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March 2021

ESG – A CRUCIAL ELEMENT OF VALUE CREATION

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TPG, one of the private equity world’s giants, made headlines in 2016 for the launch of their Rise Impact fund with Jeff Skoll and U2’s Bono. The fund has $5 billion in AuM that it aims to invest in mission-driven growth stage companies that have “the power to change the world”. Shortly after, Bain Capital launched its Double Impact fund, aiming to finance companies which are solving critical global solution in a sustainable manner. In early 2020, another private equity giant, KKR, closed its $1.3 billion Global Impact Fund. Blackstone, in 2019, launched an impact investing platform that targets four specific investment themes all the while delivering a positive finance impact. Apollo Global Management has also announced it plans to enter the impact investing market seeking to launch a $1 billion fund.

Hedda Pahlson-Moller, Founder and CEO of TIIME,

Clearly, and if you’ll pardon the pun, ESG is having an impact on private equity. Combine the drive seen within private equity firms, with the fact that private companies with over 500 employees outnumber public ones two to one, and it’s easy to realise that private equity firms are beginning to have an outsized impact on ESG. Given this, in January 2021, Luxembourg for Finance had the pleasure of hosting Hedda Pahlson-Moller, Founder and CEO of TIIME, and Vanessa Camilleri, Conducting Officer and Head of the Luxembourg Office at Partners Group, at our Focus On Private Equity event to discuss, among other topics, ESG and its importance in the private equity sphere.

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ESG is not, or rather not necessarily or directly, about positive screening to contribute solutions for societal problems. It’s simply smart investing.

Pahlson-Moller

A shift has occurred, both in investor expectations and asset management perceptions, over the last 15 years – one that introduced a completely new paradigm within the world of finance. Sustainability has moved from a negative investment signal to a positive one. The guiding theory that one needs to sacrifice financial return in order to have a sustainable return no longer holds. A number of studies have debunked this. Pahlson-Moller points to the fact that “ESG is not, or rather not necessarily or directly, about positive screening to contribute solutions for societal problems. It’s simply smart investing. It’s looking at risks and opportunities based on nonfinancial criteria.”

Vanessa Camilleri, Conducting Officer and Head of the Luxembourg Office at Partners Group,

Its value goes beyond financial returns into the common good – for investors, society and societal equity, and the planet. It is also an opportunity for private equity firms to adapt to new regulations, markets and investor demand. The private equity industry is uniquely positioned to use its expertise and place in the market to not only generate value for investors but for society as a whole. Camilleri pointed out that for private equity firms it’s critical to have “ESG specific teams integrated directly with value creation teams, so investments are screened in the due diligence process.” In this manner, private equity houses can take what they do best, driving transformation more rapidly than others, and use this power to further sustainability across their various portfolio companies.

While many private equity firms have already taken on ESG considerations into their own operations, it’s critical that this is further embedded into their investments and portfolio companies. In order to do so, private equity houses should focus on what is material and according to Pahlson-Moller, let the UN Sustainable Development Goals be a guiding factor. These will provide firms with the ability to more easily identify possible material risks mapped to these specific thematics. Pahlson-Moller emphasizes this noting that firms can “screen out the industries and companies to follow ESG performance or venture towards impact investing philosophy setting values that can filter.” While evaluating new investments on this basis is critical, firms should also implement time sensitive turnaround strategies for existing portfolio companies to green production facilities or to increase diversity within management and boards.

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Different perspectives enable us to source the best deals and create the best bespoke solutions for our clients. There’s a direct correlation between diversity, different perspectives, and better conclusions.”

Camilleri

In fact, while much emphasis has been placed on the “E” category, an increasing number of firms are looking to the “S” and “G” as well. Pahlson-Moller highlights that there is clear value creation around diversity, and that despite there only being “approximately 10% of women in senior positions, there are data-driven arguments why and how it correlates to improved performance and results.” Camilleri echoed this, noting that assessing investments from different geographies or industries requires various perspectives. “These different perspectives enable us to source the best deals and create the best bespoke solutions for our clients. There’s a direct correlation between diversity, different perspectives, and better conclusions.”

To achieve a more balanced representation a number of initiatives across the globe have already been, or are in the process of being, implemented. Germany has, for example, mandated 30% women on boards, Level 20 in the UK is powering a number of initiatives for the private equity industry, and NASDAQ has requested SEC approval for new listings with board diversity requirements. While the gender issue is concerning, Pahlson-Moller notes that “there’s a strong push towards racial equity that’s a long overdue discussion.”

In Europe, the regulatory agenda is also setting the pace and private equity fund managers will not be immune. The SFDR will require firms to disclose how ESG forms a part of their investment process. Further, societal expectations as well as internal stakeholders, are putting pressure on private equity firms to bolster their ESG credentials. New employees are increasingly calling for firms to not only talk-the-talk, but walk-the-walk when it comes to ESG and to demonstrate their commitment.

Clearly ESG has already become a critical issue for the private equity industry, not least due to the fact that investors are increasingly calling for their money not only to do good for their bottom line. Across the private equity sphere, it is clear that ESG mitigates certain risks, creates a longer-term sustainable value that fits with private equity investment timelines and enhances value for all parties, be it the investor, the private equity firm, the company or the clientele.

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There’s a strong push towards racial equity that’s a long overdue discussion.

Pahlson-Moller