Investment and sustainability have, to put it mildly, a bit of history. It’s unlikely that the money makers of previous centuries spent much time thinking about the long-term environmental or social effects of the businesses that were expanding their capital, as long as there were ships crossing the ocean, oil in the machines and drills in the ground. At the same time, improving governance has always been one of the aims of private equity ownership.

Capital has now woken up to the idea that it needs a functioning planet from which to make money, that a diverse and happy talent pool might help achieve those aims, and that transparency and good governance could also lead to greater market confidence. This philosophy has been wrapped up and called environmental, social and governance, or ESG.

In April, Orbis published its annual Private Equity ESG Transparency Index. The sustainability consultancy measures PE firms’ own reporting of performance at a time when, according to Orbis’s MD Rupert Clark-Lowes, “the private equity sector might be seen as a late adopter of ESG when compared with its listed counterparts, but its drive towards a socially conscious world has never been stronger”.

Leading the way overall and in the mid-market category (firms targeting business with an enterprise value of £25m-£750m at the point of investment) in the Orbis index is 3i. For Silvia Santoro, 3i’s group investor relations and sustainability strategy director, her firm’s approach to ESG has been a journey in which “we started embedding certain assessments in our processes long ago and have achieved incremental progress over time”.

The Orbis index measures the publicly available ESG disclosures of 161 PE houses, and covers both the portfolio and in-house approaches of each firm. Santoro acknowledges that, in gaining top spot, 3i “has been a public company for a long time, and our externally available reporting is probably more comprehensive than that of other privately-owned PE houses”.

Another differentiator is that 3i has a relatively small portfolio. “That allows us to engage actively with our portfolio companies on ESG matters,” says Santoro. “Also, because we invest our permanent capital and are long-term investors, we can focus on building companies that have long-term resilience. We invest in very few sectors and a limited number of geographies and, overall, they’re not particularly ‘dirty’ sectors or at-risk geographies.”

Simon Borrows, 3i’s chief executive, describes assessments of the sustainability profile of 3i’s investments as being both a risk-management tool and “a framework to assess the many opportunities that arise from the development of solutions to sustainability challenges within our portfolio and more broadly”.

Strong challengers

It’s a similar story for NorthEdge, which ranked third in the mid-market list, although as NorthEdge’s Lucie Mills points out, 3i and Hg – the two firms ranked higher than NorthEdge – have multi-billion-dollar sums available to invest. “We’re delighted with our placing relative to size,” she says.

Mills is value creation and ESG partner at NorthEdge, and linking those two concepts is not arbitrary. “The reason that ESG sits with me is because as a house we firmly believe that good ESG drives better businesses and that attracts more value,” she says. “So, we felt it was appropriate that it’s in the value creation team rather than anywhere else in the business.”

She is keen to show that ESG is not just for the larger cap space. “In the past few years, we’ve transitioned from being able to report fairly successfully and have policies around governance and assessing ESG as part of our investment approach, to really practically helping our portfolio companies in making progress on all things ESG.”

Business sense

And all things ESG are often common business sense. “We’re trying to build better businesses – businesses that take responsibility to drive more positive impact, whether from an environmental perspective, a social perspective or a governance perspective,” says Mills. “We spend a lot of time with our companies on the ‘S’ and the ‘G’ – we are backing predominantly people-based businesses and therefore climate is less material in our portfolio than some of the other issues that ESG encompasses.

“ESG, when you focus on what is material to your business, customer and sector, is a value driver. Fundamentally, if you are a people-based business, you need to attract talent to support your growth, and you need to retain your key employees to support your efficiency and your quality. Everything around the ‘S’ becomes super important because you get more ideas and better insights, and represent your customer base more from a wider, deeper talent pool. When you think of ESG in that context, it becomes very difficult to argue against it as a principle.”

And yet, some do. In the US, there are signs that perceptions of ESG in private equity are beginning to mirror a wider political divide. Just as firms have added ESG angles to their thesis to maximise portfolio profit while also attracting politically sympathetic investment, some asset managers have pitched for the ‘red state’ money that has been withdrawn from the likes of Blackrock and are investing in consciously non-ESG areas. Of course, if there is life left in such assets, and less competition for them, some ESG-shunning investors may find value, but there may be some question marks over the sustainability of that strategy.

Orbis has introduced a separate category for alternative lenders. Emily Woollaston, head of investor relations at Beechbrook Capital, is proud of her firm’s high ranking on the inaugural Orbis Index and welcomes alternative lenders being judged in a different category to PE firms. 

“When you’re comparing private debt against private equity on post-investment engagement, it’s very different because they typically have majority ownership and therefore control,” she explains. “It was good to see that the analysis was done on a peer comparison, which isn’t always the case.”

Without ownership, but with important input into the SMEs it typically provides financing for, Beechbrook’s strategy has been about “influencing where we can, rather than telling companies what to do”. Its ESG strategy has involved formalising a lot of processes around the three pillars that were already in place. 

For example, Woollaston says, “We’ve just signed up to the Investing in Women Code. It’s not because we weren’t committed to female advancement before signing up to that, but it’s a way of demonstrating our support for it.”

NorthEdge’s Mills also sees ESG and its formalised reporting as a manifestation of normal business sense. “Governance is about how you’re mitigating the risks in your business. If you focus on what is material, it isn’t a distraction for the business. It can be something that helps you improve growth, improve your bottom line, improve your approach to people: whatever those metrics are that will ultimately drive performance in your business,” she says.

“We believe if you focus on the right things, ESG and value creation and shareholder and stakeholder value are aligned. ‘G’ is what private equity does. It’s what we’ve always done – put more governance into a business, professionalise it, help it scale.”

“The first time we were scored in the Orbis index, we were doing good things from a governance and policy perspective, but just weren’t publicising it,” says Mills. “Now we are much more transparent about what we’re doing in our business, including what our policies are, as well as the progress our portfolio companies are making.

“Reporting what you’re doing is important. From a commercial perspective, I think it’s helpful for investors and customers, and it gives others who haven’t started on their journey something to refer to, sharing ideas to improve the industries we work in.”