In a world of competing frameworks and acronyms, some GPs are showing what it means to successfully implement ESG strategies at the operational level and create value
Investor pressure, sustainability concerns, and cost of capital are driving a more rigorous conversation around ESG across the private equity universe. Institutional investors have indicated that they are willing to walk away from investments and sponsors who aren’t willing to embrace ESG. These LPs want to see more than just improvements in governance too. Investors are looking for improvements in sustainability, diversity, and inclusion, as well as limited exposure to legacy industries like fossil fuels.
For firms that are willing to take ESG concerns seriously, there is big money available. According to The US SIF Foundation’s 2020 biennial report on US Sustainable and Impact Investing Trends, sustainable investing assets now account for $17.1 trillion—or 1 in 3 dollars—of the total US assets under professional management. This represents a 42 percent increase over 2018.
However, the response from private equity GPs has been somewhat mixed. According to newly released data from Bain & Company and the Institutional Limited Partners Association (ILPA), fewer than 25% of GPs can provide data on scope 1 & scope 2 emissions all or most of the time. Fewer than 35% of GPs provide data on all principal adverse indicators all or most of the time. Both LPs and GPs recognize that there is no set standard for collecting and providing these data. As a result, gaining visibility into ESG issues at the portfolio company level has been challenging for many private equity firms to get.
Still, there are some indicators that more standardization is coming to ESG metrics. And, several large GPs are showing that when approached rigorously, ESG data can be collected and firms can deliver on ESG metrics. Two factors that are linked to improved investment performance.
On the surface, the discussion around ESG may look like an alphabet soup of organizations and standards that ultimately lead to not much more than a lot of white papers about the importance of ESG. But there are a small handful of institutional frameworks that are having a significant impact and are quickly becoming yardsticks by which the best ESG performers are being measured.
ILPA, which is known for providing due diligence questionnaires that institutional LPs can use to compare funds and standardize the diligence process, recently released its ESG framework. The assessment is designed to help investors understand and compare whether firms have ESG policies in place that deal with issues like diversity, equity, and inclusion, as one example. The framework can also be used as a discussion template for establishing metrics that investors can use to measure improvements. ILPA’s metrics include Scopes 1 and 2 greenhouse gas emissions, renewable energy, board diversity, work-related injuries, net new hires, and employee engagement.
The framework is designed to be an evolving assessment that can be used to track ESG investors within firms and funds. Both investors and GPs are submitting best practices to ILPA, which will adjust the assessment framework as greater standardization emerges.
The Standards Board for Alternative Investments (SBAI) has also launched a working group in a similar vein. SBAI’s group is collecting best practices from investors and sponsors with the goal of providing information sharing on ESG topics. SBAI will also be looking at ways to measure and compare funds that claim to be aligned with the United Nations Principles For Responsible Investing (UN PRI) and the Sustainable Development Goals (SDGs). The SDGs have specific outcomes tied to each goal. Typically funds that use the SDGs as criteria will pick one or several of the goals and identify companies that contribute to the desired outcome of a given goal.
Frameworks in action
Three firms are exemplars when it comes to generating positive investment performance through ESG. Blackstone, Bain Capital, and TPG all frequently top rankings for ESG implementation and each has a unique approach.
In 2021, Blackstone made news by hiring for some of the most high-profile ESG roles in the industry. The firm brought on Dr. Jean Rogers, Founder and Former CEO of the Sustainability Accounting Standards Board (SASB) as its global head of ESG, and Amisha Parekh as global head of ESG for private equity. Parekh most recently led ESG data acquisition and curation efforts at Bloomberg. Rogers and Parekh are part of a growing senior team of ESG professionals within the firm that are working on implementing significant ESG policies firmwide and at the portfolio company level.
As of last year, Blackstone is working on an emissions reduction program for investments where they control energy usage that will cut emissions by 15% within the first three years. Blackstone will also make its own office space energy efficient and low emission – both of these goals align with the ILPA framework on carbon emissions reduction. The firm has also implemented a significant diversity, equity, and inclusion effort – it achieved 41% female representation globally and 49% racially diverse representation in the US among its 2021 analyst class.
Additionally, Blackstone’s recent bolt-on acquisition of ESG data company Sphera added the ability to gather and score ESG data for internal use and external consulting. With Sphera, Blackstone will be able to partner with other firms on ESG data gathering and analysis – an opportunity to drive best practices throughout the industry.
Bain Capital has taken a multi-pronged approach to ESG. As a multi-strategy investment firm, Bain is implementing ESG within its traditional private equity vehicles as part of its assessment framework and has also established a set of discrete ESG investment strategies. Bain Double Impact launched in 2016 as an impact investing vehicle and in 2021 Bain announced the launch of an ESG focused hedge fund that will make long and short investments in companies based on ESG metrics.
As part of its core ESG investment framework, Bain avoids companies with more than 10% exposure to tobacco alcohol, gaming, coal, and other fossil fuels. It also works to align itself to many of the metrics laid out in the ILPA framework on ESG. Additionally, Bain Capital Credit considers issues of financial materiality before the initial investment to understand whether a company has any significant ESG risks that could impact investment performance. Post-investment ESG monitoring is an ongoing aspect of portfolio company reporting and may lead to additional action if an ESG issue emerges over the lifecycle of a given investment.
TPG also takes a multi-pronged approach to ESG investing. The firm has implemented an ESG framework based on SASB’s indicators of financial materiality that it uses for its investment vehicles. TPG’s high-profile Rise Fund also makes impact investments that are tied to the SDGs – with the goal of supporting improvements in sustainable development. Rise runs a dedicated climate vehicle in addition to its impact strategy.
At the firm level, TPG’s office footprint is carbon neutral and the firm has implemented a DEI policy across all of its teams. TPG is also working to achieve similar goals within its portfolio companies by improving emissions scores across its portfolios and diversifying management. Over 100 women have been added to portfolio company boards, and approximately 300 diverse directors are seated on portfolio company boards.
TPG views ESG as core to its mission and argues that having a rigorous ESG policy in place helps recruit talent at the firm level and at the portfolio company level. Being able to present specific metrics of financial impact and hiring impact is also meaningful to the investor community.
ESG issues are manifold and only recently has the investment community started to coalesce around best practices and standards for data collection and comparison. But that effort is beginning to bear fruit. With common frameworks in place, it is now easier to understand how firms are implementing ESG strategies and to what effect.
Leaders in this area including Blackstone, Bain Capital, and TPG have chosen to focus on metrics that highlight both financial materiality and positive impact. In effect, they’re putting the frameworks into action. That’s made these firms leaders when it comes to ESG implementation. Over time, their successes will likely be the best practices that many other firms copy.
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