling says they “express the sentiment of Sweden’s finance department, politicians and society, so we believe we should comply anyway, and we think we already do”.
The new asset allocation rules allow the first four funds to move onto AP6’s turf more firmly by ramping up their exposure to unlisted assets and, eventually, direct investments (AP2 and AP4 have already discussed their plans to do that). This could arguably have bigger implications for AP6 than the recent changes in sustainability rules, but Swartling doesn’t think in reality it will put much additional pressure on the fund.
“Competition from pension funds is already there, but we are more experienced and better resourced, and – when it comes to ESG – we are more able to deal with direct exposure to company risks.”
The new ESG laws may not apply to AP6, but Swartling and Follér do have some new year’s resolutions of their own for the fund.“We’ve been focusing on diversity & inclusion and climate change, and we want to continue that,” says Follér, echoing AP2’s comments earlier this week that private equity performs “particularly poorly” on gender.
On climate change, much like the other AP funds, the Taskforce on Climate-related Financial Disclosures will be a big focus in 2019. “We want to further align with the recommendations – specifically the forward-looking analysis,” says Follér. When asked if this means developing scenario analysis for AP6’s portfolio, she gulps and says: “It’s so complex that I barely dare to use the words ‘scenario analysis’ – we don’t know for sure what the outcome will be”. Whatever it is, Swartling confirms that it is being driven by requests from the board of AP6, which has a dedicated sustainability committee, and that it “will be more than just a one-year project”.
The Sustainable Development Goals will become a bigger part of AP6’s process, too, Follér adds. Having already done an in-house training session on the topic, looking at real-life investment cases, AP6 will now look at how it can more systematically assess its investments using the SDGs. “We currently conduct a high-level SDG ‘mapping’ of new investment opportunities, but we’d like to develop a more comprehensive process over the coming year or so and work out how to best use the SDGs both when investing in new companies and funds, and when continuing engagement with investees,” they explain.
Swartling says AP6 is “humble in terms of the challenges” that some of these big sustainability issues will present for the fund, but that 2019 will a in year in which steps are taken to be more forward-looking and dynamic, and to prove that private equity is capable of being a leading voice in the ESG debate.