As we know, human beings are “natural storytellers”. We didn’t learn this in school or college – it is innate and takes us back to the times when our early ancestors communicated around campfires at night, telling stories of their discoveries during the day (whether these stories were true or not!).
In recent years ESG (Environmental, Social, and Governance) considerations have gained increased attention among private equity firms. In 2016 over $100 billion of AUM was committed by institutional investors specifically for ESG-screened deals. This represents a 10 percent increase from 2015 and nearly 20x more than levels seen five years ago (in 2011). The numbers support that ESG integration has moved from being a niche strategy into mainstream private equity.
While this increased interest is encouraging, some firms may find it difficult to integrate ESG into their strategies as there is often a gap between “strategic intentions” and “real-life implementation”. In fact, most private equity peers report that they incorporate ESG factors into the investment decision-making process at a low level of maturity compared with banking or real estate peers.
A recent study reveals that less than one-third of private equity firms claim to have an explicit governance policy in place for integrating ESG considerations into the fund management process. Furthermore, only 16 percent of firms indicated that they assess potential investments on more than 10 environmental metrics and less than half (47 percent) have environmental sustainability reporting requirements embedded into their fund agreements.
These results underline that there is still a great potential for improvement in integrating ESG considerations into the private equity business model (in order to make it an integral part of how each investment decision is made).
This paper will discuss strategies on how to weave storytelling into your ESG strategy – because investors are listening, and they have a human narrative expectation as criteria for making allocation decisions. So if you can’t tell them “your impact story” in a truly compelling way, why should they invest with you?
Over the last few years, it has become increasingly clear that investors are highly interested in integrating ESG factors into their portfolio companies. Recent research by Mercer indicates that this is an important consideration for a significant part of institutional investors – namely 27 percent of North American and 28 percent European pension funds surveyed declared to be very or fairly likely to invest in companies that demonstrate a strong focus on environmental sustainability over time (in order to reduce their investment risk). However, many fund managers struggle with how to integrate these considerations into their private equity strategies.
In recent years there seems to have been somewhat of a shift from purely focusing on financial performance metrics (e.g. IRRs) towards more holistic measures reflecting societal impact (such as ESG). This trend towards making investments with business as well as societal impact is even more prominent among younger investors, who increasingly prefer to invest in companies with a purpose.
In today’s fast-moving world where the latest technological developments are constantly changing and innovation happens at lightning speed, it can be difficult for private equity firms to stay on top of all new trends that might affect their portfolio companies (or future investment opportunities). A strong narrative can help make your firm “talkable” – especially when you have great stories to tell.
The media loves this stuff, and so do our peers. In fact, good storytelling has become a key component of any competitive strategy in the private equity industry. Great stories may get us more money, better investors, and even physical space! If you aren’t sure what is meant by “storytelling” – it is generally described as the process of presenting a narrative in order to share a message.
But why should we care about storytelling? It is clear that connecting with potential investors creates many opportunities: it gives us the chance to forge new relationships and gain access to new markets/capital.
Furthermore, having a great story behind your private equity firm can create trust between yourself and your investors (which will translate into stronger partnerships, better fund performance and returns, and more referrals for future business). And finally, as storytelling is often known to be effective in getting people emotionally invested into your brand or mission, it can help differentiate yourself from the competition.
It is important to properly communicate your ESG strategy to your investors because they are looking for specific information that demonstrates how you manage your ESG risks and opportunities. By using a storytelling approach, you can effectively communicate complex ideas in an easy-to-digest manner (which is likely to be more engaging than a purely analytical or quantitative approach).
The key message that investors want from a good story: show me the evidence that your investment strategy is guided by sound principles of sustainable wealth creation. So if we can prove that investing with us will not only improve our performance but also help society/environment at the same time then our potential investors will be more attracted and will invest with us!
Getting active in storytelling ultimately helps us unlock access to new investor segments and sources of capital. Doing so also creates better brand awareness amongst institutional investors like pension funds, foundations, and endowments, etc.
The complex global challenges driving institutional investors to demand increased transparency and accountability from portfolio companies are more important than ever (think climate change, racial injustice, and economic inequality).
ESG issues have now reached the top of many institutional investment agendas. As an asset class that has traditionally had a – perhaps deserved – reputation as being focused on returns alone, private equity funds that fail to adequately address ESG threats will find themselves at a competitive disadvantage in today's market where capital is plentiful and performance pressure is fierce.
For those who desire to engage with the global community of stakeholders invested in their businesses, or wish to build up trust within their network of advisors and industry peers without sacrificing opportunities for value creation, instilling greater transparency through an integrated approach to ESG reporting may be the answer.
At its simplest, impact reporting is a way for private equity firms to communicate their social and environmental performance over time. For owners of companies being acquired by or invested in by private equity funds, it can also provide an opportunity to demonstrate that they are good corporate citizens, partners, or stewards of resources – all key considerations within today's investment environment.
Developing an effective communication strategy is not always straightforward. The process can require a significant effort on the part of fund teams who work hard to create value with limited public exposure, but the rewards go beyond simply adding another layer to a firm's existing investor reporting efforts.
A cohesive approach to ESG and impact reporting gives managers ways to build and maintain relationships with a broad range of stakeholders, including investors. It can also improve operations within target companies by simultaneously providing a measurable framework for funds and their portfolio companies to demonstrate that they are responsible actors in their local communities and along supply chains.
ESG/impact reporting is not limited to showcase events or social responsibility initiatives. Several major PE firms have built reporting into their acquisition criteria as part of an overall ESG strategy, reinforcing the message that quality ESG disclosure is increasingly essential for differentiating funds and building value over time.
A focus on impact as it relates to ESG helps promote transparency around performance metrics, builds long-term trust with key stakeholders, and provides a mechanism for educating owners about how they can continue to add value after the investment has been made.
When done well, ESG/impact reporting becomes part of a firm's "story" and should be integrated into the process for all fund-related activities that take place after investment. Focusing on impact as an element of investor communications is also an effective way to encourage increased participation of portfolio companies in their overall ESG processes.
The more private equity firms can do this – by asking questions, probing for responses, providing resources, and offering support – the greater the likelihood that their portfolios will realize higher levels of sustainability (and performance) over time.
The road to building your ESG/impact strategy requires you to think about how best to add value from start to finish and across multiple stakeholder groups.
As you strategically plan how to engage with these key stakeholders, it is important to consider the three common goals of impact reporting: build trust, inspire action and achieve results. If fund teams can accomplish each of these steps, they will have a foundation on which to build a successful strategy and put themselves in a position to maximize opportunities for value creation within their portfolio companies over time.
To conclude, ESG/impact reporting can be an essential tool for differentiating a firm's brand, building relationships with key stakeholders, and enhancing value creation. A well-conceived ESG strategy that includes comprehensive impact reporting will not only help achieve these objectives but also establish the reputation of a fund team as one that is thoughtful, transparent, and committed to generating real results.
Level up your 2023 ESG / impact strategy with Tablecloth’s free resource for Private Equity investors. Contact us today to learn how our experts can help you drive ESG value creation across your portfolio.