To judge from various surveys, private equity funds and limited partners increasingly agree that environmental, social and governance considerations are a crucial component of their investment process and practices. To borrow from the title of a recent PricewaterhouseCoopers study, however, fund managers and investors have yet to “bridge the gap” in understanding how to achieve their responsible investment objectives. Amid a confusion of acronyms and divergent definitions, PwC found that expectations and approaches have yet to align.
In growth markets, seeing eye-to-eye on defining “impact” matters a lot less than the simple truth that responsible investing boils down to common sense. For limited partners and general partners alike, applying the policies and procedures that companies and investors in their home markets take for granted not only protects against reputational and financial risk, but also creates value. And, in the absence of codified governance, labor and environmental standards in many of these markets, private equity becomes an important driver of positive change in businesses that are as a result both profitable and sustainable. Success with a social purpose.
The company I work for, The Abraaj Group, invests only in growth markets. We have learned through more than 140 investments since 2002 that to deliver robust returns, ESG must be an integral element of the investment process, from screening and due diligence, to operational management and oversight, through to exit. Our experience has taken us from regarding ESG as a tool to reduce risk and liabilities to embracing it as an opportunity to increase business performance and strengthen valuations.
We see this across several of our partner companies. At Southey Holdings (Pty.) Ltd. — one of the largest privately owned groups in South Africa in which we invested and subsequently exited via a management buyout — we, along with the management team, insisted that “service with safety” was to be at the core of the company’s ship and oil rig repair business. Through enhanced staff training, equipment upgrades and rigorous monitoring, Southey was able to further improve its ESG record and win significant assignments from major oil companies that had shied away from local contractors because of safety concerns. Health and safety or good business practice?
At Condor Travel, Peru’s leading inbound tourism operator, the business provides market opportunities for a large number of local micro-enterprises that would not otherwise be able to reach customers and promote their services. It also now offers U.S. and European ecotourists travel packages that come with carbon credits to mitigate deforestation in the Tambopata National Reserve in the Amazon Basin. Saving the planet or smart marketing?
And at PT. ODG, a leading mechanical, electrical and fire-equipment design and installation provider to the Indonesian mining and construction sectors, the executive team has built a clear career path for all employees. The firm’s commitment to upward mobility and merit-based salary raises has resulted in an exceptionally low staff turnover rate of 3% per year since 2011. The high rate of retention of experienced staff has helped to enhance brand equity in the market and make ODG a preferred supplier to blue-chip clients. Worker protections or superior client service?
Taken from this perspective, responsible investing is not a trade-off, as in “the cost of doing business.” It is a long-term investment imperative that time and again creates healthier businesses and healthier societies.
While the anecdotal benefits of infusing ESG principles into investments are clear, limited partners understandably seek proof in data. This remains a “frontier market” for the private equity industry, where measuring the impact of responsible investing practices is a complex and far-from-uniform undertaking.
There are, as yet, no agreed-upon standards for data needs, reporting requirements or quantifiable measures of the value that ESG creates. So, in 2008 we invented our own approach and have continued to improve it over time. The Abraaj Sustainability index measures the development impact of partner companies across almost 80 indicators of financial performance; socio-economic impact; economic linkages; private-sector development; management and governance; and health, safety and environment. It shows, for example, that as of 2014, the number of female employees at our partner companies increased by 16% during our holding period. The revenue growth of our partner companies during the same period was more than 100%. Such data allow us to measure sustainability across our investments, across the world. As importantly, individual companies can improve their own index score through specific actions.
Will there be uniform benchmarks and shared approaches to responsible investing across private equity? ESG factors are crucial to business now more than at any time in the history of private enterprise — and all indications point to a move toward a common understanding of the reasons why ESG protects and enhances value. Until that time comes, let’s agree on two things. Responsible investing is not just the right thing to do; it’s the sensible business choice.
Tom Speechley is a partner at The Abraaj Group, where he serves as head of global markets and the CEO of Abraaj North America LLC.
