12th October 2016
Bridging the credibility gap
It’s time for Private Equity firms to ask some hard questions about their integration of environmental, social and governance factors.
Well done to Bank of America Merrill Lynch for hosting The Crowd’s lively ESG focused event last week. More than 200 sustainability and investment professionals attended The Shareholder Revolution? to discuss whether environmental, social and governance (ESG) considerations have truly revolutionised the investment community.
The ESG revolution has already taken place. ESG is no longer the preserve of a tiny minority. ESG data sources and analytical tools are now well-established in investment analysis and due diligence.
And these tools are growing increasingly sophisticated. The audience was impressed by Omar Selim’s presentation, showing how Arabesque Partners uses billions of data points and 200 ESG filters to screen over 70,000 firms. He revealed the exciting prospect of freely-available analytics that could be used by millions of personal investors.
Take the evolutionary road
But the promise and pyrotechnics of ESG data should not distract us from the important task of building up an evidence base of how ESG has added value in specific cases. It’s this slower, more evolutionary road that needs to be travelled.
Case studies and examples offer practical assistance to managers in a way that aggregate data never can.
Private Equity Sceptics
I brought this perspective to a round-table I chaired at the event, looking at how private equity can drive sustainability. Several of the participants expressed scepticism about exactly how and when PE firms add value through ESG.
Wider questions about the role ESG currently plays in individual private equity firms are perfectly legitimate. While ESG practices vary from firm to firm, this is often difficult to discern because firms often publicly communicate their ESG credentials in a similar fashion; some do little more than summarise their commitments as a signatory to the Principles on Responsible Investment.
Avoiding the credibility gap
An absence of evidence as to how these principles are put into practice – and to what effect – can easily create the impression that ESG is largely a tick box exercise, a matter of compliance rather than real commitment. A credibility gap can easily emerge where there is a gap between the impression a firm creates, however inadvertently, and what they do in practice.
If private equity firms want to appear credible, they should ask themselves three key questions about ESG in their firms:
- Is ESG primarily a due diligence and screening tool?
- Is ESG mainly a matter of compliance?
- Is ESG largely the preserve of a dedicated manager and a handful of other colleagues or is ESG understood and applied across the firm?
Whatever the answers, a PE firm’s communications should not give rise to expectations that cannot be met. It’s more important to be credible than appear to embrace leading practice when that cannot be substantiated.
Four Ways Forward
Our recommendations to the growing cadre of ESG heads at private equity firms is to work with their IR and communications colleagues to:
1 – Tell a story about ESG that is integrated into the firm’s overarching narrative. The goal should be to create a compelling, credible and distinctive story about how your company operates, not merely to present facts about the integration of widely-adopted ESG tools.
2 – ESG should have a life outside of your dedicated ESG reports and sections in annual reviews and websites. It should also be expressed in how you communicate your values and investment strategy, for example. Compartmentalising your ESG communications can undermine messaging about ESG integration.
3 – Use case studies and other evidence to illustrate how your firm has added value to portfolio companies, spelling out specifically what your interventions were, the subsequent actions taken and the financially-relevant outcomes, such as a reduction in the number of working days lost due to better workplace practices.
4 – Show how you have translated ESG issues into meaningful financial information. It has been said that sustainability types speak in PowerPoint, and investors speak in Excel. This is still largely true but the PRI has many good case studies of ESG factors successfully translated into financial information. The story should focus both on the expertise that produced the data and the insights that it has since generated.
Best practice on integrating ESG is now well-established. As last week’s event made clear, investors now need to embrace best practice on how they communicate ESG to the audiences that matter most to them – investors, portfolio companies and their other stakeholders.