LPs lukewarm on ESG

Only one-third of LPs describe ESG as a major consideration, but that doesn’t tell the full story, pension funds say.

For managers feeling the pressure from LPs to deploy more time and resources in the pursuit of environmental, social and governance policies, the rather muted LP interest in ESG captured by PEI’s LP Perspectives Survey may come as a surprise.

For about a third of LPs, ESG is a “major consideration” in fund due diligence, with the remainder reporting ESG issues were of minor or no concern at all, while two-thirds believe GP investments reflect their ESG policies only “somewhat”. Just 19 percent report their ESG outlook was strongly aligned with manager practices.

However, David Russell, head of responsible investment at the UK’s largest pension scheme by assets, USS Investment Management, described this reading of the results as “perhaps a little too simplistic”.

“What this means is that the majority [of LPs] will put some emphasis on ESG in fund due diligence and that would seem to be a positive step forward compared to the past. There is obviously still some way to go, but there is a definite growth in the number of LPs assessing ESG risks in their private equity investment,” he says.

USS has developed a responsible investing questionnaire that it sends to all potential GPs and scrutinises new GPs’ track records on ESG issues. It is critical, however, that LPs continue to monitor ESG activities post-investment to gain assurance policies are being implemented but also to signal that the LP takes this issue seriously, Russell says.

The definition of ESG continues to stretch. “What LPs are demanding of GPs [in terms of ESG] continues to grow”, says David Jeffrey, partner and head of StepStone Global’s European business. “It really matters to us because it matters to our end investors.”

However, one impediment is the absence of tangible data on the contribution of ESG to returns. “We’re still on a journey within the world of private markets to be able to provide the empirical data that is required to show responsible investment can add value,” Jeffrey says, noting that it falls to the LP community as a whole to standardise due diligence so managers can prove that they are good corporate citizens.