In Search Of Alpha Through ESG In The Private Markets

Environmental, social and governance (ESG) issues have become an important topic across financial markets. However, much of the commentary and focus on ESG has been in the general markets. In fact, ESG is getting the same attention in private markets.

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Applying ESG to private markets

In a recent interview with ValueWalk, Michael Carrillo of fund manager Apex Group highlighted ESG issues as they apply to private markets.

One trend he’s seeing across the industry is linking alpha and positive returns to ESG-based impact investing. He added that proving these links can be difficult, partly because of the lack of a standard framework for measuring ESG and impact indicators.

Among the many frameworks currently in use in private markets are:

  • United Nations Principles for Responsible Investment (UNPRI)
  • EU Sustainable Financial Disclosure Regulations (SFDR)
  • ESG Data Integration Project
  • Sustainability Accounting Standards Board (SASB)
  • United Nations Sustainable Development Goals (UN SDGs)
  • Organization for Economic Cooperation and Development (OECD).

“Mapping private company performance against one or more of these standards can be difficult and time-consuming, but it is also necessary for private market investors seeking to mitigate ESG risks and improve ESG performance through greater returns or alpha. connect,” Carrillo explains. “Investors cannot analyze what they cannot measure.”

Measuring ESG is possible

He stressed the need to find a way to properly measure ESG skills to see one way or another whether ESG skills lead to better returns. Carrillo thinks there is a qualitative consensus that this is possible.

“ESG is related to business materiality, so we need to get to the point where we have that critical mass of data, not just qualitative,” he opined.

Apex Group provides technology-based ESG consulting services that include proactively measuring over 2,000 private companies and independently verifying all data inputs.

“For PE-backed portfolio companies, we can measure progress against ESG prowess throughout the holding period,” Michael says. “When verified ESG data is collected, starting from pre-investment research that takes place over a period of time, we can benchmark against ESG capabilities and support how ESG development helps generate alpha in the context of specific companies. provide specific or relevant data. total funds.”

He added that only a small number of venture capital and private equity funds have collected this data during their 10-year tenure, so a larger analysis will be done in the future.

Many ESG rating systems

Carrillo has observed that many firms in the industry are increasingly measuring against ESG and impact capabilities. The Apex team believes that the biggest strength of what they are putting together is versatility.

“There are many different standards designed for different purposes and thus preferred by different stakeholders,” he explains. “That’s why we’ve created a platform that’s constantly evolving to allow customers to engage with all or any of these.”

A team of more than 50 ESG experts continuously measure, monitor and analyze standards in real time, and Apex uses that work to build its platform. There is a continuum in the field of ESG and impact.

One side has pure, diligent advisors who analyze private market assets for ESG. The other end of the spectrum consists of software-as-a-service platforms that track ESG. Apex Group’s effort is in the middle of that spectrum, consisting of a technology-driven ESG advisory service with a human focus.

Greenwashing in private markets

Another hot topic in ESG right now is greenwashing. Most of the focus on greenwashing is in public markets, but it is also a major issue in private markets. He said that five years ago or so, it was more acceptable to philosophically align around ESG or influence investing without providing evidence to support those values.

Philosophical alignment is helpful, of course, but many PE and VC fund investors want or need measurable ESG or impact evidence, making greenwashing in private markets a real concern.

“Investors in private equity funds place great importance on ESG skills and will not hesitate to ask managers about the issue,” he said. “You see long detailed questionnaires being distributed by allocators, investors and advisors, with Heads of Investor Relations at PE or VC firms often flooded with an increasing number of ESG questions. Understanding greenwashing can increase capital commitments. risk the future, so we see that In many cases, PE or VC firms are hiring their first ESG leaders. Many of these people are the first in newly created roles to fully focus on ESG integration. .”

Michael points out that these ESG heads have great work to do because ESG is not something that just happens in the fundraising process. They need to consider ESG when the asset is deployed and even during the holding period of any particular asset.

How ESG is about more than marketing

Carrillo believes that ESG is materially linked to the success of a business, although he acknowledged that many are skeptical on the matter. He thinks it’s right to be skeptical because in private markets, ESG is often associated with fund marketing.

“We’re now at a point where private equity has a PR problem,” Michael adds. “A lot of people like to think of PE as not a big deal in society, but private equity and venture capital, in the long run, are very important to the global economy… I’m on my soapbox, but if the private market is for “If we are working to create sustainability of investment, we will see a movement and impact that is in some cases greater than that achieved by governments.”

He has seen a remarkable change in the way capital is deployed in private markets to create changes that are good for both business and the world.


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