Private equity: taking the lead on ESG? EVCA Responsible Investment Summit report

GPs and LPs join the dots on ESG integration in the venture and buy-out worlds.

The take up of ESG by private equity (PE) firms has been one of the success stories in recent years. It was only in 2009 that some of the world’s biggest signed up to a set of voluntary ESG investment standards drawn up by the Washington-based US Private Equity Council: Link
A significant number – estimated to be about 100 – have also signed the United Nations-backed Principles for Responsible Investment (UNPRI).
Yet, in a updated study by Mercer, the investment consultant, released this week, private equity managers demonstrated the highest proportion of highly rated ESG 1 and 2 strategies, indicating good ESG integration into investment ideas, portfolio construction, active ownership and firm-wide commitment to ESG issues:
The mantra has been that in private markets managers get things done on ESG because of their hands-on direction of companies.
Nonetheless, private equity has in recent years suffered from persistent allegations of asset stripping and low taxation. Most recently, critics pilloried US Republican election candidate Mitt Romney’s income tax levels as a partner at Bain Capital, the US private equity firm. As a result, PE firms are on a public relations push. Many private equity fund managers (General Partners or GPs) are thought to be planning to raise funds in the next 24 months after sitting out much of the financial crisis. ESG has become an important manager selection criterion amongst Europe’s largest institutional asset owners (Limited Partners or LPs) and allocators to private equity. It has also become an important image flag for the industry to wave. Consequently, the recent European Venture Capital Association Responsible Investment Summit in Brussels, jointly held with CSR Europe, was a good venue to take private equity’s ESG temperature.At moments, the charm offensive in front of a significant European political audience was overt. For some in the industry, responsible investment means business-as-usual. Karsten Langer, chairman of EVCA and head of Riverside, the US leveraged buy-out firm, said the industry’s alignment of interest over the long-term already gave it a strong element of responsible investing. He said investing in small and medium-sized businesses was also implicitly responsible, although he went little further in actual ESG practice. If responsible investing is merely economic growth then few investors will claim they have much to think about. US private equity giant, KKR, is seen as a standard bearer on ESG. Its Green Portfolio Program Link , an environmental efficiency strategy at 13 companies, has, the company says, saved it hundreds of millions of dollars and significantly reduced C02, waste and water consumption. Industry observers say they are impressed with KKR’s ESG commitment. Nonetheless, the programme currently covers less than 20% of KKR’s global portfolio of 72 companies, although the firm is expanding this focus. Jacques Garaïalde, Partner at KKR, said it fully backed its ESG commitment, but offered a reality check on sustainability that chimes with many in the private equity business: “How do you know you are not damaging returns? What is the cost of ESG? We shouldn’t be naïve about this, what is the cost to employment, etc? It’s a balance we have to consider very carefully.” Garaïalde said KKR sought to avoid investing in companies where there were any risks of issues such as child labour: “We have said to some companies that we will invest in them if certain things change, but we want to see this as an outcome not as something we invest in and then work towards.”
Maaike van der Schoot Corporate Social Responsibility
Officer at AlpInvest Partners, the Dutch private equity group that was sold last year by ABP and PGGM to The Carlyle Group – Carlyle has just released its second Corporate Citizenship Report: Link – and Alpinvest’s managers, said the firm has an instinctive RI bar for the private equity funds in which it invests: “We want our general partners to be able to pass the front page of the Wall Street Journal test, i.e. we don’t to see them on it for bad news.” She said major issues that Alpinvest kept a close eye on tended to be around portfolio company and regulatory compliance.
One of the most significant panels of the day brought together limited and general partners and was moderated by Claire Wilkinson, Chairman of the Responsible Investment Working Group at EVCA. Alan Mackay, Chief Executive Officer at Hermes GPE, the private equity arm of the UK pensions manager, said there were three main reasons the firm was involved in responsible investment: firstly, that it was important to clients, second that it made the business more sustainable, and third the firm’s reporting to its own pension beneficiaries. One issue raised, however, by GPs was the apparent complexity of sustainable reporting across hundreds of portfolio companies.
Dushy Sivanithy, Principal, at Pantheon Ventures, the fund of funds house and a UNPRI signatory, said the firm had not yet asked its general partners for formal ESG reports and questioned the value of standardising questionnaires: “When you have 5000 portfolio companies, for example, you’ve got a lot of people spending a lot of hours on this.”
Katharina Lichtner, Managing Director at Capital Dynamics, the fund-of-funds house, said the manager invested in about 10,000 companies across 800 third-party portfolios: “This means we need to understand what can be measured. C02 emissions, energy use, waste and corporate governance are generally OK to measure. Social issues, however, are the most difficult to get some standardisation. EVCA’s Wilkinson asked whether it wasn’t just a “kop out” for private equity companies to say they had too many companies to measure.Mackay at Hermes responded: “The reality, I think, is that if ESG becomes a checklist of issues then it’s dead, but if it’s about quality of businesses that’s different.”
Kris Douma, Head of Responsible Investment & Active Ownership at Mn Services, said asset owners (LPs) should be prompting their GPs to be moving portfolio companies towards the standards of listed equities because of the IPO or trade sale (often to listed companies) exit route.
“As an asset owner, we want to know what the near misses are on ESG issues within the GP’s portfolios and how the firm has dealt with them. We are realistic though; for us the important issue is how things are managed so that they don’t become surprises!” Dushy Sivanithy, said: “LPs have the responsibility of testing whether ESG is embedded across the house or just in the hands of a responsibility officer. Some PE firms are doing things because it is in vogue at the moment.” Douma added: “We want to see PE firms that are dealing with the issues and being a PRI signatory is not sufficient, it needs more. It’s not clear yet though what best practice is, so this is a learning curve, and one hopefully taken together.” Nonetheless, Capital Dynamics’ Lichtner noted that PE managers coming back to the market that have not come up to standard on ESG issues will “fall through the grid” when they go out to raise funds: “What that means practically is that you have you have to your ESG blocks in place in the fund raising documentation. These are, of course, marketing documents, so the LPs job is to look through them and probe the managers’ commitments.
Hermes’ Mackay, added: “There has been a 180 degree turnaround on ESG by some firms: you might say some are playing the game, but that is of course what we are asking them to do.” He said private equity firms had been in recent discussion with the UNPRI and both had agreed that the reporting process is not good enough at the moment: “In short, it needs to be made relevant to the asset class and EVCA and other organisations are joining the dots on this.”