Following a busy 2017, and speaking with dozens of Private Equity sector clients along the way, Anthesis offers the following insights into ESG-related themes and anticipated trends for 2018.
2017 featured plenty of fundraising activity as many global buyout firms assembled and closed large investment funds and will be looking to deploy some of this capital in 2018. However, the availability of this “dry powder” will likely add to an already competitive market and contribute to even higher valuations of target companies and assets. According to one firm we met with, “there will be more money than targets” out there in 2018. Activity is expected to be brisk, but the competition for deals will see many firms dropping out and moving onto the next opportunity on the pipeline. Deal teams will need to be patient.
From a sector perspective, our key contacts in the Private Equity and investment sectors are indicating that Healthcare, Tech/Software and Chemical companies will be key investment targets in 2018. Further, some of the larger buyout firms have assembled significant funds dedicated to Infrastructure investments, so increased activity in highways, airports, power generation, and mid-stream oil and gas can also be anticipated.
ESG and “Big Data”
Responsible Investment and environmental, social and governance (ESG) considerations, particularly when it comes to investment decision-making and the identification of potential risks and opportunities, will continue to evolve in the Private Equity sector. Not surprisingly, due to short timeframes and the lack of a standardized approach, deal teams and ESG leads are receiving inconsistent analysis and reporting from technical advisors during the due diligence phase. Further, while there is a plethora of relevant ESG information and data available in the public domain, the tight timelines associated with due diligence and the broad scope of ESG considerations do not enable advisors to efficiently harness this information and utilize it to inform an opinion. Further, the aforementioned market competition often results in the retainment of advisors much later in the deal process --- when exclusivity has been achieved or the short list of bidders is sufficiently narrowed. This places additional pressure on advisors to find new ways to capture, filter and utilize “big data” when it comes to ESG assessments.
As a result, more proactive deal teams and ESG leads are increasingly now seeking IT-enabled solutions and tools to more effectively identify, analyze and report on ESG risks during investment due diligence. However, it’s more than just risk --- the approach and analysis must also identify opportunities for ESG performance improvement and value creation post-transaction. Based on our recent discussions with PE firms, capabilities being sought from ESG advisors are faster and more comprehensive ESG pre-screening leveraging publicly available “big data”, greater consistency of analysis and scoring/ranking of potential ESG risks, and a more structured and fit-for-purpose output report. And, according to several firms, if the above can be stored and managed in a hosted, online system, that would be an added plus .
Different ESG Solutions for Different Investors
There are numerous subscription-based ESG data providers available on the market today, such as Bloomberg ESG Data Service, Institutional Shareholder Services (ISS), MSCI ESG Research and Sustainalytics, to name a few. These are mostly geared towards institutional investors who are trading in public equities. ESG reports and ratings are provided to assess and measure company ESG performance over time, as well as comparative benchmarking. However, ratings methodology, scope and coverage have been found to vary among these providers. Further, many of the methodologies are considered proprietary and are generally not shared with customers. An Anthesis client in the Private Equity sector summed it up this way: “We looked at a few of the ESG data providers. We considered their pricing to be high and they offered limited coverage of private companies, which is what we really need.”
As a result, asset managers like Private Equity firms are seeking alternative ESG solutions to help them improve and add efficiency to their Responsible Investment processes. Plus, given the fact that direct access to private companies is critical to understanding ESG risks and opportunities associated with target investments, Private Equity firms are looking for solutions that can streamline and IT-enable their current investment due diligence processes .
ESG Priorities for 2018
Finally, as Anthesis closed out 2017 with a number of end-of-year meetings with our Private Equity clients, we asked about key ESG initiatives and objectives for 2018. Here is a snapshot of what we heard:
- More targeted engagement with portfolio companies, and the use of ESG data;
- Deepen the identification and monitoring of ESG matters across the portfolio;
- Focus on growth vs. efficiency within the portfolio, which will impact ESG priorities;
- Develop a deeper understanding of the carbon footprint of our portfolio;
- Re-vamping the due diligence process, with an emphasis on ESG risks and opportunities;
- A fresh look at supply chains at the company level, but looking beyond compliance; and
- Begin to engage and align portfolio companies with the Sustainable Development Goals (SDG).
Stay tuned for our next installment in the Responsible Investment series: an interview with Paul Davies, partner at Latham & Watkins, discussing the emergence of ESG within the due diligence space and how to introduce ESG risk factors.