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Meketa: LPs have ESG baked into decisions; managers must step up

Pressure is mounting on private markets managers to provide sustainable, repeatable returns, write Christy Fields, head of real estate portfolio solutions and John Haggerty, director of private market investments at Meketa Investment Group.

Sustainability is no longer viewed as distinct and apart from asset owners’ core risk/return framework. In the past, we would have to convince clients that ESG doesn’t require a return “give up”. That misperception, however, has been disabused.

Every institution we work with has a unique mission, serves distinct constituencies and has their own philosophy that guides manager selection. Yet, in most cases, sustainability considerations have been baked into core investment processes, alongside fundamental analysis and due diligence.

In 2020 – after a few years in which it felt like the momentum behind ESG and impact had stalled – we could see that this holistic approach has instilled an immutability to ESG adoption that suggests the “sustainability” string can’t be pushed back, regardless of macroeconomic developments or shifts on the geopolitical landscape.

To be sure, the concept of sustainable investing has been around for decades. Many of our clients put their own spin on it depending on their objectives. Some, particularly in the foundation space, have a more intentional mandate to impart a distinct social impact, whereas others, see it as a more rigorous approach to risk-management – the prevailing view among large public pensions.

However, the inability to pursue ESG and impact strategies at scale has heretofore limited adoption. In this regard, the emergence and outgrowth of new strategies over the past few years is providing the building blocks to construct sustainable portfolios.

For instance, under the banner of environmental sustainability, commitments can range from renewable energy funds in wind and solar to more targeted strategies focused on decarbonisation. At Meketa, we’ve created a unique private capital exposure comprised of venture capital and natural resources strategies that serves as a “catch-all” for miscellaneous sustainability strategies. The fund managers within this sleeve, which accounts for approximately 10 percent of our model portfolio, aren’t necessarily aiming for “moonshot” solutions that will alone solve climate change. Rather, they’re pursuing investments in industrial, energy, chemical and even mining companies that deliver incremental but material improvements over the status quo. and play into a secular shift in demand to reduce or eliminate carbon across global supply chains.

Even across more traditional allocations, environmental sustainability has simply become a core consideration. In agriculture, for instance, to maximise farmland value, capital is being channelled to managers and companies that embrace regenerative agriculture practices more generally, which at the same time is creating a market for agtech to optimise land ownership. The same is true in real estate, where CRE investors well know that LEED-certified buildings can generate better rental rates, higher occupancy levels and premium market values, while also enjoying lower operating costs. Again, these considerations are baked into the core investment frameworks of our clients.

While the “E” and “G” factors tend to be easier to track and categorise, socially oriented lenses can be more complicated for institutions without an articulated social mission. Still, we’re helping asset owners address social objectives through scrutinising diversity KPIs and analysing workforce turnover and labour conditions at the portfolio company level and across the larger supply chain.

As it relates to ‘building back better’, ESG and impact investing will continue to evolve, particularly as reporting standards are refined and adopted more universally, and as new strategies emerge.

It may seem like it’s evolving too slowly for some. But anyone who understands the deliberate, risk-averse approach of most institutional investors who face scrutiny and second guessing with every decision they make (as well as those they don’t) – should understand that the recent advances are quite significant.

Moreover, with a framework in place that now recognises and prioritises ESG factors, the pressure will mount on fund managers (and, ultimately, the companies they back) to produce persistent, “sustainable” returns that will be repeatable over time. This is where the alpha opportunity in ESG and impact resides.

Christy Fields is head of real estate portfolio solutions and John Haggerty is director of private market investments at Meketa Investment Group