Friday Letter: Get your ESG act together or else

LPs are raising the stakes on GPs’ responsible investment policies. Managers that haven’t yet responded will need to do so soon, including smaller ones with limited budgets 

The first rule of Private Equity Club is that if you're not aligned with your investors you'll soon be thrown out. One determinant of who gets to stay and continue to raise capital has been gaining traction among managers and investors alike in recent years, and looks set to exert even greater influence in the coming years: responsible investment.

Many limited partners have made ESG a hallmark of their asset allocation decision processes.

And if there was any uncertainty about the pressure for GPs to adopt ESG-compliant investment strategies, it should have been well laid to rest this week after PricewaterhouseCoopers released its latest survey of 60 limited partners in 14 countries, accounting for a collective $500 billion worth of LP commitments.

Titled “Bridging the gap: aligning the responsible investment interests of limited partners and general partners” , the PwC study revealed strong sentiment on the part of investors about the need for fund managers to demonstrate responsible investment practices. No fewer than 71 percent of those surveyed said they would decline making a commitment based on ESG grounds or lack thereof. Of the participating GPs, 85 percent said their investors had shown interest in their approach to responsible investment.

PwC's findings reflect what London Business School's Coller Institute of Private Equity and Adveq concluded earlier this year in a study of 42 GPs: that ESG has shifted from being viewed as a back-office compliance-type function to becoming a key, if not integral, part of the investment process.

It's hardly surprising that many managers are paying attention. Few things, after all, quite sharpen the minds of busy private equity professionals than what their sources of investment capital and fee income think about them and their appropriateness as fiduciary managers. If GPs are keen to raise capital institutions such as pension funds, endowments and sovereign wealth funds that are making a focus on ESG part of their institutional mandate, then aligning with them on this particular issue becomes non-negotiable.

Predictably, it is the largest firms in the business that are amongst the most advanced in terms of rising to the challenge. Carlyle for instance has internal requirements to ensure both during its investment committee review process and throughout the subsequent holding periods that its majority investments comply with the firm's Responsible Investment Guidelines developed in 2010. Chief sustainability officer Jackie Roberts, who assists the firm's deal teams with evaluating ESG risks and potential alleviation plans, says: “Increasingly, LPs expect Carlyle to have the internal expertise to identify, mitigate if necessary and act on new opportunities driven by a set of emerging environmental and social issues.” 

The investment required in the people and processes designed to achieving ESG excellence can be substantial, and may be a challenge for smaller firms whose investing clients are now expecting them to catch up. But if the PwC survey has it right, not making the investment seems a risky call to make: faced with a choice between two equally well performing managers, the majority of LPs will go with the group with the better set-up for responsible investment. So for any manager who thinks they still have work to do in the ESG department, now would be a very good time to get on to it. 

If you want to hear more about ESG and investing responsibly, attend PEI's 6th Responsible Investment Forum on June 23rd. Click here for further details.