ESG Investing Creates a Better Bottom Line for PE Firms

ESG investing is a method of investing that seeks out companies that meet defined criteria in the ESG categories—Environmental, Social, and Governance. This approach considers both financial and non-financial performance and practices. One shift that this approach introduces for firms is that non-financial criteria haven’t been considered in traditional financial analysis. But, it has been shown that if a company or investor integrates the non-financial data into analysis, it results in more secure investments. 

Given today’s realities, ignoring non-financial data and making business and investing decisions solely on the merit of financial performance—seeking profit at any cost—puts shareholders at risk of reputational, financial, and criminal damages.  

In light of the move to more responsible investing, many PE firms are looking at ESG investment strategies as a core way to future-proof their portfolio. It has only been a few years since ESG first appeared on the scene. In the years since it was introduced, we have seen firms treat ESG investments as a side project, not necessarily incorporating the practice into the fund’s standard investments. 

Yet, as the concept of ESG and our world evolves, firms need to react by incorporating ESG investment more holistically into the overall fund and investment strategies. European firms are moving quickly to make ESG a core focus. Some US firms are following suit but at a slower rate. 

The Market is Demanding Change

The value of ESG strategies for PE firms is illustrated through the increased market, consumer, and investor demands for change. It’s not enough to be “well-intentioned.” Investors and their constituents are looking for proof of change beyond stated policies and “green-washing.” Qualitative change is valued just as much, if not more than quantitative change. 

A good example of this shift to ESG consumerism is a company called Sustainable that ranks businesses across the ESG criteria. Using aggregate data, consumers can make informed decisions about the businesses they support, based on their environmental, social, and governance data.

Future-thinking firms recognize that consumers, regulators, and employees believe that investors have a responsibility to leverage their economic power to address the big problems the world faces. And, as illustrated by Sustainable and companies like it, the data is becoming more readily available to empower consumers to make more informed choices. In fact, a recent report published by Bain shows that stakeholders in several areas of the market are demanding change.

ESG investing

The data above is from a 2020 Capgemini survey of 7,500 consumers and 750 executives globally. What’s interesting is to observe the disconnect between buyers’ preferences and organizations’ expectations of buyers. Businesses clearly have some catching up to do. The data shows the increasing importance of ESG-minded business practices and investment decisions. 

The Elements of a Strong ESG Investing Strategy

Given the survey results, it’s in a firm’s best interest to start to develop a thoughtful ESG strategy. An effective strategy must be multi-faceted. It needs to consider policies, practices, and reporting. Firms often account for policies and reporting, but don’t address practices. All three pieces are core elements of a successful ESG strategy. 

To put an ESG strategy into practice the policies have to be fully integrated. Getting the full value from ESG requires embedding its values throughout the entire PE value chain—all the way from deal sourcing, due diligence, performance improvement, to the exit. If your firm takes the perspective that ESG is a core competency of your firm, it will become an inherent element of value creation. 

A firm’s strategy must also have a focus to be successful. Selecting a few areas that your firm cares about and doubling down on those areas will make a bigger impact than a scatter-shot approach. Identify the areas of ESG that your firm cares about and commit and execute on those. 

The Competitive Benefits of ESG Investing

Firms are moving to an ESG-focused approach and it isn’t just out of the goodness of their hearts. There are tangible financial and business benefits. Both companies and investors are developing frameworks, standards, tools, operating procedures, and data collection to enable ESG strategies to differentiate their businesses. 

In the same article mentioned above, Bain featured a great example of the impact of ESG incorporation into the value-creation cycle. 

In 2016, EQT bought AutoStore, a Norwegian maker of warehousing robots that is headquartered on a remote fjord, a six-hour drive from Oslo. The warehouse industry had limited focus on environmental or workplace issues at the time. But the firm and management saw an opportunity to change the conversation with AutoStore’s flagship robot, which automates retail warehouses by wandering through a compact shelving system, picking and packing.

EQT anticipated two ways it could create value at AutoStore. First, the firm would encourage the company to address its own footprint with a series of cost-saving initiatives aimed at decreasing consumption and reducing carbon emissions. Second, it would focus the company’s marketing on sustainability and workplace quality. AutoStore’s robot already used less energy and was significantly quieter than any other product on the market. But the management team and salesforce weren’t hitting those value arguments in their sales pitch.

EQT’s perspective came from the top of the firm―one of its primary investment themes is that sustainability attributes are increasingly becoming key purchasing criteria in any industry, and the AutoStore deal team was convinced warehousing was no different. To bring the company’s leadership on board, it launched a set of value-creation initiatives linked to sustainability and put a regular reporting function on the board agenda, tying environmental concerns to governance. The company also launched a project to determine if the robot’s sustainability features were a point of differentiation among customers. The answer was yes.

Leadership directed the company’s R&D lab to make its robot even more sustainable and worker friendly. By switching from a lead-acid to lithium-ion battery and increasing the share of recyclable components, engineers significantly reduced the carbon footprint of the product while maintaining its remarkable energy efficiency. (The robot uses one-tenth the energy of a vacuum cleaner.) By running in the dark, it also reduces energy usage within the warehouse.

Armed with a much improved next-generation product, the company then retooled its communication strategy to focus on sustainability and savings alongside the robot’s impressive technical abilities. The new message resonated loudly with customers globally. During EQT’s ownership, its global installations grew by 2.5 times, the number of installed robots tripled, revenues quadrupled and EBITDA increased by 4.5 times. And the social impact was significant: During ownership, global employment doubled, including in the small village where the company has its headquarters and is an important contributor to the local economy.

As you can see in this example, incorporating an ESG perspective into your investing approach helps to incorporate ESG throughout the entire value chain and can result in great returns.

There’s still more to learn about ESG approaches. There’s more data to collect, and best practices to be defined, but it’s important that firms start thinking about their ESG strategy now. The market is changing rapidly, consumer expectations shift quickly, and companies are actively changing their policies and procedures to meet those demands. Investors need to evolve with the market to stay competitive and more fully incorporate responsible investing into their portfolios.

Want to learn more about how our clients are incorporating ESG into their funds? Listen to the Preferred Return episode, “Waiting on the World to Change”.

A traditional crm was built for general ‘customer’ scenarios

Software platforms have made the world a better place by making work a better place. Indeed the world is better off when people enjoy their jobs even marginally more, and workplace applications on big CRM platforms like Salesforce.com have done that and much more.

But the potential that platforms like these offer presents diminishing returns: once the platform provider has engineered too many industry specific components into its platform, its usefulness for other industries begins to be threatened, and with that so do the usefulness of the component tools built into the platform.

So it is with the CRM category that Salesforce.com has defined: it is generic enough to work for many industries, and yet still offers the potential for others to round off the edges and nail more vertically-oriented and extremely tailored software solutions.

Private capital markets are actually a great demonstration of this dynamic. Where generic CRM platforms simplify — appropriately so — to assume there’s a business, a customer, a sale, and service of that customer, there are a few industry-specific pieces that are missing.

Take for example, that investors become customers by investing through legal entities the GP raises. It’s a subtle but important nuance that just doesn’t make sense at a platform-as-a-service level (because it’s overly complicated for a simple one-time sale that many industries require), but which can easily be added without 10 years or software engineering. Once provided, the rest of the platform’s components become tremendously powerful again and you’re set to take over the world.

As a traditional CRM in our pillars methodology, these nuances must be present to properly account for investors in these legal entities, potential target companies and which are owned by these entities, the context of all interactions with these parties (as well as the appropriate overlap, ie co-investments), and how you’re arriving at finding these opportunities on both sides of the equation, such that you’re able to piece together what’s effective and what’s not. Not just because we say so, but because these are the very relationships and data that are key to the motivation behind a CRM in any industry.

It’s critical, too, that the valuable publicly-available information that helps to enrich CRM systems and save users painful steps of entering it themselves is fully-integrated at the platform level.

Again, look no further than the 3,000+ pre-built integrations that Salesforce.com — the creator of the CRM platform concept — has at a platform level to do so, and which only exists by way of holding just short of overly-specifying certain industry workflows that would present challenges to properly integrate.

Stakeholder reporting and communication (investor relations) draws on a range of datasets

The traditional “customer service” model of CRM systems once again makes overly-simplified assumptions about the customer relationship when applied to private capital markets.

In fifteen years I personally have yet to hear the terms “warranty” or “service call” in this market because it’s just not the same. But make no mistake, as uncomfortable as it may be to say aloud, customer service is more important now than ever and it’s constantly happening; the industry is, after all, considered to be a financial “service”.

As it turns out, that service is primarily information-based — it’s driven by data and takes the form of reports and analysis that drive decisions, and then end up again in investor-facing reports and analysis.

The foundational elements of a private capital markets CRM must be built such that they accommodate this data (like we discussed above), but so too that it can accommodate additional supporting data that investors (customers!) need in the context of service.

Oftentimes this supporting data — financial metrics and time-based values, for example — is believed not to meet the traditional definition of CRM and the natural thought is “well, better do this in Excel!”.

While I happen to believe Excel is still the greatest software application ever built, its introduction to this value chain we’ve discussed herein actually creates the problem many firms suffer from: key data needed to provide customer service (again: effectively the entirety of a firm’s reports and analysis) is now in disparate systems and detached.

Both of those dynamics are important and distinct: not only is this supplemental data disparate, but when brought together there is no logical association that can be made between the two data sets.

Allow me, then, to make the point very simply: not only can this financial and time-based value data (you may be thinking about is as “portfolio monitoring” or “accounting”) be a part of a CRM, it is arguably the most important part of a CRM because it’s at the core of what providing service to the customer entails — information that comes out of data!

Firms need a digital method to engage stakeholders (ie investor portals)

Investor portals are not new; in fact, for many of us — including myself — they conjure up horrifying nightmares in which we’re aimlessly guessing at folders to find the newest document we need.

So in lies the opportunity: not only have the portals we’ve come to hate not simplified the process of acquiring information, they’ve failed to create an entirely new experience that is “customer service” driven.

To be fair, this is not a B2C market where you’d be long out of business for not having focused on customer service and thus the customer’s technology-driven experience. But don’t expect to be around too much longer if you aren’t thinking about this shift.

Today’s institutional investors increasingly expect this same consumer-like experience, and a massive opportunity is being missed by not providing it. It’s not about providing them the experience they desire; it’s more about the ability to measure engagement that is had in return.

Put simply: what’s keeping the market from providing this experience is the availability of the information that’s required to create the service that provides the experience.

If you’ve hung in this long, you know that by focusing on your CRM, you have the data that’s required to manage the customer relationship and the technology-driven experience through which that information is shared to create a differentiated and opportunistic customer experience.

ESG investing