In a recent roundtable discussion on the private markets and ESG, we brought together experts from across the industry to explore investor trends, evolving regulatory requirements and data demands.
What we heard is that the focus on sustainability and ESG, particularly on industry agnostic topics such as climate change and diversity, has investors in the private markets increasingly looking to integrate ESG into their portfolios. Yet, managers are not always equipped to provide the granular and accurate data that investors are demanding. And on the regulatory side, standards bodies are increasingly asking more of market participants. To thrive in an ESG-focused landscape, powerful analytics and proactively integrating and reporting on ESG standard will be essential.
 

Responding to new investor demands
With elevated interest in ESG come demands for greater transparency. Are private market managers ready?

Growing concerns that traditional government bonds and other listed securities will not deliver expected long-term sustainable returns to meet liabilities are driving greater demand for investments in private markets funds. To reduce the risks that environmental, social and governance (ESG) factors pose to their portfolios, investors are taking a sharp look at their asset allocations. With that shift, comes new expectations for transparency and a richer understanding of portfolio assets.
 

ESG investors move into private assets
As Vincent Georgel-O'Reilly, EMEA head of Alternatives at State Street, points out, asset owners investing more in private markets are the main influencers behind the value of ESG data. “There is a big shift toward insurers and pension funds, and these two categories are at the forefront.” he says. 

Jan Straatman, partner at Astarte Capital Partners and a former pension fund chief investment officer, explains that asset owners are no longer just looking at the long-term promise they have made to members in financial terms. “They are also looking to what extent they are implicitly making a promise regarding sustainability because that is what their members are concerned about.”

Evelyn Lee, editor of PEI Media’s Private Equity Real Estate publication, believes the pandemic has further highlighted ESG issues such as health, education, gender and economic inequality. “Investors were already focusing on these issues, but now it’s become even more of a priority, [including] for other groups that maybe weren’t paying as much attention before the pandemic.
 

Managers must deliver deeper insights
In the past, investors sought ESG information at the GP level, but now there is growing interest in the underlying asset level as well.

Gennell Jefferson, managing director, Private Equity & Business Development at State Street Global Advisors, says asset owners are asking more questions about diversity – covering gender, ethnicity, and disabilities – at GPs and their portfolio companies.

She adds: “We [also] see more demand from asset owners to set up discrete diversity manager programs, where the outsourced investment manager or other service provider will have to go out and source diverse managers to allocate assets over the course of three to five years.

”Investors now expect asset managers to align their reporting to ESG standards, such as the UN’s Principles for Responsible Investment (UNPRI), so they can compare information from different managers and use it to make decisions.

A State Street survey¹ conducted in 2020 found that three out of four private equity, hedge fund and real estate managers believe reporting and analyzing ESG data will be crucial to their success over the next three years. However, the private markets sector, which has lagged the public markets on ESG reporting, has a lot of catching up to do since this is a relatively new area of focus for many managers and allocators.To stay on the right side of investors’ evolving demands for asset allocation to ESG-focused investments and requests for a greater understanding of those investments, private fund managers must recognize the growing materiality of ESG issues as intangible value drivers. By defining and building approaches to navigate these challenges and obtaining access to data that provides more transparency and allows them to act on insights, private fund managers will be in a stronger position to address and perhaps even stay ahead of their clients’ needs.
 

Developing solutions for ESG data reporting
Managers face numerous data and technology challenges – powerful analytics are essential.

Investors’ approach to environmental, social and governance (ESG)-themed investing has evolved to where they’re now asking detailed questions about how they can integrate and reflect responsible and sustainable investment criteria into their portfolio reporting.

To meet requirements from both investors and regulators, private fund managers will have to gather more granular and accurate data at an asset level. Gathering this data is particularly acute in the alternatives and private markets sectors where many managers do not yet systematically integrate ESG standards into their investment processes.
 

The challenge for managers
After establishing an ESG policy, managers face the complex task of staffing and implementing processes and technology to collect and manage relevant data.

One approach to data collection are the questionnaires that managers send to downstream assets in their portfolios. These must be customized to reflect the varying materiality of significant ESG factors from one business to the next, as every asset class has different data requirements. For instance, extracting information on carbon emissions can be more difficult for some unlisted assets compared to others.

Once managers collect relevant data, they must clean and manage it at scale. Integrating this into investment and risk models applies further pressure to the accuracy and standardization of underlying data points.

Gennell Jefferson, managing director, Private Equity & Business Development for State Street Global Advisors, explains that there is a “significant dispersion” of ESG adoption, implementation, data capture and reporting across private equity managers.

“Mega managers are probably more advanced in their efforts to integrate meaningful ESG measures in their platforms by virtue of their size, their tenure and the scope of their investor base because a lot of the push is coming from their investors [such as pension funds and insurers],” she says.

The level of data they can access will also depend on the underlying investment strategy and the market cap of the companies in which they invest. Certain industries may be impacted more by environmental considerations, while large-cap focused GPs tend to have more refined policies, data capture and monitoring processes, versus a middle market manager. Small and medium-sized firms may rely on external partners to help capture and interpret data and provide it to LPs directly.
 

Responding to evolving data needs
Jan Straatman, partner at Astarte Capital Partners and a former pension fund chief investment officer, is working with companies, operators and suppliers to build a framework that goes further than reporting backward-looking data.

He explains: “What’s more important is to create a situation where we can define objectives and targets going forward. That is where it becomes much more interesting. We are more focused on taking [data] and then defining objectives with the operators [to understand] where they’re heading.

”In State Street’s 2020 pulse survey 70 percent of alternative managers said they needed to increase spending on data management and analysis, and 20 percent of those noted that their expenditure would have to significantly increase to deal with rising demand.

Solutions that couple traditional financial data points with ESG data will help provide greater insight into the true value of assets and funds. This can be achieved through assessing ESG factors against a manager’s reporting standards and frameworks.

As an industry that heavily relies on manual processes, disparate systems and spreadsheets, private markets data tends to be siloed and difficult to access. To overcome this challenge, managers who are able to automate traditionally onerous and manual alternative investment workflows will be in a stronger position to reduce processing time and provide their investors with faster access to important information.