Inside the GP: Made to measure

Committing to better ESG performance is one thing; tracking and measuring it is quite another.

Last year, in a survey of private equity houses by PwC, 94 percent said they would be increasing their focus on ESG in the next five years. That’s in part because of pressure from LPs – but it also reflects the potential for value creation in these areas, whether that’s in terms of cutting costs, mitigating risk or enhancing brand value.

There is, however, still a major stumbling block. According to ‘ESG in Private Equity’, a study by the Environmental Defense Fund, the most common barrier for investors when it comes to responsible investment is the lack of meaningful ESG metrics. How can a firm effectively compare the value derived by the low carbon footprint of one potential acquisition with, say, the value of a low staff turnover elsewhere? And can it stay on top of progress once these companies become part of its portfolio?

“The main issue around ESG used to be ‘why?’” says Rina Kupferschmid-Rojas, founder and CEO of ESG Analytics, a provider of tools to support ESG investment. “Now it is ‘how’.”

ESG Analytics’ answer to this question is Aditus, a Cloud-based software platform launched in September, which claims to provide firms with a uniform, industry-wide standard for analysing and benchmarking their ESG activity.

The system measures 127 key performance indicators – all ESG-related metrics that Aditus suggests are “deemed material to a company’s performance”. Helpfully as far as private equity firms are concerned – given the often disparate nature of their portfolios – these metrics cover a range of different industry verticals and sectors. But importantly, they’re weighted differently depending on what the industry us. For example, water intensity is a lot more significant for companies in the forestry sector than it is for companies in the consumer goods space (there are 2,542 of these industry-specific weightings, according to Aditus). 

Once these weighting have been applied, the system comes up with an overall score and a specific E, S and G score for that particular company. This can then be benchmarked against similar public companies, to give the fund manager a sense of the company’s ESG performance relative to the sector as a whole. It can also produce a graded assessment of a fund manager’s commitment to responsible investing across the portfolio. But what it won’t do is ascribe any sort of value to these metrics: so it will measure CO2 emissions, for example, but if you want to work out the cost of this, you’ll have to do that yourself.

This greater focus on ESG issues is not just a shift in thinking among private equity LPs, of course; it’s also the way legislators are moving, too. For instance, the introduction of the SR Regulations on October 1 this year made it mandatory for large-scale UK companies to record their work on ESG and report their progress year-on-year. In other words: this is an area where regulation, LP appetite and good business practice seem to be converging. “It’s no longer about checking the ESG box,” says Kupferschmid-Rojas. “It’s about building a sustainable model.”

It’s also, she suggests, reflective of the changing face of private equity as a whole. “The industry has traditionally been about confidentiality and keeping information for themselves,” says Kupferschmid-Rojas. “Now it’s moving towards more of a sharing community, with GPs passing information to LPs, and more private equity houses working together. There is more transparency and more benchmarks. It’s no longer just about how you’re performing; it’s how the competition is doing too.”