Many investors are laser-focused on ESG, but when a company in their alternative investment portfolios presents a conflict with those principles, there are few good options.
"Investors typically have three options: fix, sell or suffer through the problem," said David Fann, New York-based president and CEO of private equity consulting firm TorreyCove Capital Partners LLC. "Almost always, these are no-win situations.''
In many cases, investors do not have power over, or sufficient information about, portfolio companies to take a direct role in fixing problems. That leaves them with trying to persuade the general partner to make changes to comply with their ESG policies, Mr. Fann and other industry insiders said.
If they sell their limited partnership interests in a fund with a troubled company, they might have to take a loss. Selling limited partnership interests also is a time-consuming and arduous process, they added. And should the investor choose to stick with the general partner over the fund's 12-year or more lifespan, their reputation could take a hit.
"Most public pensions operate under intense public scrutiny," Mr. Fann said. "Any association with a firm that has a bad reputation spells trouble."
Some 42% of institutional investors either do consider or may consider environmental, social and/or governance factors in investment decisions, compared with 22% in 2013, according to the results of a Callan LLC ESG survey released in October. Investors started out focusing on ESG factors in their public equity investments; now that attention has extended to private equity, real estate and infrastructure, Callan said.
However, when portfolio companies violate limited partners' ESG policies, win-win options for investors are as rare as actual unicorns. That's a big difference from public equity investments, in which investors have the option to quickly exit the investment.
This sets up a conflict for asset owners that are more than ever keenly focused on ESG factors and less tolerant of sexism, racism or other bad behavior.
"There has been a sea change over the past five years," Mr. Fann said. The #MeToo movement has changed workplace rules, he added.
In the extreme, ESG issue poses an existential threat to the general partner and creates jeopardy to the accused, he said.
"We've seen situations where partners (at the GP level) were pushed out after an investigation substantiated allegations," Mr. Fann said.