Given its inherently analytical nature, private equity is well placed to include environment, social and governance (ESG) factors in its investment process. The challenge lies in making sure the data being collected is relevant and material. This hurdle needs to be conquered as investors are starting to pass over managers who are not taking this matter seriously.
“It would be amazing if there were clear-cut answers to what needs to be collected and measured, but the truth is it’s usually context specific,” highlights Kylie Ford, principal consultant – ESG at Goby. “As a result, many PE managers get stuck not knowing what to ask. LPs tell them they need to focus on certain areas which may or may not line up with what they’re able to collect.”
The good news is that there are frameworks to look to for guidance. In Ford’s view, the main hurdle is getting started. “Once analytics are deployed, they can be adjusted and fine-tuned. PE firms need to not let perfect be the enemy of the good in terms of getting going,” she advises.
There are a few dynamics driving the need for portfolio analytics in relation to ESG. PE’s guiding responsibility is to improve the risk/return profile of a portfolio and to make those smart investments in the first place. When it comes to ESG however, Ford outlines: “This is an incredibly broad, cross-cutting, multidisciplinary term. So, questions naturally arise around what managers need to look for and where they should go to find it. Until they have their arms around current performance, and until they have some framework to measure ESG risk, PE managers won’t be able to answer those questions.”
When it comes to applying some level of ESG analytics, Ford says the best practice for any company considering any aspect of implementation is a materiality assessment, which applies doubly to portfolio analytics. “It’s about making sure you’re asking what’s relevant, while also engaging stakeholders and understanding their own capacity. You begin to understand their own understanding, even,” she notes.
Ford gives an example of working with one PE client who, prior to conducting a materiality assessment, was convinced none of their portfolio companies were very developed in ESG implementation. Going through it, there were not just a handful of portfolio companies which were well along their journey, but some could have been considered best-in-class.
“So, not only did this exercise help our client have a better understanding of what they could ask for and collect, but it pointed them towards where they could leverage best practices. Materiality assessments check you on assumptions you might be making and ensure that stakeholder perspectives are integrated into any path forward,” she stresses.
In addition, adopting frameworks as part of ESG implementation is also best practice in this space. Ford recommends managers utilise the UNPRI’s reporting process to highlight areas where they could be better integrating ESG factors into both their investment and management process: “Utilise SASB industry-specific standards to understand what ESG considerations are likely to have an influence on a given portfolio’s bottom-line. There’s often difficulty knowing where to start and which acronym to review. Of course, a materiality assessment helps here too. The truth is, there’s purposeful synergy between most of the major disclosure frameworks.”
She also points out that many times it’s a matter of who is doing the groundwork to find and disclose the analytics: “LPs know certain pieces of ESG information help them make the best and least risky decisions, but it’s largely up to PE firms to set the specifics of their own frameworks of analysis, and certainly to implement and collect with portfolio companies.
“Industry plays a role as well, given different analytics will be available and material, and not all information is as easily attained. PE is honestly in one of the toughest spots in the supply chain, in my opinion. Managers will get pushback from both ends. LPs ask for more ESG data, more understanding of performance, and many portfolio companies just don’t have the resources, skills, or complexity to build this into their processes and immediately be able to deliver.”
But, Ford explains, this is also encouraging: “It means PE firms have the greatest opportunity to drive that impact, to leverage best practices, and to apply right-sized approaches which are actionable.”
The impetus for managers to include ESG in their analytics framework is only bound to get more compelling. Ford believes the industry will see significant adoption as LPs are becoming more discerning and not allocating to managers who don’t take this seriously. They can do this because data now exists linking ESG practices to financial returns.
“It mostly comes back to this fact, that robust ESG programmes lead to strong financial performance. It’s thinking through the ways in which you touch the world, environmentally and socially speaking, and the mechanisms to control that. I’m glad we’re finally putting the metrics in place to see it,” Ford observes.
The regulatory environment is a secondary catalyst. Ford elaborates: “The EU taxonomy is not the only mandatory ESG disclosure out there from a regulatory standpoint. Domestically, in the US, we have cities setting net-zero goals and the SEC forming an ESG committee.
“Regulation will still probably lag the industry a bit, just like we’re seeing right now, but changing regulation is coming, and in a much shorter timeframe than most people give it credit for.”
Kylie Ford, Principal Consultant – ESG, Goby
Kylie Ford is a Principal ESG Consultant at Goby, and has over a decade of ESG management, consulting and programme experience. She’s an expert at bridging multiple roles, and has worked with organisations of all sizes across every sector, where she has focused on employee engagement, strategic business development, and process improvements.
Ryan Nelson, CEO & Co-Founder, Goby
Ryan Nelson is the CEO and Co-Founder of Goby, The ESG Platform. He has more than 20 years in enterprise software and management consulting experience, including supply chain software implementation and process optimisation for Fortune 50 companies; among them, Chevron, Honeywell, AIG, and Zurich Insurance Group. Since 2009, Ryan has been focused on transforming Goby into the most intelligent, comprehensive, and intuitive platform for ESG (environmental, social, governance) management.