Environmental, social and governance (ESG) policies are becoming a key factor for institutional investors, according to a latest research. ESG has become a core strategy for many firms in their quest to create more value to investors in the changing industry and investors are adding more pressure on firms to continue the use of ESG policies as part of their investment tactics.
The findings are part of a global study conducted by the London Business School’s Coller Institute of Private Equity, supported by Adveq, the global private market investor. The research looked at 42 separate private equity firms, which combined had over $640 billion worth of assets under management. It is one of the first comprehensive studies looking at the role of ESG in private equity industry.
Academic Debate on the Role of ESG
The previous years have seen plenty of debate regarding the viability of ESG policies. The definition of ESG policies has been under debate and a wide range of policies is now viewed through the lens of ESG from consumer protection to climate change.
Furthermore, economists and private equity analysts have debated whether ESG policies are adding value to investments or hindering the creation of profit. On one hand, neoclassical economists have argued that ESG initiatives will increase costs for the firms, creating a competitive disadvantage that is hard to overcome. But on the other hand, recent studies have shown firms with higher ESG performance are able to obtain more quality resources, like talented employees, and gain a better marketing advantage.
A number of private equity firms have openly supported the implementation of ESG policies. For example, Jeremy Coller, the founder of London-based Coller Capital, has long been advocating for ESG initiatives. Different movements from the United Nations led Principles for Responsible Investment (PRI) to national working groups have been at the forefront of the industry.
Yet, there has been little research into how important ESG policies are for investors and whether private equity firms are implementing the policies as a core strategy, which is something the recent study hoped to look into.
Putting ESG to the Heart of Strategy
Although the role of ESG has previously been viewed as increasingly important, the new study suggests ESG is much more important to institutional investors than previously thought. Funds Europe commented the study saying investors now want ESG “at the heart of the investment process, rather than viewing them just as a compliance function”.
The study looked at 44 private equity firms, of which 33 firms also provided data on the assets they currently had under management. The rest of the firms participated in an online questionnaire. Furthermore, the study had quite a good range of different sized firms participating, as 11 firms were small, 9 firms were mid-sized and 13 firms were considered as large private equity firms.
The private equity firms that participated in the study overwhelmingly agreed that institutional investors are increasing pressure on firms to make sure ESG is implemented as a way to create value. 85% of the firms said this pressure of applying ESG policies to everyday working practices is heating up.
Interestingly, the most pressure was felt by firms with a European investment focus. According to the study, this could be down to the increased focus of social responsibility in investment practices in the region, especially since the financial crash. 10 of the 13 firms with North American focus also reported intensified pressure towards ESG initiatives. On the other hand, most private equity firms with a Middle East, Northern Africa and Latin American (MENALA) focus, didn’t feel there is a surge towards ESG practices, again something that could be explained by lack of societal pressure.
Only 9.5% of the private equity firms questioned reported they have no ESG policies in place, with the companies being mainly small firms in size.
Barriers Facing ESG Adaptation
But investor pressure isn’t as easy to overcome as many would hope. The study also found there are still plenty of barriers firms feel prevent them from implementing ESG policies. The biggest barrier was considered to be data collection.
Furthermore, Investment & Pensions Europe highlighted the study’s finding that internal managers with their negative attitude are slowing down implementation. The news site quoted the study saying, “It appears that, while ESG integration has become common, there remain pockets of internal managerial resistance to the whole idea of considering such issues as relevant for investment decisions.”
Dealing with a negative attitude might be easier to overcome than figuring out the way to make data collection easier. But the findings highlight the importance of continued search for better private equity data management tools, even in the field of ESG. The study notes that, “comparability of ESG information across portfolio companies might allow for higher quality decision-making, while more transparency is likely help investors to reward ESG champions with higher asset allocations.”
On top of this, the recently published report by the United Nations’ supported Principles for Responsible Investment (PRI) found that 92% of respondents believe the biggest obstacles for more sustainable markets are deeply rooted in the market culture, structure and regulatory framework.
Despite this, there is still little involvement in actual policy-making by investors, something a recent article by Mrs Helene Winch, director of public policy and research at PRI, at CFI found problematic.
Future of ESG Implementation
ESG initiatives have become increasingly important for many private equity firms. This recent study highlights the change in investment atmosphere and the need for not just deeper ESG understanding but also deeper implementation of ESG as a core investment strategy. The study argues that ESG policies are driven to the forefront of private equity investment strategy mainly by investors, but that government and societal changes have also helped increase the focus on sustainable and ethical practices.
The researchers behind the study acknowledge that more research must be done in the sector. But in the meantime, it is interesting to note that ESG is taking such a big role in investment and how data collection and management continue to present problems for many private equity firms.