How many jobs did your private equity portfolio create this month? How much closer is it to net-zero emissions? Right now, private equity investors cannot easily answer such questions.
The environmental, social and governance information that limited partners currently receive tends to be gathered at the point of due diligence – via an ESG-focused due diligence questionnaire – and sometimes appended through periodic (often annual) questioning of general partners.
“In our ESG due diligence we are still ‘nice guys’,” a senior private equity investor at one Scandinavian pension tells Private Equity International. It is a reference to the fact that even managers that come out with the lowest possible score from their ESG assessment process could still win themselves a commitment.
The head of private capital for a large European private bank tells PEI that the organisation has not yet created an ESG due diligence questionnaire for its private markets managers. The executive adds that the bank is in the process of adapting an established ESG scoring system for traditional liquid funds to its PE programme.
According to our LP Perspectives 2021 Study, these examples are representative. For 50 percent of investors, ESG forms only a minor part of due diligence, while for 12 percent it is not covered at all. Thirty-eight percent of LPs say it forms a major part of due diligence. Two other investors PEI has spoken to – a consultant in the US and a state-owned investor in Scandinavia – gather ESG data at the due diligence stage and subsequently through recurring annual surveys of all their partners.
All the investors note that ‘best practice’ in reporting ESG data to LPs is being formulated and driven by forward-looking GPs.
With its historical connection to development finance, private fund manager Actis is progressive when it comes to integrating and reporting ESG. As part of its quarterly reporting, the firm includes asset-by-asset responsible investing reports, which sit alongside the businesses’ operational updates, financial metrics and team news. This has been part of the firm’s standard reporting for around a decade, says Daniel Price, a principal in the EMEA investor coverage team, but “the detail has increased over the last couple of years”.
James Magor is a director in Actis’s four-strong responsible investment team. “We see ESG and responsible investment as being fully integrated into our investment approach, so our house view is that our reporting to our LPs should reflect that,” he tells PEI.
Magor points out that Actis has started including sustainability highlights at the front end of quarterly reports alongside the executive summary of the fund performance. “It is a standalone section, which includes things like, for example, the CO2 offsets for our infrastructure funds,” he explains. The section also includes some of the “softer” activities, like ESG-focused media articles that Actis has participated in or panels it has contributed to. The aim, says Magor, is to “show our investors that this is truly authentic to Actis. It is about our leadership in the market and not just some sort of glossy bolt-on”.
Stories behind the data
In a conversation about gathering and imparting quantitative ESG data, the subject turns to the more familiar territory of qualitative information. Magor says feedback from investors suggests they are interested as much in the qualitative information as the hard data. “It’s not just pulling down numbers and figures – jobs created, tons of CO2 avoided,” he says. “It’s the human-interest stories.”
He refers to building properties for the Masai community around a wind farm in Kenya, and stresses the importance of communicating this story in a meaningful, “non-trite way” – with “really great imagery” – about how private capital is improving lives. “We know our investors really enjoy that, because if you’re sitting in an office in New York, you feel disconnected from a wind farm in Kenya.”
That is not to say the firm eschews hard numbers. Actis developed and launched its own impact scoring system – based on the work of the Impact Management Project – which it has made available to any other managers wishing to use it. In the same way that investors will be given an idea of the financial return they should receive from a fund, they will also have an idea of the impact expected to be generated and whether the fund is on track to achieve this.
It is not easy to collect consistent, relevant data from across an entire portfolio when investments are in different sectors. The impact score was created to allow effective comparison between the impacts of otherwise incomparable assets in different sectors and geographies.
Actis does its reporting through the conventional PE route of secure data rooms, slick presentations and high-touch investor relations. Like most firms, it has not yet made use of the budding market for high-tech investor communications on ESG.
As and when Actis and its GP peers decide to automate or streamline ESG reporting, tech providers and consultants will be ready. One such service provider, Apex Group, has launched a product – a combination of a software platform, data methodology and consultancy – that facilitates the regular collection of ESG data from portfolio companies, benchmarks each company against its peers and allows the sponsor to aggregate data and present them to investors in a dashboard format. It will also produce gap analyses on each portfolio company, identifying how it scores on each of the criteria against the global standard.
“We tried to work out what is best in class; what do all the LPs generally want; what is going to satisfy legislation; what do stock exchanges require if you are thinking of IPOing?”
Andy Pitts-Tucker, a long-time banker (and sometime conservationist) who joined Apex to help shape its ESG offering, says the firm spent “about a year” working out the methodology and exactly what data should be included in the platform: “We tried to work out what is best in class; what do all the LPs generally want; what is going to satisfy legislation; what do stock exchanges require if you are thinking of IPOing?”
There is an 80-page report “which defines how every single data point is matched to a global standard”, he adds. “We have sought to collect data that helps investors understand the alignment of their underlying investments to the major global standards, to regulation and to organisations and associations like the Sustainable Development Goals and the UN Principles for Responsible Investment, which seem to be significant driving forces at the moment.”
The firm has onboarded “dozens” of clients from across private markets, says Pitts-Tucker. He expects that, having conducted the exercise once – establishing the baseline for each of the portfolio companies – GPs will repeat it on an annual basis. He notes, however, that some LPs are looking for very specific metrics relating to emissions to be updated and communicated quarterly.
IQ-EQ, an investor services group, officially launched a product to “identify and mitigate ESG-related risks” in January this year. The product – called IQ-EQ Compass – is an ESG-focused module that operates alongside its existing portfolio performance reporting platform, IQ-EQ Cosmos.
So, while Cosmos delivers an investor dashboard covering the likes of net asset value, internal rate of return, and funded vs unfunded comparisons, Compass delivers data based on the set of Core Metrics outlined by the World Economic Forum.
The WEF’s Core Metrics are a set of 21 data points – grouped under ‘principles of governance’, ‘planet’, ‘people’ and ‘prosperity’. The core metrics are described by the organisation as being “more-established or critically important”, and “primarily quantitative metrics for which information is already being reported by many firms (albeit in different formats) or can be obtained with reasonable effort”.
Why go for the WEF’s metrics? Hugh Stacey, the executive director in IQ-EQ’s investor solutions team responsible for the Compass launch, says one factor was the impending arrival of EU rules around sustainability. The Sustainable Finance Disclosure Regulation will require asset managers doing business in the EU to make detailed disclosures about the sustainability of their investment approaches and portfolios. “With the SFDR regulation coming into play in March 2021, we wanted to use metrics that are accessible, useful and more standardised,” says Stacey.
Regulation is likely to be a significant driver for improved ESG reporting and, in turn, adoption of products like those from Apex and IQ-EQ. “We have a product that helps investment managers collect data on themselves, which is going to help them align with SFDR,” says Apex’s Pitts-Tucker, who anticipates a “scramble for the line” reminiscent of the rush to comply with the EU’s General Data Protection Regulation as March approaches.
Looking for commitment
Impending European regulation aside, we should not get ahead of ourselves. The private capital industry may have a penchant for investing in tech companies, but GPs are not noted for being early adopters of tech when it comes to their own operations. Many are still wrestling with their conventional investment data and wondering how to bring automation to bear on that. At the same time, ESG policies, let alone data, are not yet standard practice among GPs.
A world in which an LP pulls up a dashboard to check for substantial movements in its private equity portfolio’s carbon footprint, or whether there has been a reduction in health and safety incidents, is still a long way off.
To focus too much at this stage on data may – to some extent – miss the point. As Actis’s Magor notes, LPs value narrative. And as the private bank PE head puts it: “Our clients are not very interested in the data. They are more concerned about generally making sure that whoever is managing their wealth is going to be a good steward of their capital, full stop. They are much more interested in selecting managers based on a commitment to ESG than measuring a tangible impact.”
That said, service providers in this space are confident that demand for their products is only going in one direction. “Every day we are demoing our product multiple times a day and we have a huge number of discussions going on,” says one service provider. “People are signing up very actively. It’s great.”