Only a third of investors in private markets say that analysis of a manager’s environmental, social and governance credentials represents a major part of their due diligence process. Surprisingly, 19 percent do not include any examination of ESG practices at all.
Nevertheless, ESG is expected to be a growing consideration. “For European LPs investing in infrastructure, we think ESG will be a significant factor in the due diligence process,” says Darryl Murphy, head of infrastructure debt at Aviva Investors. He adds that there are nonetheless distinct regional differences in terms of approaches to ESG and its perceived importance.
Given the longevity of infrastructure investments and the role the assets play in the environment and society, LPs are increasingly aware that ESG can no longer be a box-ticking exercise. There is also a growing understanding that ESG considerations enhance performance. Viewing dealflow through an ESG lens has unlocked investment opportunities, most notably in sustainable energy generation. In addition, it is increasingly apparent that the number of potential buyers of assets with negative ESG features is steadily decreasing, while a strong ESG rating lowers the exit risk.
However, analysing ESG compliance is not easy. Covering everything from pollution to workplace equality, it is more nuanced than financial due diligence, and vulnerabilities persist in the tools created for benchmarking ESG performance. This was made clear when Southern Water, which had been given a five-star rating by leading ESG benchmarker GRESB, was fined a record £126 million ($164 million; €148 million) by regulator Ofwat for failing to prevent sewage spillages over seven years and manipulating figures to avoid penalties.
If ESG is still low on some investors’ priority lists, diversity and inclusion receive even less attention. Fewer than a quarter of investors in private markets consider reviews of diversity and inclusion policies and practices to be a major part of their due diligence process. Some 22 percent do not undertake any reviews of diversity and inclusion when making fund commitments.
“The overall view seems to be that infrastructure is no better or worse in this area, and indeed has some way to go,” says Murphy. “This is an important element to improve upon, both at the manager level and through increased demands from LPs.”
Despite a lack of overall focus on diversity policies, 14 percent of LPs say they previously declined an investment opportunity because of a lack of diversity at the fund management level. Murphy warns: “Managers should view this finding as a wake-up call, both that diversity and inclusion is an area of increasing importance to investors and also that this is an area which needs to be focused on and improved.”
Research by HEC Partners and placement agent MVision in the buyout space in 2019 concluded that investment committees with at least one female member performed better, with a lower risk of failure, than all-male teams. Chicago Teachers’ Pension Fund’s initial decision in 2018 to pass on Blackstone Group and Brookfield Asset Management is understood to have been, in part, based on a lack of workplace diversity at the GPs, though it has since committed to Brookfield.
Given the spotlight that has been cast on gender equality, in particular, over the past 12 months, it seems probable that diversity and inclusion will follow in ESG’s footsteps.
What was once an interesting talking point could ultimately become a fundraising dealbreaker.