LPs Seek to Understand GPs’ ESG Management Capabilities
LPs are starting to view GPs’ ESG management capabilities as table stakes when selecting a fund manager. Gone are the days where LPs can be satisfied by a GP checking the box on a number of ESG items. Though fund performance remains the chief criteria for fund manager selection, Malk Partners’s recently published ESG in Private Equity – 2015 study found that an increasing number of North American pension plans, foundations/endowments, and other investors want to invest with GPs that have effective ESG management capabilities. The cases below highlight the importance LPs place on effective ESG management.
CalPERS, the $308Bn pension fund, will begin a one-year pilot program (subscribers) this month aimed at incorporating ESG risk and opportunity considerations into its investment and decision making processes across all of its asset classes. The program will include asking fund managers to showcase how ESG has been incorporated into their investment process, incorporating ESG/sustainable investing requirements into contracts, and establishing a monitoring process. CalPERS will base the program’s foundations on its 10 investment beliefs, PRI’s Principles, and CalPERS’ Global Principles of Accountable Corporate Governance. Anne Simpson, Senior Portfolio Manager and Director of Global Governance, said that “This is going beyond asking ‘Are you a signatory to the PRI?’ It lifts the lid, as they have to report to us on this.”
Also in the past quarter, we saw several prominent cases of an ESG issue at a portfolio company affecting the GP-LP relationship. ACE Cash Express, a payday lender owned by JLL Partners Fund V, was fined $10 million by the Consumer Financial Protection Bureau for engaging in illegal debt collection tactics. After the fine was announced, the New Jersey State Investment Council, which committed $50 million to JLL, led a lively debate with the National Association for the Advancement of Colored People (NAACP) and the New Jersey Citizen Action organization about its stake in the company.
Activists were frustrated as it is illegal for payday lenders to operate in New Jersey given their predatory lending practices, and yet the state had invested in one (which is not technically illegal). Following discussion with activists and to prevent further damage to its reputation, New Jersey may exit the fund. New Jersey has also considered developing ESG standards for its GPs (subscribers), especially around investing their funds in businesses that are illegal to operate in the state.
In another case, Cerberus sought to satisfy investors, most notably CalSTRS, by recently announcing that it will allow investors to exit their position in Remington, the gun manufacturer of the rifle used in the Sandy Hook school shooting. California’s state treasurer, John Chiang, also publicly pressed CalSTRS to sell its stake in the company. Cerberus moved Remington into a special financial vehicle as it was unable to strike a suitable deal, compounded by the fact that several big lenders refused to participate in the sales process in an effort to protect their own reputations, according to the New York Times.
Unlike in previous years, LPs’ exposure to headline risk and subsequent reputational damage has been amplified. To minimize this and other risks, LPs increasingly seek to ensure that their GPs have developed appropriate ESG management capabilities before committing capital. As Simpson said in an interview with top1000funds, “The industry needs to be asking a new set of questions. This is pioneering work, we are looking at what are the new questions we need to ask.” In response to the growing LP expectations, GPs are building appropriate ESG management capabilities and keeping an open communication channel with LPs, whether through formal reporting or non-traditional channels, such as email and ad-hoc phone conversations.
*Note, this article originally appeared in Malk Partners’s newsletter: ESG in Private Equity Quarterly, published June 30th, 2015. To sign up for Malk Partners’s quarterly newsletter, visit our contact page.*