Responsible Investing: Continental divide

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More than a decade ago, Kofi Annan, then the UN secretary-general, gathered a group of institutional investors from around the world to develop the UN’s Principles for Responsible Investment (PRI). Today there are 1,380 signatories comprising asset owners, investment managers and services providers representing $59 trillion in assets under management.

The environmental, social and governance (ESG) factor within private equity investing is still in its nascent stage: in continuous development driven mostly by LPs, particularly those in Europe.

Mirja Lehmler-Brown, senior investment manager at Aberdeen, leads ESG efforts for the private markets team and has categorised the evolution of the private equity value creation model into three phases.

The first was financially focused and the second operationally focused. In the second phase newly-hired operational partners were tasked with achieving cost and efficiency savings. Having progressed through these phases, private equity managers are able to focus more on sustainability issues, with the third (and current) phase concerned with achieving long-term sustainable growth.

“Europe is ahead of the US and Asia when it comes to ESG issues, with most European general partners actively incorporating ESG topics into their investment processes,” says Lehmler-Brown. “While some of the larger US GPs have incorporated ESG into their policies, it has not yet trickled down to the smaller firms.

“My understanding is in the US there are lots of firms that still don’t have a [ESG] policy. It’s larger scale rather than grassroots activity.”

In a Private Equity International survey of 73 LPs last year, 50 percent of all respondents said ESG was part of their standard operational due diligence questionnaire.

Regionally, however, divisions could be seen. In Europe, 77 percent of respondents acknowledged ESG, compared with 33 percent and 32 percent in Asia and North America, respectively.

The same survey found that eight of the 30 European investors ranked “adherence to ESG principles” as one of the top three criteria when selecting a fund manager. In contrast, only one Asian investor of the 12 who answered, and none of the 31 North American investors, selected ESG.

Hamilton Lane managing director Ana Lei Ortiz sees a missing puzzle piece for industry-wide ESG implementation.

“Larger GPs have a lot of resources, while the smaller ones are figuring out where they want to be thinking about ESG, because all LPs approach it differently,” she says. “If we can help standardise ESG due diligence a little bit, in terms of types of questions and metrics, it would make it more likely that more GPs would respond and begin integrating ESG into their processes. Smaller GPs are being overwhelmed for information around ESG.”

The geographic discrepancy may also be tied to different regulatory environments, according to Candice Brenet, CSR [corporate social responsibility] officer at Ardian in Paris. The relative advancement of European investors’ ESG integration could be owed to more prescriptive regulations – such as those surrounding employment – than those faced by their US counterparts. Indeed, Lei Ortiz said the discussion around ESG is more political in the US than Europe.

“The higher adoption rate [in Europe] may be because there’s less debate here around certain things,” she says. “In the US, there’s more discussion around ‘what does ESG mean?’ and ‘do we really want to introduce this?’ but certainly, the high profile US LPs are vocal on ESG.”

According to TorreyCove Capital Partners’ ESG and Private Equity Survey from December 2015, the proportion of socially responsible investment (SRI) relative to total managed assets was the highest in Europe. In 2014, 59 percent, or $13.6 trillion, of total European AUM accounted for SRI, compared with $8.6 trillion in 2012. In the US, the portion was slightly lower, at 31 percent ($6.6 trillion).

Brenet says she notices an increasing interest across all LPs, and ESG due diligence is becoming “pretty common”.

The same TorreyCove report found that, globally, more than half (57 percent) of private equity firms surveyed indicated they made a “formal public commitment” to ESG, and 55 percent had implemented a formal ESG policy, citing investor pressure as a large incentive for general partners to do so.

In fact, according to the report, outside pressure from investors coupled with risk management – rather than a simple question of firm culture – are the main factors fuelling ESG interest among fund managers.

“We see a wide diversity of questions raised by the LPs that shows their level of understanding and maturity,” Brenet says. “But I think there is one common theme: LPs really ask GPs to integrate ESG in their investment process.”

Aberdeen, Ardian and Hamilton Lane are three of the 1,380 signatories to the UN PRI. There are 328 signatories in the US and Canada including Puerto Rico, 781 in Europe, 72 in Asia, 62 in Latin America, 135 in Australia and New Zealand, 12 in the Middle East and 55 in Africa, according to the UN PRI website.