Malk Report highlights increasing influence of Institutional Investor on ESG in Private Equity

When Environmental Defense Fund (EDF) started its partnership with KKR five years ago, it would have been hard to anticipate the dramatic findings from Malk Sustainability Partners' report “ESG in Private Equity – 2013,” released Monday.

The private equity sector has rapidly shifted to understand the business imperative of Environmental, Social and Governance (ESG) management, with many different firms now making a public commitment to delivering measurable results.

What’s driving this trend?  The report suggests a few factors that we’ve also been seeing in the industry recently:

1)      A dramatic increase in the level of interest and leadership of a small but influential group of limited partners (LPs).  Fifty eight percent of the LPs surveyed said that they had increased their commitment.

2)      Since LP expectations are now cited as the largest driver for general partner (GP) action, increased LP focus likely is the primary force leading 74 percent of GPs surveyed to boost their commitment to ESG in the past 12 months.

3)      As is evidenced by the 14 different professionals quoted in the study, responsibility for ESG management is spreading to include several different job functions and operational areas, beyond the traditional domains of investor relations and general counsel.

Perhaps even more exciting is the indication from several of the participants that this interest from LPs is only growing stronger. While cost savings, revenue growth and reputation all are excellent drivers for increased ESG activity, hearing from a growing number of your clients about the importance of ESG management builds a sense of urgency that can drive even stronger results.

Overall, the report highlights a growing ecosystem within the sector that is driving firms to act now to deliver stronger environmental, social and financial results.

Carlyle's Annual Report Highlights $7 Million in ESG Savings

The Carlyle Group's annual report, released last week, highlights significant savings and environmental impact from the sustainability programs ongoing at Carlyle portfolio companies.  In addition, as Carlyle continues to branch out beyond buyouts it's showing an interest in integrating ESG into investment decisions in other asset classes, beginning with real estate.

Environmental initiatives have saved or are anticipated to save Carlyle portfolio companies $7 million while reducing greenhouse gas emissions by more than 31,000 metric tons, Carlyle said. This report marks the first year Carlyle has released measurable results and the third year of reporting on its environmental, social and governance (ESG) program.

We're excited to see these concrete results from the ESG initiatives that we’ve worked with Carlyle to develop in recent years.  By leveraging EcoValuScreen early in the due diligence phase Carlyle is able to create financial and environmental value from the beginning of their investment period.

The annual report describes more than a dozen portfolio companies' sustainability efforts including Yashili Group, Syniverse, RAC and Booz Allen Hamilton, with initiatives and status or outcome clearly listed — an important development for future accountability. We're particularly proud of the integral role that EDF's Climate Corps fellows have had in driving results.   Fellows have identified compelling energy efficiency opportunities at Carlyle's real estate portfolio and at specific portfolio companies including Booz, Dunkin Brands and Syniverse.

By integrating sustainability into the firm's annual report, Carlyle emphasizes that ESG is central to the investment direction and strategy, rather than a separate or peripheral interest area.

We’re excited to see Carlyle expand this effort and continue to demonstrate that sustainability can create value across multiple asset classes.

EDF’s private equity work highlighted in Environmental Finance

Last week, Environmental Defense Fund (EDF) was featured in Environmental Finance. The piece centers on results from our work with the private equity sector on environmental initiatives like EDF Climate Corps and our ESG Management Tool. Below are a couple interesting excerpts from the article:

Creating a competitive advantage

When it comes to managing environmental, social and governance issues, the private equity industry is moving from 'why?' to 'how?', say Tom Murray and Lee Coker

Can you hear it? The private equity (PE) drumbeat for responsible investment is growing louder. 

In five years of leading this effort, Environmental Defense Fund (EDF) has seen the conversation shift fundamentally from why PE firms should care about environmental, social and governance (ESG) factors, to how they can leverage ESG management to improve financial performance – while also driving better environmental and social outcomes.

Today, a whopping 92% of fund managers plan to increase their focus on ESG management in the next three to five years, according to research by Malk Sustainability Partners.

And our ongoing conversations with leading firms support the thesis that ESG issues are increasingly becoming top-of-mind, and not just from a theoretical perspective.

Simply put, PE firms are recognizing the importance of ESG assessment and integration throughout the investment process to decrease risk, improve returns and responsibly manage their institutional investors’ money…

Keys to getting started

Another terrific resource for getting started is EDF’s Climate Corps programme, which places specially trained MBA students in companies to develop practical, actionable energy efficiency plans. It is a powerful way to obtain measurable results for investors, companies and the environment. Since 2008, we have placed 20 Climate Corps fellows at 12 different PE-backed portfolio companies. On average, EDF Climate Corps fellows have found $1 million in savings for their hosts with a total of $1.2 billion in identified savings since the programme began four years ago.

PE sponsors have included Apollo, Carlyle, CD&R, General Atlantic, KKR, Oak Hill Capital Partners and TPG. PE firms have also hosted fellows at the firm level, including CD&R, Carlyle Group’s Real Estate Fund and KKR’s Capstone.

 

To read the full article, visit Environmental Finance

ESG Management Takes Center Stage at SuperReturn Berlin

Last week, I attended Europe’s largest private equity event of the year, where 1,400 of the world’s leading private equity sector professionals gathered to discuss the future of the industry, fundraising opportunities and the economic climate.

I spoke at two events: a panel entitled “ESG: Theory vs. Practice – Discerning quality ESG from claims of best practice” and a more informal roundtable discussion on creating value through ESG initiatives, which I was pleased to host. My primary goal was to spread adoption of EDF’s new ESG Management Tool, which defines the building blocks of a successful ESG management program at private equity firms of all sizes.

Four themes of the conference stuck out for me:

1)      ESG management can improve the reputation of the industry. 

Carlyle co-founder David Rubenstein repeatedly mentioned the eroding reputation the private equity sector has experienced over the past several years. When asked how to fix the reputation, he suggested one method is for all GPs to better understand that investors and other stakeholders are interested in more than just financial returns. “They want to hear about the environmental impact of what we do. ESG factors are very important to what we do at Carlyle,” Rubenstein said in his keynote address.

2)      ESG management plays an important role in fundraising.

In an increasingly difficult fundraising environment for GPs, having ESG as a core part of your value creation strategy can assure LPs that the firm is adequately managing risks and identifying opportunities. GPs ignore ESG at their peril, as highlighted by a comment by Dushy Sivanithy, a principal at Pantheon who is a member of their European Investment Committee. “I just met with a GP that stated when he hears ESG his eyes glaze over. We haven’t invested in him in the past and we will not in the future,” Sivanithy remarked during our "ESG: Theory vs. Practice" panel.

3)      ESG management will be increasingly important as natural gas investing spreads worldwide.

Not only is the fracking boom here to stay, but it is quickly going to spread around the globe, as will the related environmental challenges. I learned from William E. Macaulay, chairman and CEO of First Reserve Corp. that China has more shale reserves than we do here in the U.S. This further highlights the importance of EDF’s work in getting the science, policy and best practices for unconventional gas right in the U.S. not only for environmental protection but also the numerous financial risks that exist in shale extraction, as the industry goes global.

4)      ESG management is even more important with continued lower economic growth.

The current economic climate creates an increased need for better risk analysis and operational excellence. Private equity firms are still expected by their LPs to make returns in the 20 percent range, just as they did when interest rates were 5 or 6 percent. With returns across asset classes declining and PE firms still expected to perform as they did pre-crisis, two things will happen. The first is that firms will look to riskier investments and strategies, making improved ESG analysis even more critical in the due diligence process. The second is that operational performance will play a bigger role than ever before in creating value. Firms that can capture the value from ESG initiatives in their portfolio companies by improving ESG performance in areas like energy efficiency, worker productivity and supply chain transparency will outperform their competitors.

My most important take away was that the importance of ESG management is increasingly understood by all the players in the global private equity sector.  It’s not just Europeans anymore but also an increasingly diverse array of global stakeholders that includes GPs, placement agents, insurers and deal professionals that understand the value creation potential of ESG integration.

 

Pitchbook webcast sheds light on ESG trends in private equity

Private equity (PE) firms are increasingly aware of the need for environmental, social, and governance (ESG) management, a trend likely to continue, with 55 percent of firms recently surveyed by PitchBook saying they plan to increase their attention to ESG issues in the future.

The biggest challenge that PE firms cited in establishing an effective ESG program was effective metrics, followed by implementation, cost and employee participation, said PitchBook editor in chief Adley Bowden on a recent webcast, in which I was happy to participate.

The primary driver of PE interest in ESG is limited partners' growing attention to the issue, followed by environmental or social consciousness, brand or image, risk management, corporate governance, portfolio companies, government regulation, operational efficiency, cost management, employee interests and competitors, the survey found.

"Increasingly, we are being sent ESG questionnaires as part of the due diligence that LPs are doing on our fund," said Carlyle Group principal Bryan Corbett, on the webcast. "We view our program at Carlyle as providing them an answer and serving as a jumping off point for a broader conversation with our LPs about what their interests are and how we at Carlyle can do a better job of addressing them."

PE firms at the beginning stages of ESG management should start small and look for opportunities for early wins, without trying to achieve their goals all at once, Corbett said. Also, bear in mind that every firm is different in what drives adoption and what resources are needed, he said, urging firms to make use of free resources like EDF's Climate Corps fellows and ESG management tool. (I'll be speaking about the tool during a panel discussion at SuperReturn International in Berlin, Feb. 25-28.)

TPG senior advisor Beth Lowery agreed, noting that a couple of TPG's portfolio companies participated in Climate Corps. "You get a real product that can really improve energy efficiency and reduce costs; it's an excellent program," she said.

Some PE firms mistakenly believe that an ESG program will be expensive and that investors don't care about ESG issues, she said. In fact, successful ESG management should improve the bottom line, and many LPs care both about return and ESG management — you have to be careful how you word the question. Lowery stressed the importance of leadership support for ESG at both the firm and portfolio company levels.

"We found that our companies were interested in ESG to the extent that we could (1) show them value creation (and) (2) show them how it would benefit their relationships with customers and suppliers," Corbett said. "Very quickly, the companies begin to see it not so much as a bureaucratic, administrative task being pushed on them by their GP owner but rather as a business development tool that's going to help them expand their revenue base."

Both Corbett and Lowery stressed the importance of understanding your internal firm culture and building support with all stakeholders, rather than moving too quickly and losing buy-in. TPG's sustainability and leadership council has spread best practices among its portfolio companies, a framework that Carlyle and others have adopted with great results.

Overall the theme of the webinar was that a network of professionals is rapidly emerging across the private equity sector and collaborating in a way that is unusual for the industry. "We're all competitive. We're all trying to get the highest returns. We're all fighting over LPs, but on these issues, to a certain extent we're all in the same boat," Corbett said.

Impressive new results of KKR's Green Portfolio Program provide important insights for the private equity sector

Today KKR announced the fourth year of results from its Green Portfolio Program (GPP), with portfolio companies saving a whopping $644 million and avoiding more than 1.2 million metric tons of greenhouse gas emissions, 3.4 million tons of waste, and 13.2 million cubic meters of water.

We know it has taken a significant amount of hard work from portfolio companies, KKR and external partners to continue to build these impressive results since the GPP began in 2008.

However, these results were created by more than just hard work; KKR’s strategic approach to ESG management ensures that they continue to capitalize on new opportunities in a changing environment. As a partner helping to build this approach at KKR, we drew on our work together to develop Environmental Defense Fund's (EDF) new ESG Management Tool.  I’d like to highlight a few of the practices from the tool that are clearly leading to these strong results at KKR.

Emphasizing the Firm’s Commitment:  Both George Roberts and Henry Kravis have provided clear public statements that highlight the firm’s ongoing commitment to integrating ESG considerations into firm practices.

Leveraging Expertise:  In addition to the expertise of many KKR staff that help drive results, they have also built an impressive list of external partners in addition to EDF, including BSR, Transparency International, American Heart Association and CSR Europe.  These internal and external experts combine to provide the tools and resources that portfolio companies need to identify opportunities and create results.

Building a Network: In today’s announcement KKR’s Ken Mehlman states that their next step is to share best practices across their entire portfolio.  The early 2013 launch of KKR's best practices handbook, will share lessons learned at some portfolio companies with others to help them identify and implement projects that improve environmental and financial performance.  This highlights a huge advantage we’ve always seen in private equity: the ability to share tools and resources developed at one company with many others.

Reporting with rigorous metrics: You can’t change what you don’t measure.  With that in mind, the GPP has ensured that environmental metrics are sound and accurately track progress for KKR's investors and stakeholders to judge for themselves.

The GPP began modestly with just three companies and now encompasses 24 KKR portfolio companies globally.  Today’s results continue to prove to institutional investors that reducing environmental impacts does provide stronger rates of return.

The solutions KKR has developed will continue to spread throughout its portfolio companies — and indeed, to other private equity firms and asset managers.  The bottom line results are too compelling to justify inaction.

EDF Releases New ESG Management Tool for Private Equity

We're gratified by the response to our new tool for measuring environmental, social and governance performance in the private equity sector, which for the first time defines the practices needed to build a successful ESG management program and provides a framework to assess and improve ESG management at firms of all sizes.

EDF developed the free Excel-based tool in collaboration with Irbaris, a strategy consulting firm specializing in sustainability. Our goal is to make measuring and managing ESG performance a standard practice for value creation across the private equity sector.

In less than an hour, users of the tool can evaluate performance across 22 best practice areas, including commitment and leadership from the top, access to ESG resources, integration of ESG management into the investment process and portfolio company operations, and measuring and reporting results.  The broader framework assesses performance across four categories: leadership, management, investment process and reporting results.

We expect the tool to be used by:

  • General Partners to compare their current approach with best practices and to develop plans for improvement;
  • Limited Partners to assess general partners’ ESG performance and to compare practices across firms;
  • Consultants to provide analysis for their clients; and
  • Media and research teams to evaluate the industry's performance to develop reports or stories.

The tool works by giving users a detailed analysis of the firm's practices and a menu of strategic initiatives to consider. We're grateful for the thorough peer review of the tool and feedback we received from a broad range of stakeholders, including Actis, Blackstone, Bloomberg, BSR, The Carlyle Group, Doughty Hanson, Harvard Management Company, Kohlberg, Kravis & Roberts Co.(KKR), Oak Hill Capital Partners, PwC US and TPG.

The tool was also informed by our experience partnering with prominent private equity firms including KKR, Carlyle Group and Oak Hill Capital Partners.  These partnerships combined have impacted over 30 portfolio companies and resulted in approximately $370 million dollars of operating cost savings or revenue growth as well as 820,000 metric tons of avoided CO2 emissions. Going forward, EDF will work with BSR and other industry partners to broadly disseminate the tool across the industry. We welcome any additional feedback or questions about the tool specifically, or ESG management generally.

AlpInvest CEO Wants to See Private Equity take its ESG Efforts to the Next Level – We’re Developing a Tool for That

We were excited to hear AlpInvest Partners Chief Executive Volkert Doeksen's recent remarks where he urged institutional investors (LPs) in private equity to keep pushing for greater integration of environmental, social and governance (ESG) initiatives into the management of private equity firms (GPs) by focusing their efforts on implementation and results.

Incorporating ESG into a firm's overall investment strategy will lead to stronger portfolio companies and a better public image for the industry, Doeksen told delegates at Private Equity International's Responsible Investment Forum in Amsterdam, according to PEI's Amanda Janis, who described the crowd as standing room only. Now that progress has been made to raise awareness about the bottom-line value of ESG investment policies at private equity firms, leading LPs should push to take ESG to the next level, Doeksen said.

In addition to added LP focus on the topic, the tight fundraising environment has made quantifiable progress in ESG management a clear differentiator for private equity firms.  The conversation has gone from “why should we do this?” to “how do we get this done?”  This has created a growing need for tools and resources that both GPs and LPs can use to analyze and assess specific ESG practices at private equity firms.

EDF has been working to fill that need.  We’re developing an ESG Management Tool for private equity that defines for the first time the practices necessary to build a successful ESG program at firms of all sizes.

Building on our work with KKR, The Carlyle Group and Oak Hill Capital Partners, a growing body of research on ESG best practices in private equity and an extensive peer review process, we’re developing a Tool that provides the necessary framework to assess, analyze and improve ESG management. Twenty-one key indicators are included in the tool, best practices that highlight not only how to integrate ESG processes into a firm’s operations but also how to create measurable environmental, social and financial results at portfolio companies.

We will publicly release the tool in coordination with the Responsible Investor ESG in the USA conference at Bloomberg on December 11th and are looking forward to working with both institutional investors and private equity firms to leverage the Tool to make measuring and managing environmental, social and governance performance a standard practice for value creation across the private equity sector.

Oak Hill Partnership Shows That Environmental Opportunities Abound for Middle-Market Private Equity Firms

Large private equity firms like The Carlyle Group (Carlyle) and KKR have clearly proven the environmental, financial and reputational benefits of undertaking environmental initiatives within their portfolios. Since we started our private equity work in 2008, however, smaller firms have repeatedly questioned whether it is really possible to replicate a similar approach at the majority of private equity firms that manage less capital and invest in smaller companies.

Now, we have the answer: a resounding yes.

Environmental Defense Fund (EDF) and Oak Hill Capital Partners (Oak Hill Capital) worked together to create a methodology that mapped Oak Hill Capital’s portfolio of 20 companies according to environmental impacts, financial opportunities and management readiness. Our goal is to create a model that other private equity firms can use to jumpstart their environmental initiatives by first focusing on the portfolio companies with the largest opportunities.  The initial success can then be utilized to build further buy-in and engagement throughout the firm and at additional portfolio companies.

The recently concluded pilot program at Oak Hill Capital identified more than $700,000 in annual energy cost savings and an annual CO2 emissions reduction of 2,900 metric tons at just a small number of facilities of three portfolio companies. The methodology found the biggest impact was likely at Dave & Buster’s, a leading operator of high volume entertainment/dining complexes; Jacobson Companies, the Des Moines, Iowa-based transportation and logistics firm; and ViaWest, one of the largest privately held data center, cloud computing and managed service providers in North America.

Going forward, Oak Hill Capital will share results at its annual CFO conference, expand on the three programs underway and begin working with additional management teams in its portfolio. Already, Oak Hill has used its annual CEO conference, its relationships with various operating consultants and its internal ESG committee, as well as EDF’s Climate Corps program, to further these efforts.

Dow Jones and Wall Street Journal media coverage of this successful collaboration highlights the growing interest that private equity firms and their institutional investors have in seeing firms incorporate this approach.

Private Equity Firms Realize the Value of Participating in EDF Climate Corps

In recent weeks, the eight EDF Climate Corps fellows who have been embedded at private equity firms and their portfolio companies began giving their final reports to senior management about their efforts to identify strategic opportunities to increase energy efficiency and returns.

We've been impressed at the level of engagement by top leaders at The Carlyle Group (Carlyle) and Clayton Dubilier & Rice (CD&R) in the work of EDF Climate Corps fellows, as well as the receptivity of portfolio companies to boosting return on investment through energy efficiency opportunities.

Today, we want to highlight the work of three fellows, just to give a taste of the kind of projects this energetic and dynamic group is completing. Their experience demonstrates that EDF Climate Corps can be a powerful tool for jumpstarting or energizing an ESG initiative, whether at a private equity firm or one of its portfolio companies.

Developing an ESG effort at a leading private equity firm

CD&R had already been working on developing its ESG program when the firm decided to take on Sarah Stern as an EDF Climate Corps fellow, to prioritize efforts in its portfolio of 16 companies. Stern, an MBA candidate at the Tuck School, developed criteria and metrics for prioritization by looking at management receptivity, the importance of sustainability to clients, geographic location and energy use to select seven companies for further investigation.

She then identified key stakeholders, gathered energy data and identified relevant upcoming capital expenditures. Through data analysis she narrowed the field to three companies, developing a business case for individual energy efficiency investment opportunities based on the best financial and environmental return. Sarah also created a tool – “The CD&R Energy Efficiency Playbook” – to help portfolio company facility managers identify and evaluate energy efficiency projects on their own.

Creating Tools and Strategies for Real Estate Investments

At Carlyle, Cornell University MBA candidate Jennifer Le spent the summer developing an approach aimed at enabling the firm to identify and capitalize on opportunities to create positive financial and environmental outcomes for select real estate assets across its portfolio. Jennifer began by reviewing Carlyle's EcoValuScreen approach within its buyout funds and talking with numerous internal and external experts, gaining an understanding of how to translate this approach to real estate due diligence and asset management. She then developed a framework and implementation guide focused on energy efficiency strategies for Carlyle’s real estate-focused acquisition and asset management teams.

The framework includes benchmarking of property energy usage using software tools, quantifying energy opportunities to build into pro-forma financial models, and incorporating strategies into Management Business Plans and Investment Committee Memoranda. In addition, the program addresses how to both establish appropriate energy performance goals and utilize property management partners to implement, monitor and report results of initiatives.

Based on her analysis of real estate portfolio data, she identified opportunities and developed implementation plans for potential outcomes, ranking projects based on financial and environmental return. At her final presentation last month, we were assured Jennifer’s recommendations would be seriously considered by the presence and engagement of several managing directors of the real estate funds as well as a co-founder. You can read her three recommendations for Carlyle's real estate portfolio elsewhere in her blog.

Meeting Ambitious Carbon Footprint Goals

Syniverse, a Carlyle portfolio company, develops technology that allows mobile phones to text, interconnecting voice and data systems around the world. With sustainability as an important concern to Syniverse clients, the company set ambitious goals for carbon reduction last fall. Fresh from earning an MS from Columbia University, Kevin Lehman tackled the challenge of identifying specific areas for energy efficiency that would reduce consumption by 20 percent from 2010 levels by 2015. Kevin found ways to potentially exceed these goals in the Tampa-based company's 200,000 square foot data center and office space. He also worked with the marketing and media departments to refine messaging around the existing efficiency of Syniverse operations.

His recommendations included server virtualization, cold air containment strategies and upgrades to the computer room air-conditioning units that could yield a 30 percent energy savings. Additionally, a change to the building's operating schedule presented a no-cost opportunity to create significant savings on cooling and lighting.

The bottom line: EDF Climate Corps is a powerful way to get measureable results for investors, companies and the environment. Stay tuned to see the quantifiable outcomes that the entire EDF Climate Corps program created this summer.