Environmental, social and governance (ESG) criteria are no longer a tick box exercise for private equity professionals but a serious base from which investment decisions are made. At the Integrating ESG into Private Equity Summit at SuperReturn International in Berlin we heard some compelling case studies that underlined just why this is now the case.
ESG in practice
Thomas Ludwig, Affiliate Partner at Lindsay Goldberg, talked us through the firm’s acquisition of VDM Metals – producers of high performance materials in metal – and the ensuing transformation of its ESG. They closed the deal in July 2015 at a time when the lost time injury frequency rate of its plants was extraordinarily high. This propelled health and safety to the top of the agenda, explained Ludwig.
The company put health and safety at the forefront of every conversation, including discussing every single accident with both employee and chairmen of management board. “Our target was a change in attitude and behaviour and to develop attention to health and safety across the whole company,” explained Ludwig.
They set about transforming the company culture from within with an information and awareness campaign. In addition, health and safety became a key element of the development programme for employees. Within two years, the lost time injury frequency rate had been reduced by 51%.Where are we really at with ESG in private equity? Watch our exclusive interview with Silva Deželan, Director Sustainability at Robeco Private Equity.
Ludwig explained how some of the success was down to the fact that they had built up trust with the workers. “We negotiated an agreement with the workers council, we explained our strategy, they knew what we were doing with the company, and this built up trust.”
Trust was also a key element in the example given by Frode Strand-Nielsen, Managing Partner at FSN Capital. He told us how they had worked with innovative clothing brand Kari Traa to develop their ESG and built trust among their customers. Part of the ethos of the brand, he said, was based on respect for the human rights of everyone involved in making their products.
To this end, they worked with an NGO to complete audits on all the factories where the garments were made to make sure that there was no child labour, that there were safe working conditions and that the structural integrity of the buildings were in line with expected standards.
Given that the garments were made of wool, they also looked at animal welfare. It was critical that every batch of wool was traceable all the way back to the farm in question to ensure the highest level of welfare.
“ESG was an ongoing process,” explained Strand-Nielsen. “You never become perfect, there is always more to be done, you keep setting new targets every year.”
But then there was the X-factor. Kari Traa had identified material issues faced by its core customer – women aged between 20 and 30, and launched campaigns on the back of that. The first of which was a campaign against Internet trolls. The #NoTrollCanBreakMe campaign had models wearing faces of their trollers on t-shirts at a fashion show. The campaign made it into the news.
Then last year the clothing line launched a new campaign “Celebrate Yourself” in response to a survey that found that nine out of 10 Scandinavian girls felt uncomfortable because of beauty ideals that the fashion industry pedals. Celebrate Yourselves encouraged them to accept and celebrate who they were.
The campaigns not only highlighted important issues but helped create really strong brand affinity – and that translated into healthy sales.
“Core social responsibility works,” concluded Strand-Nielsen. “It creates good returns.”
It also adds competitive edge, he said. “ESG integration creates value on several levels. Private equity competes in three arenas – talent, money and companies to buy.
“If you can create a foundation of trust, people will feel that and will want to work with you, invest in you, and leave their businesses thinking you are a good steward.”
LPs recognise it
In a later session on LP expectations, several managers agreed that LPs recognised the importance of ESG. For instance, Camilla Axvi, Head of Private Equity, External Managers at AP2, explained that their investment belief was based on high long term return and low risk. This, she said, can be achieved if sustainability is considered and included in the investment process.
It’s all about relationships and people. Yes there is data, but there is no substitute for a conversation.
“We also believe businesses with a sustainable model do generate a higher long term return and also that they will have a sustainable competitive advantage if they have a focus on ESG,” she said.
Being able to have honest discussions with GPs was a way of achieving this goal, she added. “When we have the dialogue with the GP, we would like to see that they have an ESG policy, and have the work integrated in their investment philosophy as well as in their processes.”
Adam Black, Head of ESG & Sustainability at Coller Capital agreed, saying that his preferred approach was to pick up the phone and have a genuine conversation with a GP. “It’s all about relationships and people,” he said. “Yes there is data but there is no substitute for a conversation.”
Not all used ESG as a method of fund selection. Camilla felt that, as long as the right mind-set was there, policy could come later. Adam added that they had invested in companies that didn’t have an ESG policy, but worked with them to put one in place. “We will work with managers that don’t have established programmes, but often they talk about business resilience and longer term operational risk. What we find is that elements of ESG are there but they are called something else.
Europe was streets ahead of the US with regard to ESG, but Asia was catching up, felt the panel. Future themes that ESG would include, said Rob, included financial stability boards looking at climate change more carefully, tech firms coming under more scrutiny, and the UK’s Anti-Slavery Act. Camilla added that the UN Sustainable Development Goals were also becoming more important.
“You have to plan ahead and you have to practice what you preach,” concluded Rob. “You need a diverse community. We have all experienced the painful circumstances of private equity where, once you are in an investment, it’s hard to get out. You have to stay on your toes.”