WHILE environmental, social, and governance (ESG) integration has been moving rapidly in the public market, more investors are beginning to realize that the private equity is perhaps better suited for ESG integration when compared to public market asset classes.
In fact, the most ideal asset class for ESG integration are some parts of the private market where the private equity manager (who is also the investor/buyer) acquires control over a company, particularly in the buyout space.
In the public market, unless an investor can acquire a majority stake in a company, they usually become a minority shareholder with little or no influence in the company’s management.
This is different from the private market, particularly in buyout transactions, where at any point during the acquisition the investor/buyer or private equity manager can be in a position to push for ESG integration.
In the private market, a private equity firm is traditionally referred to as a general partner (GP) and the investors that commit capital to the GP are called limited partners (LPs). Limited partners generally consist of pension funds, institutional accounts and wealthy individuals. GPs manage the assets and charge a management fee and a performance fee.
At present GPs are being pushed by their LPs to consider ESG integration and have ESG-focused policies in place when they (GPs) make investment decisions.
“When a GP is actually buying a company, it usually gets a position on the board, acquires a lot of influence in the company’s management, and is in a position to make a meaningful impact in terms of ESG integration and other issues,” says Ana Lei Ortiz, managing director at Hamilton Lane, a global private market money manager which became a signatory of the United Nations-supported Principles for Responsible Investment (PRI) in 2008.
In a buyout transaction, for example, the GP is able to engage with the company at almost all levels. This provides an ESG-focused GP with the opportunity to push ESG integration in the company being acquired.
In recent years, investors in the private market would like to see more GPs in Asia focusing on ESG in terms of developing a policy, ensuring that the policy is implemented down to the portfolio companies, and then reporting the implementation of the ESG policies to the investors.
“These are the very high-level things that we want to see. The starting point of course is understanding what is meant by ESG. Not just saying you will take ESG issues into account when making investment decisions but that the GP will ensure that ESG factors are integrated both into the investment decisions as well as into the value-added operational part of the cycle,” Ortiz says.
The challenge at present is that some GPs tend to think ESG integration requires a huge amount of resources and time. However, many of the large GPs are effectively undertaking ESG integration already when they conduct due diligence on a company.
“There is no GP that doesn’t think about governance when making an investment into a company. The GP does due diligence and tries to understand how that company is run, what the risks are, what the opportunities for improvement are, and a lot of the things they are looking at can be categorized as ESG. I’ve often said to GPs when they ask how they can begin ESG integration that they’re doing a lot of it already. They just haven’t acknowledged that what they’re doing is ESG,” Ortiz says.
A recent survey conducted by Hamilton Lane on GP relationships indicates about 80% of the respondents take into account ESG factors in their investment decision making.
Hamilton Lane reported global assets under management (AUM) of US$481 billion September 2019, a 2.5% increase from its previous level of US$469 billion in December 2018.