LPs challenge GPs on ESG

Managers have a big role to play in ensuring the resiliency and long-term value of investors’ portfolios, and they need to get better at supplying data.

Covid-19 has accelerated the trend to a more sustainable approach to investing. Findings from Private Debt Investor’s LP Perspectives 2021 Study show a greater proportion of investors factoring in environmental, social and governance considerations as part of their due diligence process. Almost nine in 10 (88 percent) respondents say ESG forms a part of evaluating managers, versus 81 percent last year.

In March, three of the world’s biggest institutional investors – California State Teachers’ Retirement System, Japan’s Government Pension Investment Fund and Universities Superannuation Scheme Investment Management – issued a joint statement warning that focusing solely on short-term returns without considering other stakeholders would be to ignore “potentially catastrophic systemic risks”.  Speaking in October at PEI’s virtual Responsible Investment Forum: Tokyo, GPIF managing director Yoshitaka Todoroki noted that the statement has attracted “far more investors who agree on that concept”.Covid-19 has shown investors need to continue their preparation around climate change and make their portfolios resilient and operational in the long term, Diandra Soobiah, head of responsible investment at Nest, a UK defined contribution pension scheme, said at PEI’s Responsible Investment Forum: Europe in November. “What covid has shown is that if you are unprepared for something, then everyone’s going to be scrambling around and then things might be too late.”

As such, asset owners that have in recent years refocused and calibrated their asset allocation to drive environmental change expect their managers to play their part too. According to the study, 41 percent of respondents agree GPs are taking climate change risks seriously enough in their own investment practices, while just under a quarter disagree.

Speaking at the forum in November, Soobiah shared that managers are an important way for Nest to achieve its climate change policy. “We are working very closely with our fund managers in setting out targets and expectations on how we expect them to evolve over time,” Soobiah added. “We are asking them to think about how to evolve their strategies.”

Nest developed a climate change investment policy early this year, setting out its goal to become net zero by 2050 at the latest, with a view to halving carbon emissions by 2030. That goal has come into force this year with the pension’s strategic asset allocation, in which it increased its exposure to companies involved in the production of renewable energy and green technology. It has also started divesting from carbon-intensive sectors across its portfolio, including thermal coal and Arctic drilling.

The Office of New York City Comptroller, which manages $229 billion of assets across five public pension funds, may be at an earlier stage in its move to sustainable investing, but it has already been actively exploring commitments to buyout and growth fund managers whose “investment strategies are related to climate change or usually back companies within the energy transition trend”, said Cristian Norambuena, a senior investment officer at the pension system, who was also speaking at the November event.

Despite moves by both asset owners and managers to address climate change risk in recent years, some investors think private markets are still lagging public markets when it comes to climate data access and reporting to LPs.New York City pension system’s two main climate change initiatives include doubling its investment in climate change solutions from around $2 billion to $4 billion across public and private assets, and evaluating divestments in fossil fuel-related investments, Norambuena added.

“The climate initiatives I see in private markets tend to be about sharing good practice rather than systemic assessments across private equity that allow us to make relevant useful comparisons between a private portfolio with lots of GPs and underlying companies and our public portfolio,” said Stephen Barrie, a deputy director of ethics and engagement at the Church of England Pensions Board, during the November forum.

He added that the pension is having to rely heavily on its GPs to get the kind of data it needs because “the ESG plumbing that enables us to sit above detailed disclosures isn’t there”.

Barrie noted the “information asymmetry” that exists, whereby GPs tend to expect “unlimited data access to their portfolio companies and at an early stage” but LPs don’t get systemic data. “I expect that asymmetry to be addressed because as LPs we want to be able to say at the portfolio level – covering both private and listed assets – that we are, for example, net-zero aligned.”