How To Communicate ESG In Alternative Asset Management
The integration of ESG investing in alternative asset management continues to grow. But how should firms communicate about ESG to accelerate its adoption and how does this differ according to their investment strategy and asset class?
An upward trajectory
While the adoption of ESG investing in alternatives varies by strategy, client segment and asset class, it’s undoubtedly gaining significant momentum. LPs and investors increasingly view ESG as additive to investment performance and integral to the investment decision making process. In private equity, and increasingly venture capital, ESG investing now extends beyond assessing a limited number of ESG data points from investee companies and basic exclusionary approaches during due diligence. Hedge funds’ adoption of ESG is comparatively less mature, but ESG funds in the long-only market are growing as LP and investor engagement with ESG also increases. The trajectory of travel is encouraging but there are challenges that are hindering progress. Ineffective communication, along with the lack of comparable data and specific data standards, are chief among these.
What steps to take
The core principles of communicating ESG apply to all alternatives managers, despite the heterogeneity of trading instruments and market strategies in the industry. Firms must create communications that enable clients to make informed decisions about their ESG investments. This includes assessing risks, limitations and performance as well as alignment with their own ESG investing preferences. But these communications need to go beyond the sustainability disclosures that typically appear on websites, in pre-contractual information and in reports to investors.
The transition to ESG adoption and implementation is a cultural process of mindset and behavioural change. So firms should promote awareness, engagement and education, and showcase best practice and innovation, in support of ESG policies, processes and practices. This facilitates engagement, collaboration and knowledge sharing with investors, and within and between investment firms. It also enables cooperation with the industry associations, regulators, non-governmental organisations and academics that play an important role in driving collective action in support of ESG.
The first step is for firms to articulate how their values align with ESG by demonstrating their commitment to sustainability in their own operations. For example, explaining their actions to improve diversity and inclusion through recruitment target-setting or managing energy efficiency with carbon accounting plans. Firms then need to double down on providing clear and precise content about how they include ESG considerations in their investment process.
Private equity and venture capital firms should describe how they embed ESG across screening, due diligence and portfolio management and reporting. Depending on the ESG approach they adopt, firms should share information about their processes and methodologies in a detailed and granular way. For example, they should explain if they exclude specific investments from the investible universe and share the list of industries and business models in which they do not invest. Conversely, they could outline if they explicitly include certain ESG factors or adopt a selection or weighting of best-in-class or most improved companies or assets. They could also lay out their proxy voting policies and active management methods for helping companies identify and address ESG gaps. They should also detail the process for monitoring and ensuring compliance with their policies.
In the hedge fund sector, some investment processes and ownership practices overlap between long-only and hedge fund strategies, such as proxy voting. But there are also important differences, including short selling. Hedge funds have an opportunity to better explain how they use short selling to express ESG preferences, especially if and when clarification is forthcoming from EU and UK regulators about how they view the role of short selling in ESG investing.
Leading the way
Though ESG investing in alternatives remains nascent, a handful of firms are successfully adopting ESG practices and communicating about them in an engaging and credible way. For example, Abris Capital, a private equity firm, explains how it integrates ESG factors at each stage of the investment process, including a scoring application to support investment decision making and portfolio oversight. Similarly, Bay Bridge Ventures, a venture capital firm, describes how its proprietary ESG investing methodology is designed to achieve both top quartile returns and compliance with internationally accepted ESG and sustainability metrics. Man Group, the publicly-quoted hedge fund group, clearly explains how it engages with investee companies through portfolio manager dialogue and voting and breaks this down for each of its responsible investment products.
With the growth of investor demand for ESG products, and rising societal expectations for sustainability, the alternatives industry is playing an ever-greater role in mobilising and managing capital for sustainable investment. From due diligence through monitoring and value creation to exit, effective communication is crucial to encourage ESG adoption and accelerate the transition to sustainable investing.
Kamyar Naficy is Founder and Principal of KNECTCOMMS
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