Good capital

Guidelines on corporate responsibility and environmental, social and governance issues are gaining traction among both LPs and GPs

There have been nearly 700 signatories to the UN’s Principles for Responsible Investment since their establishment in 2006, a good indicator that institutional investors, investment fund managers and service providers believe a consistent, structured approach is necessary to address environmental, social and governance issues (ESG).

In October, First Reserve became the first energy-focused private equity firm to sign up to the principles, joining GPs such as BC Partners, AXA Private Equity and Abraaj Capital and LPs like the Canadian Pension Plan Investment Board and the Universities Superannuation Scheme.

“We didn’t have any LP requests [to adopt] it but we were certainly aware of the rising tide, took the time to look through it … and realised it was pretty reasonable,” says Cathleen Ellsworth, head of investor relations at First Reserve. She notes that the firm had already been fulfilling most of what was asked for, with most of the requirements relating to tracking and documentation, rather than agreeing not to invest  in certain sectors or make investment decisions based on specific social issues.

“This isn’t an ethical play, it’s a return on investment play,” explains Tom Rotheram. Rotheram has 14 years of experience in the socially responsible investing realm, having most recently spent the last two years as special advisor for private equity for the UN PRI. In January, he joined Hermes Equity Ownership Services, an internal consultancy unit for Hermes, to start an ESG-focused engagement programme for the group’s private equity fund of funds division. Company performance and exit prospects are better when ESG policies are in place, he says.

Rotheram is keen to stress that PRI isn’t “about changing the world”. It doesn’t provide guidance on many issues people associate with ESG, like human rights or climate change, but asks GPs to create a process-based approach to ESG, follow it throughout the life of the investment, document it and share the information with LPs. “The reason why the PRI is a process-based framework is there are certain steps we would expect you to go through, but we’re not in a position to tell you what issues are and aren’t material. As a fund manager, as a GP, as a fund of funds, as an LP, it’s up to you to decide.”

Harold Bradley, chief investment officer at the Ewing Marion Kauffman Foundation, a US endowment with a $1.7 billion investment portfolio, isn’t convinced one has to be a signatory to the PRI to be a responsible – and successful – investor, however. That’s partly because of the subjectivity that comes into making ESG-related evaluations. PRI and ESG “means what to whom? The definition shifts based on who’s arguing their own political philosophy at the moment,” he says. 

If LPs are following their fiduciary duties, they should already be investing in the sort of companies that “meet and raise social utility”, Bradley argues. “If you are investing in socially irresponsible companies, you will lose money in the long-term.”

“I don’t think anyone’s objective is to get the whole world signed up to the PRI,” counters Rotheram. “3i is a good example – they aren’t a signatory but their responsible investment policy is public and they’ve got a pretty robust system. What matters is what you’re actually doing and how it’s influencing your decision making and ownership of a company.”

3i’s Patrick Dunne, global head of communications, says the firm has, since its inception more than 60 years ago, examined factors including good governance, health and safety, environmental and other issues during due diligence and throughout management of the portfolio companies. “Our view for many decades has been that companies are much easier to sell if they don’t have any corporate responsibility issues.”