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ESG & private equity: What to look out for and how it affects investment and staffing

23 Mar 2022

CRS Group Managing Director and Compass Executives Director, Sam Leighton-Smith, takes stock of the current mutually benefitting relationship between environmental, social and governance (ESG) and the private equity community.

In this insight piece, he addresses persistent legacy issues and challenges, as well as opportunities to drive value creation for investors. He further draws parallels to current staffing initiatives being intrinsically linked to retention.

Social strategies and route to market

ESG is here to stay – that’s for certain – along with the certainty the effect it will have on organisations who are yet to consider the recommendations, or fail to fully understand the ramifications of even partial acceptance.

As a basis for this commentary, we have combined elements of numerous conversations we have in the course of our work, alongside sharing details of reports carried out by notable consultancy firms. From this I will clarify the impact of the social elements of ESG and crystallise a few clear “watch outs” and thoughts on how to plan ahead.

In the first of a series of pieces on ESG, we have chosen to focus on the social factors as well as touching on the investment and value creation factors that are embedded into an ESG strategy. As recruiters, these are the elements we have the most exposure to and therefore the expertise to share. From this, we have the ability to work with you to help define your proposition and therefore your specific route to market.

Globally, businesses are adapting by bringing ESG issues into the centre of their strategic concern. ESG and its effects are seen as a driver for value creation. Evidence shows that private equity firms are on the same journey and focussing on sustainable and/or ethical investing and the necessity of creating sustainable and inclusive people strategies as a result.[1] It’s easy to see why ethical investment strategies are gaining traction at Board level; a recent report by the Financial Services firm, Morningstar, found that most ESG funds outperform the wider market over a 10-year period. Interestingly, this coincides with a recent report by PwC that shows that ESG matters appearing on Board agendas has increased from 35% in 2019 to 56% in 2021.[2] Not only is ESG here to stay, but it will also continue to remain a more prevalent topic in the near term.

The impact on investment decisions

Under guidance from the leadership teams and investment leads we are advising beyond the investment and governance aspects of ESG and their impact to investment decisions. We are focussed on the social aspects of ESG, specifically created to increase the current levels of diversity and inclusion in the sector. However, taking statistics from a recent PwC report the figures make for greater scrutiny:

  • 46% of respondents set some form of gender or ethnic or racial diversity targets
  • 77% see diversity as a core value to the organisation
  • Yet, despite these targets – greater than 90% of the leadership teams remain concerned about diversity and inclusion.

We know that diverse teams (including diversity of thought) generate significant business benefits. The hackneyed phrase “war for talent” is frequently used, but in reality, talent retention and acquisition has only escalated in both intensity and competition. The post-pandemic workforce is even more fluid and the “great resignation” impacts are clearly apparent. Diversity is not only a factor to be considered when attracting talent of course, it’s directly linked to retention and enhanced employee motivation, showing itself in increased output and a sense of purpose. What is clear is that those who choose to fail to embrace this change in diversity alone will risk significant value loss as a direct consequence.

Meaningful partnerships, meaningful change

In the private equity (PE) sector specifically, diversity is a key factor as firms compete for a new generation of talent. We have to see that diversity is the norm and not an exception and your chosen recruitment partners have to demonstrate the authenticity of this message to ensure traction in the candidate pools they curate.

A recent PwC poll of PE firms shows half of the respondents have set diversity targets, yet 36% are focussed on gender only – and staggeringly a mere 2% have set ethnicity targets with only 9% looking at both. When you consider there is inertia to link executive pay to ESG performance, you can see why this must be front and centre to any staffing or retention strategy.

In summary, ESG is not only focussing its lens on ethical or sustainable investing, and providing a governance structure to ensure its longevity, but its ongoing focus is that the teams recruited show diversity across all protected characteristics. Reviews, charters, and pledges in this space are numerous, and in truth, many if not all have lapsed, yet the results show diverse leadership numbers are unchanged and in the FTSE they have declined. ESG will hit value creation in the PE space alone so the message is clear: narrow recruitment processes will hit hard and impair the value in both investment value creation and ethical reputation.

I’ll leave with a final quote from a recent McKinsey report which states:

“Taking proper account of investment returns require that you start from the proper baseline, when it comes to ESG, a do-nothing approach is usually an eroding line, not a straight line.”[3]

We will be delighted to hear from you and share how our process networks and expertise can move the dial in your business. It’s not impossible to affect change, last year for example our placements showed 46% of senior leadership roles were to female candidates. We have diversity at our core, in fact we undertake to place a percentage of our fee at risk if we don’t deliver a diverse longlist on our retained searches. We are committed to introducing meaningful change.

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[1] KPMG, ESG: Environmental, Social, Governance – An introductory guide for businesses July 2020

[2] PwC, Private equity’s ESG journey: From compliance to value creation – Global Private Equity Responsible Investment Survey 2021

[3] Henisz, W, Koller, T., and Nuttall, R., McKinsey & Company, Five ways that ESG creates value 14/11/2019