More than ticking a box
Investors are now looking for more than just a commitment, but for proof of how the firm is following through on that commitment. They want to see evidence of what action managers are taking to ensure they are investing in a sustainable way. As ESG rises up investors’ agendas, firms need to demonstrate comprehensive ESG approaches or risk falling behind.
The same BDO report found that 48% of UK PE firms report in detail on the ESG impact of their investments and 25% of PE firms now have a dedicated ESG team. The leading managers are going much further than ticking the box and leveraging ESG as a core tool for creating value and demonstrating competitive advantage.
With no single standard for firms to follow, and a multitude of different potential data points, a key challenge for managers setting up their ESG strategy has been identifying which metrics to track. This is a particular challenge for firms who invest across diverse industries for whom relevant data points may differ substantially across their portfolio companies.
Many firms have tried to tackle this by capturing a huge number of data points, varying on a company-by-company basis, but have then struggled to achieve meaningful, aggregated reporting. Significant time and complexity has been added to portfolio monitoring processes, without adding a lot of value.
As reported in the FT, The Big Four recently unveiled a set of ESG reporting standards, made up of 21 core ESG metrics and 34 extended metrics, aiming to encourage companies to adopt the standards for their 2021 accounts. If this initiative is successful, it will bring significant efficiencies, but it is at an infant stage. We have yet to see how many global companies will adopt the standards.
For now, firms must decide which metrics are important to them and their investors and standardise across the portfolio as far as possible.
What does good look like?
Once firms have begun collecting ESG data, the next challenge is often a lack of benchmark data to determine what good looks like. While there is a multitude of ESG data providers and indexes for the public markets, there are few reputable, independent providers for private markets.
Firms can either engage with large consultancies who leverage their broad experience to measure ESG maturity or they can focus on reporting change over time. Investors can either compare ESG scores to peer group firms managing similar portfolios or to the managers’ own history.
Combining the data
When it comes to systemising ESG monitoring, rather than implementing a dedicated ESG tool, most firms are leveraging their existing portfolio monitoring system. We work with managers to either develop ESG-specific data collection templates or to build ESG measures into their standard financial data collection templates. Specific ESG reports and dashboards can then be driven by the system, combining ESG metrics with valuations data to demonstrate the impact on returns over time.
While some of the leading firms are successfully achieving this, challenges remain. It is rare that firms successfully aggregate all the necessary data without reliance on ancillary Excel spreadsheets. ESG metrics are ever-changing and the current tools can be inflexible.
We are working with our most digitally advanced clients to aggregate data from multiple sources into the ATLAS data platform, thereby creating one source of truth, and surfacing the data in a flexible visualisation tool such as Power BI.
What is evident is that no Private Equity firm can afford not to think about ESG. The pressure will only increase to mobilize large pools of investment capital to combat the world’s most intractable problems. With the ever-increasing importance of ESG to investors’, the firms that have the data analytics capabilities to prove both ESG impact and a positive effect on returns are in the best position to attract investment.
Kim leads Holland Mountain’s middle office practice, focusing on portfolio monitoring, valuations and ESG. Kim works closely with Private Capital firms to provide strategic advice on operating models and offering best practice recommendations for the successful delivery of operational improvement projects. As a Private Capital expert, Kim has extensive experience in Private Capital operations and systems, having managed system selection, implementation, remediation and continuous improvement projects.