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Environmental, social and governance (ESG) factors have become integral to the operating models of private equity and venture capital (PE-VC) investors worldwide over the last decade. Beyond profits, leading firms such as American buyout shops Blackstone and KKR, growth investor TPG, as well as Asian PE powerhouses such as Hillhouse, CICC Capital and Temasek Holdings, now measure investment returns in terms of their impact on issues such as climate change, diversity and inclusion.
Historically, developmental finance institutions such as the World Bank arm International Finance Corporation (IFC) and British International Investments (formerly known as CDC Group) have prioritised ESG factors in their investment strategies. Recently joining the fray of ESG prioritisation are mainstream LPs who have recognised that ESG is no longer a good-to-have, but a must-have instead.
Recent survey findings denoted that cancellation risks and obstacles within proposed investment deals have become contingent on the degree of incorporation of ESG factors into investment strategies. As a result, LPs are discarding afterthought attitudes towards ESG factors in favour of making them a primary component in their investment decisions, including the American public pension fund CalPERS, Malaysia’s sovereign wealth fund Khazanah Nasional Berhad, and more.
With Finance institutions and LPs now embracing ESG – PE-VC investors are increasingly positioned as key drivers of sustainable investment through ESG factors. Such investors are significantly influential over their portfolio enterprises, with assets under the industry estimated to total US$18.7 trillion by 2027. This influence covers governance, where these investors have the authority to terminate even C-Suite leaders in the event of underperformance.
This means PE-VC investors can make a genuine impact on ESG outcomes through their investments. ESG has several positive impacts on cash flow, as outlined by Mckinsey. A key impact relevant to PE-VC investors is to utilise ESG factors for “investment and asset optimisation”. For instance, PE-VC investors could influence investments into sustainable plant and equipment, an element that enhances ESG factor outcomes while ensuring stable and long-term returns.
When executing such sustainable investments, PE-VC investors can look towards adhering to internationally recognised frameworks such as the United Nation’s Principles for Responsible Investment (UNPRI). Following these guidelines, PE-VC investors can reaffirm their commitment to incorporating ESG factors into their investment decision-making and reporting – as they prioritise components such as human rights elevation, internal governance structures, and consuming green technology consumption.
Signalling the growing investor appetite for delivering sustainable impact to the people and planet, a further 140 global organisations have already been added as new UNPRI signatories, adding to the current total of 5,319 signatories that represent US$121 trillion in AUM (Assets Under Management).
Although ESG factors have gained significant ground on PE-VC investing strategies in North America and Europe, they are not nearly as prevalent in Asia – highlighting a gap that investors should consider. Observations found that compliance to ESG frameworks are not required in most investing documentation and when ESG factors are incorporated, they appear to be “superficial” at best.
However, given that a significant proportion of institutional or LP cash flowing into Asian PE-VC funds originates in North America and Europe, it is just a matter of time until Asian fund managers begin to understand the importance and benefits of incorporating ESG into their operating models.
From a macro perspective, boosting the flow of ESG-based investments may do wonders for various Asian economies, particularly emerging ones plagued by social and economic imbalances. For example, Bangalore-based 3one4 Capital, a UNPRI signatory, aligned its investment strategy with reducing poverty, gender disparities, and utilising affordable and clean energy, all of which have a positive impact on people in the region.
Other PE-VC investors that have done similar strategies include Hong Kong-based Affinity Equity Partners that had an ESG policy in place since 2012, that targeted nine target sectors of investment that include food and beverages, retail, healthcare, education and manufacturing.
Additionally, Jakarta-founded East Ventures, a recent UNPRI signatory, developed a proprietary Sustainable Investment Toolkit to assess the ESG of potential investments. The firm further champions gender equality by having 52 percent of its active portfolio consisting of women-founded or co-founded businesses.
Singapore-based Vertex Ventures had also consistently abided by ESG principles over several years – transparently creating approximately 75,000 jobs, generating US$7.7 billion in income for over 13 million micro, small and medium enterprises (SMEs), and ensuring that 30 percent of its portfolio companies are operated by at least one woman founder.
The importance of ESG factors in investments is gaining momentum throughout Asia. However, a lack of standardised reporting metrics can stymie ESG integration as objective analysis and comparison ESG performance across different organisations and industries may not be the most accurate. This is due to the fact that ESG data is frequently subjective or inconsistent, which impedes investment appraisal procedures.
Such lack of reliable ESG data to access can be especially challenging for private companies operating in emerging Asian markets to accurately assess the risks and opportunities of ESG-focused investments. Moreover, aside from unstandardised data, understanding actual ESG issues, such as the mechanics of environmental degradation, could hinder effective ESG-investment integration.
Therefore, there must be a collective effort by Asia-based PE-VC investors to enhance relevant ESG knowledge and expertise that is required to manage such investment risks. For example, investors can devote resources to conducting comprehensive ESG due diligence and ongoing monitoring. Smaller PE-VC firms, on the other hand, can conduct sound resource management practices to ensure their budgets can sustain long-term ESG-focused investments.
It is also worth noting that the long-term nature of many ESG issues may not align with traditional investment timelines. For example, sustainable investments such as next-generation income democratization plans may require a substantial time before investors can witness its full impact on income inequality. Thus, Asia-based PE-VC investors must also be cognizant of differing time horizons affecting the certainties potential long-term returns of ESG-focused investments.
While there is rising interest in ESG investment in Asia, investor preferences and expectations surrounding ESG integration might differ. Thus, PE-VC businesses may have difficulties balancing financial returns and ESG results while fulfilling investor expectations. Moreover, concerns over greenwashing may lead to stakeholders questioning the authenticity and credibility of such ESG-focused investments.
Nonetheless, despite these worries, we have already seen various Asian PE-VC investors continuing to educate themselves on ESG problems while transparently executing their investments for the betterment of surrounding societies. These actions have garnered significant stakeholder trust and overall, we look forward to witnessing what comes next in the rapidly developing world of ESG investing in Asia.