This article is sponsored by KPMG.
Tania Carnegie is the global lead for private equity and asset management at KPMG IMPACT. She discusses how attitudes towards ESG and impact investing have evolved among GPs, LPs and portfolio companies, opportunities for shared learning, and the challenges around defining what a successful approach might look like in this fast-moving space.
What are the challenges for GPs around determining what ‘good’ looks like, particularly across jurisdictions?
ESG is a key priority for GPs and LPs, and leading practices are continuing to evolve. Many private equity firms have been incorporating ESG for several years and are iterating their approach, incorporating lessons learned and focusing on ways ESG drives value. Meanwhile, LPs are going through a similar exercise.
Key themes commonly prioritised are climate and diversity, equity and inclusion. Within these areas, there are degrees of sophistication and differing views on what is important, with lessons being learned all the time. GPs are responsive to the views of investors, and sometimes LPs are looking to GPs for perspective. Generally, we are seeing increased interest in collaboration between GPs and LPs to align on more consistent approaches.
Ultimately, what is connecting everyone today is a focus on value creation. Beyond reporting, the focus is on how consideration of ESG and impact enables better decisions and outcomes, for investors as well as society.
What impact is regulation having?
Until recently, ESG practices were largely voluntary even though certain LPs have had clear expectations for a while. ESG has quickly become a regulatory priority, with new requirements including the Sustainable Finance Disclosure Regulation having a significant impact on GPs around the world, and additional regulation is expected.
This is also resulting in a significant engagement of portfolio companies in order to satisfy required reporting and disclosures. Data collection is challenging given the nature and volume of information that needs to be collected, in some cases in areas that have not been tracked previously.
Data management and monitoring practices also must be enhanced. In addition to preparing credible reporting to ensure compliance, it is important not to lose sight of how this information can be used to inform better decisions.
What are the current themes at the portfolio level and how are these impacting the GP-portfolio company ESG relationship?
As GPs are evolving their approach to ESG, portfolio companies are also becoming more proactive in integrating ESG as part of their business. We have seen an increase in the number of portfolio companies asking for guidance to better understand and address material opportunities and risks to their business. They are also asking their private equity investors for guidance to understand the basics of key issues and how to deal with them.
Management teams are also being asked questions by their employees, customers and other stakeholders about their practices. Expectations are shifting and they too want to understand how ESG can differentiate their business and enable them to navigate changing market dynamics, consumer preferences and so on.
This is presenting new opportunities for collaboration and clarifying performance expectations: sharing knowledge, learning together and leveraging similar experiences among companies in the portfolio. This is important especially as ESG is rapidly evolving.
Some companies aspire to be leaders, others seek to be credible and pick their spots. Ultimately, their approach needs to align to the culture and growth story of the company to be effective.
What opportunities are you seeing around gender as a driver of ESG and impact?
We are observing two key themes. First, many GPs are increasing their focus and intention to invest in companies with female leaders and gender diverse management teams and boardrooms. Second, we have observed that the leadership around ESG and impact investing involves a significant number of women at the forefront. This is the case with our own ESG leadership team at KPMG, and is the case across the private equity industry. We feel bullish that ESG and impact investing could be key drivers attracting diverse talent into senior roles, an area the industry has been very focused on.
ESG and impact investing are particularly expressed as areas important to recent graduates and professionals in the early stages of their career – women, in particular, have been vocal about wanting to be part of this. They want to establish their careers in a meaningful way and with a strong sense of purpose, which is powerful in itself.
How would you describe the key elements of a successful ESG and impact approach?
Key elements of successful approaches include authenticity, rigour and transparency. Although investors are interested in strong results, they also want to understand lessons learned and how they are influencing an enhanced approach going forward. They understand many aspects of ESG are evolving and things do not always go as planned, and that provides helpful insight as they are going through an iterative process themselves.
The focus on value creation is a common element underpinning the interest of both GPs and LPs. Understanding and demonstrating how the ESG and impact lens leads to better investment outcomes and better societal outcomes is the question, particularly in the case of impact investing. Ultimately, financial returns matter to commercial investors, but the way those returns are generated also matters greatly.
To be successful, the approach also needs to be pragmatic and focused. Starting with an excellence over perfection mindset is critical because leading practices will continue to evolve.
GPs should be curious, thoughtful and purposeful. They ignore climate risk at their peril, and must equally recognise that climate presents a significant range of new investment opportunities as well as the opportunity to transition traditional portfolio companies to be more resilient in the new economy.
All the answers do not exist today, and there are certainly challenges with that. However, there is also a lot of excitement and demand, and that is what drives the opportunities for differentiation in this space.
What do GPs need to do to ensure investment and operations teams embrace ESG and impact?
Given the significance of ESG and impact to portfolio performance, professionals across the private equity firm now need to have deeper knowledge about ESG and impact. In most cases, ownership and oversight of these issues sits with them with support from the ESG team.
Establishing an enterprise-wide approach to ESG and strategy around key issues like climate is important to level-set activity and expectations. Providing guidance that distils priorities and ways decisions will be made does the heavy lifting so teams can focus on the task at hand.
Education is also key. Another critical step is providing teams with a strong fact base and consistent understanding of complex issues relative to their accountabilities and role as an investor. With an understanding of the ‘what’, next is tackling ‘how’ – how to better identify and assess opportunities and risks when sourcing deals, how to influence and amplify impact through ownership, and how this enhances the value of the company.
Having a mindset of continuous learning and creating a safe space for questions is necessary. Often good strategies and policies fail to take hold because the relevance of key issues is not put into the context of their area of focus or industry, or teams have concerns about limitations that consideration may have on their work or a different understanding of applicability.
Tania Carnegie, MVO, MBA, CPA, is global lead – private equity and asset management at KPMG IMPACT