AP4’s alternatives head on the three ESG areas GPs need to improve on

What kind of funds did AP4 commit to during 2018?

We invested in all four categories: private equity, high yield, infrastructure and real estate. All were fund investments, and we additionally did some co-investments in real estate. Two of the funds were sustainability themed, the others were more generalist funds. The infrastructure funds also have more of a long-term sustainability angle in that they have a large focus on renewables.

Where does the PE community stand with regards to ESG?

If you look at the private equity community, I think that we’ve seen a large improvement over the last couple of years. I think almost everyone now has a responsible investment policy or ESG policy, they include ESG in one way or another in their due diligence forms, etc. There is still room for improvement within three areas, however.

The first relates to including sustainability in the business plan and value creation plan and to regularly follow up, so that the companies actually improve over time, and that the GP also has KPIs to follow up and report on. The second is in the strategic focus of the fund, where I still feel that private equity firms in general have not realised the risks associated with stranded assets. I think that most private equity firms, or most investors, see the risk of stranded assets as being companies that are involved with extracting coal or oil and so forth, but I see a large risk in the value chains of those companies. And I see several private equity firms investing in suppliers to extraction firms for instance, where I feel they lack the strategic insight in the focus of the fund. So a better strategic angle is needed when it comes to sustainability, and investing with the trend rather than against it.

The final area is within the funds themselves where I think that there’s huge improvement potential with regards to issues such as diversity (gender, age, schools), managing conflicts of interests, compensation (more democratic distribution of carry, for instance), etc. These are areas we will continue to focus on going forward.

What are the guidelines for 2019?

There’s a revision of the AP4 law – the first part of it came into effect on 1 January. There was previously a cap of 5 percent in illiquid assets and now it’s been increased to 40 percent. So it’s a good opportunity for us to increase the private market side of investments, which is great.

The second part of the revision is under discussion now, where we hope to see more flexibility in terms of how private market investments can be made. And when it comes to sustainability, in the new AP funds Act, the expectations from our government have been increased; it now says we should be a role model when it comes to sustainability and that it should be taken into account when we do investments. We don’t expect major changes to how we work, as we already think we are on par with the increased expectations, but it gives us credibility and confidence in that what we’re doing is the right thing to do.

What could the private equity industry work on improving with regards to sustainability?

There are three layers of sustainability, whereas private equity firms now only focus on one: the due diligence phase. One needs to understand that climate change and the transition to a sustainable society will have such a tremendous impact on many industries that it has to be part of the strategic evaluation as well. More investors need to have a strategic view of how climate change and other sustainability issues will impact their portfolio and their investment strategy, and very few have that today.

The other major issue is the sustainability of the investment organisation, where the culture is a bit outdated in many firms. Younger people expect more from future employers: an increased focus on values, purpose driven culture, diversity, gender equality – many of these issues have not really been taken to heart by private equity firms. Many firms talk about it, but only scratch the surface and don’t discuss things more in-depth. I feel that there’s still a lot of insight and work lacking.

Jenny Askfelt Ruud joined AP Fonden 4 as its head of alternative investments in September. She has prior experience at Nordic private equity and venture capital firm Ratos, McKinsey and Morgan Stanley.