About the Author(s)
David Korngold, Manager, Advisory Services
October 2, 2012
Even though credible sustainability initiatives serve as an engine of value creation, there are still critics who claim such efforts are more about public relations. Yet several prominent private equity firms—known for their rigorous focus on producing returns for investors—are emerging as sustainability leaders, particularly when it comes to integrating sustainability into investment decisions and management.
So how do leading private equity firms apply sustainability to generate and protect value, and what can other companies learn from that?
Through BSR's work with private equity firms, we have identified five practices that highlight the potential for lagging firms to catch up, for leading firms to take bolder steps, and for companies in all sectors to realize the value of sustainability.
These practices are especially important in light of questions that have been raised recently during the U.S. presidential race about the role and responsibility of private equity firms in the economy. It is timely now to identify how private equity can integrate sustainability and stakeholder considerations to enhance value, and how the industry can engage with other sectors to create a more sustainable global economy.
Think holistically about value. Leading private equity firms think beyond immediate dollar returns to consider how managing environmental, social, and governance (ESG) issues can protect and build value. Kohlberg, Kravis, and Roberts (KKR) cofounder George Roberts has noted that his firm's sustainability initiatives help the company recruit and retain talented employees. KKR also looks outward to build sustainable companies and brands. KKR's Responsible Sourcing Initiative—which BSR collaborates on—reviews and enhances sourcing practices across the firm's portfolio to help companies manage risk and strengthen supplier relationships.
Go beyond the short term. The average amount of time investment funds typically hold a stock has plummeted in recent decades, with some estimates measuring the time in seconds. Many companies chiefly measure their own progress in quarters. In contrast, private equity firms might hold investments and influence companies for several years. This helps the companies in a private equity firm's portfolio make longer-term investments in programs like supply chain responsibility or energy retrofits that might not pay off for two or three years. But there are clear financial and sustainability benefits for companies willing to commit to programs for the medium and long term: Since 2008, KKR's Green Portfolio program has saved US$365 million and has avoided 810,000 metric tons of greenhouse gas emissions, 2.2 million tons of waste, and 300 million liters of water.
Engage emerging markets. At a Private Equity International forum on sustainability last year, firms focused on emerging markets made it clear that managing ESG is simply how they must do business—even if they don't call it "sustainability." This imperative is because many companies operating in emerging markets have opportunities to protect and enhance value by improving environment, health, and safety standards; community relations; resource use; and other ESG factors. Companies can engage emerging markets to identify ESG value and find opportunities to apply best practices globally. Private equity firm Actis presented a powerful example in its sale of Indian consumer goods company Paras to Britain-based Reckitt Benckiser. An Actis spokesperson explained that if Paras had not been able to demonstrate effective ESG management, the sale might not have happened at all.
Consider sustainability at the outset and measure ongoing progress. Leading private equity firms assess opportunities to generate value from sustainability or manage the ESG risks of an investment at the earliest stage, and then build that into ongoing evaluation and management. Such firms are beginning to incorporate ESG considerations into traditional due diligence processes in order to understand how ESG risks and opportunities could impact the financial and strategic value of an investment. Once they make an acquisition, such firms assess what matters most in creating value in the newly acquired company, and then set clear targets for those areas, linking compensation to performance. For example, the Carlyle Group uses its "EcoValue Screen" to evaluate the sustainability risks and opportunities of potential investments. All companies make investments such as mergers and acquisitions, product development, or expansion, and they can safeguard these decisions and enhance outcomes by applying a rigorous due diligence process that asks the right questions about ESG risks, liabilities, and opportunities, and then follows up with targeted action.
Pay attention to where investors are going. Major institutional investors such as CalPERS and New York City's pension funds actively monitor ESG issues and advocate for better company practices. Other investors such as TIAA-CREF are participating in multistakeholder efforts to develop standards for sustainability ratings and accounting. In working closely with limited partners, private equity firms are seeing up close how major investors are demanding more ESG data, increased ESG oversight, and greater integration of sustainability considerations into decision-making. As these practices continue to enter the mainstream, those demands are likely to increase for private equity and public companies alike. By addressing sustainability, companies of all types can develop the reputation and structures to respond to investor demands and become a preferred place for capital.
For all companies, these lessons come at a time when critics are continuing to question the financial worth of sustainability efforts. Private equity leaders are demonstrating that even the most ROI-focused companies can build robust approaches that enhance and secure value. While the unique circumstances of private equity are conducive to sustainability efforts, all companies can adapt and apply the mindset and tactics that underpin that value.
For private equity firms in particular, these lessons underscore that the time is right to be bold. Especially given the recent questions about the role of private equity in the economy, sustainability leadership is an opportunity for the industry to align business and stakeholder interests to enhance returns, produce greater societal value, and strengthen relationships with stakeholders.
Such leadership can be accomplished through deeper integration of ESG issues and stakeholder views into diligence and management teams—ensuring that ESG is not simply an afterthought, but a fundamental part of how private equity firms operate. This is especially important for the many firms that are catching up with industry leaders. Additionally, private equity can do more to engage with other sectors at the firm level, not just through portfolio companies. In doing so, they can apply their mindset to learn from and shape the valuation of sustainability across sectors. This will also help firms identify opportunities to better understand how sustainability affects industry dynamics. Lastly, firms should look for leadership opportunities to use their multisector, global, and value-driven approach to effect change at the systems level. In touching so many parts of the economy, private equity has the unique opportunity to build connections that create value and fast forward progress toward a more sustainable global economy.
For additional perspectives on this topic, join us at the BSR Conference sessions on "What All Businesses Can Learn from Privately Held Companies" and "Environmental, Social, and Corporate Governance (ESG) Investments in Emerging Markets."