ESG and diversity are rarely out of the headlines these days. It feels like almost every fund manager boasts of ESG considerations being part of the firm’s DNA. But our latest LP Perspectives Survey reveals that a minority of institutional investors consider ESG and diversity as central concerns when deciding on investment opportunities.

Just 31 percent of LPs say that evidence and consideration of ESG form a major part of their due diligence process – a figure that has decreased from 39 percent last year. Half of respondents said ESG formed only a minor part of the process, while 19 percent claimed not to consider ESG at all.

“If LPs start to say ‘no’ to teams that are not diverse enough, I think we’re going to start to see a lot of change very quickly”

Anamica Broetz
DWS Private Equity

Part of the problem may be that there is no standard way to measure ESG outcomes across the industry. In the absence of a clear framework to benchmark fund managers’ performance, LPs lack an obvious starting point for integrating ESG into due diligence – beyond undertaking ‘tick box’ exercises. Speaking on a panel at the Spanish private equity and venture capital association ASCRI’s Forum in London in October, Maria Sanz Garcia, managing partner of Yielco Investments, commented that “the quantitative side of this is very thin,” and that the way forward is for funds to have measurable goals on specific ESG measures, such as energy usage.

Meanwhile, the traditional interpretation of fiduciary duty favoured by regulators in the US can deter LPs from prioritising any factor other than financial return. Vadim Avdeychik of the law firm Paul Hastings told sister publication Private Equity International in November that “there is very little specific regulation whatsoever” on ESG in the US, but guidelines for public pensions plans mandate that they focus on maximising shareholder returns rather than addressing ESG policy goals. But, says Avdeychik, “what we have seen in Europe is almost the complete opposite”, with an increasing volume of regulatory proposals that would require both investors and managers to undertake greater reporting on ESG measures.

Diversity dilemmas

Responses on diversity are similar, forming a major part of due diligence for only 23 percent of LPs. And for every LP placing diversity at the heart of due diligence, there is another not covering it at all. For 55 percent, it is a minor factor.

Nevertheless, 35 percent of LPs say they are actively encouraging fund managers to promote gender diversity and some, albeit still a minority, are prepared to walk away from GPs that do not reflect their values – 14 percent of respondents report they have refused an opportunity due to a lack of diversity at the fund manager level.

At PEI’s Women in Private Equity Forum in November, delegates largely agreed that LPs will ask questions about diversity but are generally reluctant to pull the trigger on withholding an investment based on diversity factors. Brunel Pension Partnership, for example, considers diversity when grading managers on sustainability, but Gillian de Candole, an investment principal at the pension, told the forum that while a lack of diversity can leave a manager with a lower overall score, alone it wouldn’t stop a commitment.

And Anamica Broetz, head of business development and strategy at DWS Private Equity, says LPs are not doing enough to use their influence to push investment teams to become more inclusive. “The pain point is at capital. If LPs start to say ‘no’ to teams that are not diverse enough, I think we’re going to start to see a lot of change very quickly.”