Driving conversations and action on sustainability

Effective engagement has long been seen as a key component of any asset manager’s fiduciary duty, representing one of the two key pillars (along with voting) of stewardship or active ownership, as defined by the UN Principles for Responsible Investment (PRI) and consequently adopted by LPs and GPs alike. And while stewardship in ‘traditional’ asset classes, such as public equity markets, can often be relatively easily monitored and effectiveness quantified, an (until recently) under-publicized topic is engagement by Limited Partners (LPs) with General Partners (GPs) in private markets.

LPs can (and do) define engagement differently, but the term is widely understood to encompass some form of two-way dialogue with GPs, with the aim of exchanging information, improving understanding and driving specific actions or outcomes. The ultimate goal of this engagement is to enhance an investment’s financial and non-financial performance, clearly benefiting all parties involved.

Although engagement is a long-standing practice and was never restricted to sustainability issues (such as net-zero targets, exposure to physical climate risks or health and safety track record), it has recently come under the spotlight as to how effective it can be in enhancing sustainability performance and delivering tangible non-financial outcomes, at the same time as improving the financial risk-adjusted returns and maximizing long-term value.

Despite private market LPs often holding a reasonable amount of influence over their underlying GPs, engagement (on sustainability topics but also more broadly) in these alternative asset classes is made more challenging by a lack of direct control and (sometimes) visibility over underlying investments (portfolio companies, real estate assets, etc.).

Additionally, the nature of underlying investments can vary greatly across private market portfolios, ranging from multi-family housing to software companies, from bridges to ferry operators. Market practices on sustainability-related engagement can also differ by LP size (for example depending on number of employees or assets under management in that LP), location and geographic focus of investments, and very often the LP’s wider environment alongside other general market conditions. Engaging with a GP on setting a net-zero target when faced with the prospect of jeopardized investment returns is a far more challenging exercise than the same exercise in a less volatile and return-steady market.

Client expectations are also evolving, with growing demands for improved sustainability practices and results; this is driven by a number of factors such as pressure for greater investment returns (and the belief of many that sustainability is linked to risk-adjusted financial returns) and fast-evolving disclosure regulations (e.g. demanding evidence of discussions with investee companies, monitoring and following up on discussed action points, etc.). These factors and pressures all add to the complexity of delivering and carrying out an effective engagement program in alternative asset classes for LPs and their GPs, but have also accelerated progress and improvement across the market too.