Environmental, social and governance (ESG) issues have become a major focus in financial markets. However, much of the commentary and focus has been on ESG in the public markets. In fact, ESG is also a focus in the private markets.
Applying ESG to the private markets
In a recent interview with ValueWalk, fund manager Apex Group’s Michael Carrillo highlighted ESG issues in relation to private markets.
Michael Carlos
Photo credit: Apex Group
One trend he’s seeing across the industry is the association of alpha and positive returns with ESG or impact investing. He added that proving these connections can be difficult, in part due to the lack of a standard framework for measuring ESG and impact indicators.
Among the many frameworks currently in use in the private markets are:
- United Nations Principles for Responsible Investment (UNPRI)
- EU Sustainable Finance Disclosure Rules (SFDR)
- ESG data convergence project
- Sustainability Accounting Standards Board (SASB)
- United Nations Sustainable Development Goals (UN SDGs)
- Organization for Economic Co-operation and Development (OECD).
“Attributing private company performance to one or more of these standards can be difficult and time-consuming, but also a necessity for private markets investors looking to mitigate ESG risks and tie advances in ESG competencies to higher returns or alpha,” said Carrillo. “Investors can’t analyze what they can’t measure.”
ESG measurement is possible
He stressed the need for a method to systematically measure ESG skills to see in one way or another whether ESG skills lead to better returns. Carrillo believes there is a qualitative consensus that this is possible.
“ESG is tied to business materiality, so we need to get to the point where we have that critical mass of data, not just qualitative,” he says.
Apex Group provides technology-enabled ESG advisory services that include active measurement of more than 2,000 private companies and independent verification of all data inputs.
“For PE-backed portfolio companies, we can measure progress on ESG competencies over the entire holding period,” explains Michael. “When verifiable ESG data is aggregated, from pre-investment due diligence to eventual passing, we are able to benchmark against ESG competencies and provide correlation data to support whether ESG Advances help generate alpha in the context of specific private companies or entire funds.”
He added that a relatively small number of private equity and venture capital funds have collected this data throughout their 10-year lifecycle, so more comprehensive analysis will be possible in the future.
Many systems of ESG measurement
Carrillo has seen many companies enter the burgeoning industry of measuring ESG and impact competencies. The Apex team believes that the greatest strength of what they put together is versatility.
“There are so many different standards that have been developed for different purposes and are therefore preferred by different stakeholders,” he explains. “So we’ve built a platform that’s constantly evolving so customers can correlate with all or some of them.”
A team of more than 50 ESG professionals constantly measures, monitors and analyzes standards in real time, and Apex uses this work to grow its platform. There is a continuum in ESG and impact.
One side has pure due diligence advisors who analyze private markets investments from an ESG perspective. At the other end of the spectrum are software-as-a-service platforms that track ESG. Apex Group’s efforts fall in the middle of this spectrum and consist of a technology-enhanced, human-focused ESG advisory service.
Greenwashing in the private markets
Another hot topic in ESG right now is greenwashing. Greenwashing is mainly focused on the public markets, but it is also an important issue in the private markets. He said that five or more years ago it was more acceptable to philosophize about ESG or impact investing without providing evidence to support those values.
Of course, a philosophical orientation is helpful, but many PE and VC fund investors want or need measurable ESG or impact evidence, making greenwashing a real problem in private markets.
“Investors in private equity funds place a high value on ESG competencies and will not hesitate to consult managers on this topic,” he said. “You see lengthy due diligence questionnaires being circulated by allocators, investors and advisors, with the investor relations heads of PE or VC firms often being inundated with an increasing number of ESG inquiries. The perception of greenwashing can potentially jeopardize future capital commitments, as we see in a In many cases, PE or VC shops are hiring their first ESG leaders. Many of these people are the first in newly created positions focused solely on ESG integration.”
Michael notes that these ESG leaders have tremendous work to do as ESG is not just in the fundraising process. You need to consider ESG in the deployment of capital and even during the holding period of any private asset.
How ESG is more than marketing
Carrillo believes that ESG is integral to a company’s success, although he admits that many are skeptical about the topic. He thinks his skepticism is correct, since ESG in the private markets often correlates with the marketing of funds.
“We’re at a point now where private equity has a PR problem,” adds Michael. “A lot of people like to point out that PE isn’t such a great thing in society, but private equity and venture capital in a broader sense are hugely important to the global economy…I’m on my soapbox, but if the private markets were used to create sustainable.” To create investments, we will see movements and impacts that are larger than those influenced by governments in certain circumstances.”
He observed an interesting shift in the way capital is deployed in the private markets to bring about changes that are beneficial to both business and the world.
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