GPs under pressure on ESG strategies

Even though ESG issues seem to be on the mind of GPs, mostly driven by investor demand, their preparation to implement in-house ESG policies appears staggering.

The report states that 88% of the 17 private equity firms surveyed expect attention on responsible investment to increase in the next five years. But despite this mounting pressure, half of the PE houses interviewed currently lack a policy on ESG issues or responsible investment.

According to the report, this reluctance to formalise an ESG strategy is due a lack of internal expertise on the matters. Hence the firms' core investment strategies are unlikely to include them. This lack of internal expertise drives portfolio fragmentation since ESG activities are limited to only a fraction of portfolio companies.

"Many PE houses commented on ESG as an ‘imprecise science' that will evolve over time but in such a competitive fundraising environment, investors may not be so patient," says Malcolm Preston, global head of sustainability services at PwC.

But the report also argues that a build up of an internal capacity is unlikely to occur given the prevailing management structure of private equity firms, before it goes on to recommend collaborations with third parties that are more experienced in the ESG field.

Why though is an ESG strategy so crucial? Andrew Evans, pensions partner at PwC, points out that it is a particularly important issue given the need to attract more commitments from pension funds:

"Allocations of funds to private equity in some pension schemes is increasing and Scheme Trustees are being encouraged by various parties, including government, to ensure that they act as responsible investors. PE, like other sources of sustainable investment, can make a real virtue of delivering good returns over a longer than usual time horizon. It matches pension investment plans, but the demands for data and evidence will be high."

PwC defines ESG as environmental issues including the eco-friendliness of portfolio companies as well as investments in, for example, cleantech. Social and governance issues on the other hand, encompass the treatment of employees and antitrust compliance. However, this classification is perhaps not universally applicable. Some might want to differentiate between investments and conduct entirely, while others are only interested in the measurable effect of responsible investments.

The importance of ESG issues though is less open to interpretation. Certainly, regard for environmental issues has become the norm. The report also mentions that 94% of GPs believe that ESG activities can create investment value - countering the argument that an increased engagement in ESG activities could have a negative effect on returns.

The report "Responsible investment: creating value from environmental, social and governance issues" can be found here.

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• PricewaterhouseCoopers