Written by: Aberdeen Standard Investments
Currently, Europe leads the way in terms of ESG integration. Responsible investment tends to be incorporated into company due diligence and value creation plans. Typically, private equity managers work alongside management at a board level to implement and monitor ESG practices within a company. Traditionally, this included strengthening the company’s management team, improving financial reporting and enhancing governance. Recently, private equity firms have increased their focus on initiatives designed to have a positive environmental or social impact. More often than not, plans aimed at creating value will incorporate responsible investment to improve production and resource efficiency, increase diversity, or reduce waste and emissions. Improvements in these areas can make the company more profitable and marketable. They can also have a positive effect on the valuation of a business when it is sold and, ultimately, on investment returns.
Increased scrutiny from investors and regulators means that private equity firms will find themselves at risk of falling behind their peers and becoming uncompetitive in the long term if they do not adopt responsible investment practices. European private equity firms appear to be embracing responsible investment opportunities, but those in the US and Asia are lagging. That said, there are encouraging signs that this is starting to change.
ASI annual private equity ESG survey
The purpose of our ESG survey is to monitor the level of ESG engagement at the private equity firm level and underlying portfolio company level. As well as tracking the private equity market’s progress in terms of responsible investment, the survey gives us a bank of proprietary ESG information on our core private equity relationships. In addition, the data helps us assess private equity firms during the due diligence process and beyond.
In the 2019 survey, we contacted 176 core private equity relationships in Europe, the US and Asia. This is the second year the survey has included US and Asian firms. The response rate of 52% was in line with the 2018 survey. On a regional basis, the responses equated to 70%, 40% and 50% for Europe, the US and Asia, respectively. Encouragingly, response rates in the US and Asia improved from the previous year.
For the second year, the survey showed that European private equity firms are more advanced in terms of ESG practices than their US and Asian peers. For example, 88% of European respondents indicated they have an ESG policy in place, with the remaining 12% indicating a desire to implement such a policy in the near future. Conversely, only 53% and 15% of Asian and US private equity firms, respectively, had an ESG policy in place. We are encouraged by the improvement in these figures from 2018, but we believe that ESG is yet to be fully embraced from a cultural perspective within Asia and, in particular, the US.
There was greater engagement from our European participants given the emphasis placed on responsible investment by private equity investors in north-west Europe. European private equity firms tend to have ESG policies, ESG training and some form of dedicated ESG resource as standard – and many are signatories of the United Nations’ Principles for Responsible Investment.
We included a question in our 2019 survey to ascertain how, if at all, private equity firms are incorporating the United Nations’ Sustainable Development Goals (‘UN SDGs’) into their value creation plans. Around two-thirds of European private equity firms are either including or considering including the UN SDGs. Nevertheless, within the European responses, there is a clear delineation between those who are successfully including the UN SDGs into their strategies to create value and monitoring effectively, versus those still developing their strategy. We expect to see the number of European firms incorporating the UN SDGs to increase over time. However, there remains some reticence to incorporate the principles until there is a common framework for assessing performance.
Responsible investing in private equity is expected to increase in importance as private equity managers seek to differentiate themselves and to add value to companies above and beyond traditional methods. Furthermore, we believe that private equity investors, such as ourselves, will continue to play an important role in allocating capital to those firms with robust ESG practices, while simultaneously supporting other firms on the journey to improve their ESG capabilities.