ESG Investing: Here’s What’s Next

ESG investing is not a new phenomenon. Sometimes referred to as “sustainable investing,” ESG stands for “Environmental, Social, and Governance” and was first coined in 2005. It is used as a tool for investment decisions but is a more recent concept of interest among private equity firms.

Traditionally, PE firms have strictly been concerned about ROI and compliance with legal standards. A new focus on impact investing has been gaining traction where the end goal is to maximize both financial returns and social impact.

If a PE firm wants to differentiate itself from others, it might proactively set metrics to demonstrate its commitment to ESG. Firms have been subject to increased scrutiny by ESG-conscious investors and decision-makers in the environment that COVID-19 has created. Providing concrete evidence of ESG-focused due diligence and performance reporting could give a firm a distinct advantage over its peers. Tal Sheynfeld of Energy Impact Partners said that “We see a significant amount of correlation between high ESG scores and the success of our investments. We have resources available to the companies that we invest in, which makes it easier for them to make improvements across the ‘E’, ‘S’, and ‘G’.”

At the same time, evaluating portfolio companies based on their perceived commitment to ESG can be fraught with difficulties. One of the main problems is that there are many misconceptions around the topic because it is based on opinion and subjectivity. John Sheffield of Valley Ridge Investment Partners, LLC, mentioned that “ESG makes for great virtue signaling, but not great investing.” For example, an investment in solar power may appear to be environmentally beneficial on the surface from an emissions reduction perspective. However, this may be negated by the widespread mining required in production which depletes natural resources along with the exploitation of low-cost labor.

Ultimately, the degree to which a firm decides to use ESG is at their discretion. Michael Kornman of NCK Capital, LLC, said that “we do incorporate ESG in our deal process but don’t use it as a screening mechanism, per se. Historically, we have been more attracted to good businesses when they have positive ESG benefits.” 

There is not necessarily a right or wrong answer for how a firm can incorporate ESG into an investment thesis, but the subject is gaining momentum and presents many potential opportunities for firms looking to differentiate themselves by effectively adopting ESG strategies. 

In the last couple of years, ESG issues have begun to make more of an impact on companies that have shown dedication to these causes. Companies have an obligation to address ESG issues to the public and within their own company in matters of procedure. Due to the nature of the changes necessary to change the corporate structure to address ESG issues, the ESG movement must be spearheaded by industry leaders who are willing to function at the forefront of the movement.   

 

References from General Sources:

  1. ESG in Private Equity – Doing Well By Doing Good, Osler Hoskin and Harcourt LLP (available at: https://www.mondaq.com/canada/operational-impacts-and-strategy/961294/esg-in-private-equity-doing-well-by-doing-good).
  2. The Remarkable Rise of ESG, Contributed to Forbes.com by George Kell (available at: https://www.forbes.com/sites/georgkell/2018/07/11/the-remarkable-rise-of-esg/?sh=421e111c1695).
  3. Five Challenges for net-zero investing, BMO Global Asset Management (available at https://www.bmogam.com/ca-en/institutional/news-and-insights/five-challenges-for-net-zero-investing).

By Lou Sokolovskiy, Founder & CEO at Opus Connect
November 2021