‘We are finally starting to see a greater number of managers take responsible investment seriously’

Roy Kuo, the head of the Church Commissioners for England's alternative strategies team, outlines the role of private debt in its investment strategy

The Church Commissioners’ £8.3 billion ($10.8 billion; €9.6 billion) investment fund contributes 15 percent of the annual running costs of the Church of England and has delivered a 9.4 percent total return over the past 30 years. Private credit strategies accounted for 2.9 percent of the Commissioners’ asset allocation at the end of 2017, the last time figures were made available.

As part of a religious organisation, the fund makes responsible investment a priority, and the UN-backed Principles for Responsible Investment Association gave it an A+ rating for its approach. We caught up with Roy Kuo, the head of its alternative strategies team, to get his take on how private debt managers tackle RI issues. There is, it seems, considerable room for improvement.

Q: What does responsible investment mean in practice to the Church Commissioners? In what ways does the extra responsibility that comes with representing a religious organisation make itself apparent?

A: The Church Commissioners’ approach to responsible investment is shaped by the ethical polices we have adopted on the recommendation of the Church of England Ethical Investment Advisory Group and our commitment to the UN-backed Principles for Responsible Investment.

Our ambition is to be at the forefront of RI. Our approach involves the incorporation of environmental, social and governance issues, action on climate change risks and opportunities, impact investments, ethical investment exclusions, engagement and voting.

Q: How far advanced are private debt managers in their approach to responsible investment? How can they improve?

A: Our experience is that private debt managers generally lag their equity peers in RI. This is in part because they tend to think they don’t control the company in the same way an equity holder does. It often seems to be their belief that it is the job of the equity holder, which in most private debt deals is generally a dominant controlling shareholder, to drive change in the company.

Also, the pace of new private debt investments is generally much higher and the level of due diligence much lower than is the case with private equity, so there is less time and effort spent on issues related to each. Managers have always given us opt-outs from transactions which violate our ethical policy. But getting them to take RI into account is more of a work in progress.

Nonetheless, we have found managers in emerging markets and those at the more complex end of private debt to be more engaged in RI. We believe this is owing to greater control over the management of the companies and the higher due diligence required to execute these transactions. For example, we have a private debt manager in Africa which has detailed lists of improvements that borrowers need to make. This includes things like improvements to workplace safety and controls on environmental pollution.

This is in part due to a lack of financing alternatives for the borrower. However, many borrowers also like to adopt such practices because they feel it brings their companies’ operating practices up to international standards.

We have gravitated our portfolio to such managers over time in part because it is easier to engage with them on RI. However, we also believe their business models are more differentiated and sustainable over time.

Q: Are there any lessons for private debt from other asset classes?

A: For larger transactions, the trend is towards worsening terms, fewer covenants, and less control over companies. This is similar to what is happening in publicly traded debt. Debt investors in such transactions have little say over the actions of the companies they invest in, and holding to principled stances has largely meant losing out on business.

In smaller transactions, however, debt providers have been more able to set stringent terms on what businesses can do. This is because they do not have to compete with an overheated public debt market. Within our portfolio, managers targeting smaller transactions have been more proactive in incorporating RI principles into their processes.

Still, similar to what we have seen in private equity, after years of engagement on our part and on the part of many other investors, we are finally starting to see a greater number of managers take RI seriously. Some managers are meaningfully changing their business processes to reflect this approach.

Q: What persuades you that RI is genuinely part of a manager’s DNA rather than just box ticking?

A: It is when the investment professionals talk about RI more as a natural part of their business rather than just a report to investors – for example, when they are as much at ease talking about improvements in workplace conditions as they are about financials. This shows that RI principles have been incorporated into the psyche of the firm and that they are viewed as normal business practice rather than as extra work that they have to do.

Q: How might the future of RI differ from the past and present?

A: Right now there is not a clear consensus as to what RI means for investors, so managers have trouble tailoring their approach to the needs of individual investors.

Greater adoption of RI principles will likely happen when there is more standardisation, as this will make it easier for managers to adhere to them. However, there is a risk that managers will view RI as merely a compliance issue rather than truly changing their business practices. This means the push towards standardisation needs to incorporate methods on how principles should be incorporated into day-to-day business practices.