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Oregon builds out formal process for assessing fund managers’ ESG efforts

More LPs consider ESG standards as one of many factors in potential commitments, but generally it's not risen to the level of being a deciding factor when backing a manager.

Oregon’s state treasury, one of the most significant investors in all stages of private equity, has made big strides towards making sure its fund managers are getting serious about ESG.

The system is among a wave of LPs that are putting more weight behind ensuring investment managers they back are focused on building diverse organisations and understanding and perhaps mitigating the environmental impacts of their portfolio companies.

The system, with $85.53 billion in assets under management and a total of $20.61 billion invested in private equity, last year began formalising its approach to assessing managers’ efforts around environmental, social and governance improvements, according to Mike Langdon, director of private markets for the Oregon treasury.

Langdon and CIO Rex Kim gave an update on the ESG efforts at Oregon Investment Council’s meeting on 8 September.

“The goal is to develop a quantitative assessment to evaluate a manager’s application and integration of ESG and D&I factors into the management of investments and their business and to use that assessment throughout the due diligence process as managers are evaluated and approved,” Langdon said.

“Why do we focus on diligence primarily over data collecting and monitoring? Well in the private market due diligence is our core competency, it is what we do.”

Among Oregon’s fund commitments in the last year include in such venture fund managers as Mayfield, GGV Capital, Sherpa Healthcare Partners and Union Square Ventures, according to affiliate title Private Equity International‘s database.

Oregon staff pursues assessments of ESG and D&I through desktop diligence, site visits, referencing and monitoring, according to the presentation. Then, treasury staff views are formally captured and findings are included in the broader scoring across categories such as “the firm”, “the team”, “strategy” and “track record” factors.

“ESG and D&I approaches, focus areas and nomenclature vary significantly from manager to manager, making portfolio level aggregation challenging,” Langdon said.

Investing on a blind basis

Langdon noted that during any given year, Oregon’s system makes 30 manager recommendations and allocates between $5 billion and $7 billion to new investment opportunities.

“Those investment opportunities are predominantly in blind investment vehicles. We are committing capital to back the next series of investment decisions a manager makes on a blind basis, and once you are in, there are limited options to get out as it is complex and costly,” he said.

“We have a highly refined manager selection process with the final decision being a very qualitative assessment on a given manager’s capabilities, judgment and alignment on a long-term, forward-looking basis and ESG and D&I are another vector of that qualitative analysis.”

Oregon seeks to understand how each manager integrates the principals of ESG and D&I from a risk and value-creation perspective into their investment process.

“And we further seek to understand if a manager truly does value diverse perspectives, getting the right voices around the table and how that will translate to the makeup of their investment teams, board of directors and front-line management team,” said Langdon.

He noted that ESG and D&I fit “very neatly” into Oregon’s current framework, at its core, and that the investor is trying to differentiate between genuine beliefs and polished marketing.

“What we really want to know is that from a front-line perspective, how are they integrating ESG and D&I across their entire decision-making process through the lifecycle of a given investment.”

Decision factors

As far as LPs factoring in ESG and D&I into Oregon’s decision process, at “this stage it runs a wide gamut”, according to Amy Ridge, principal with the private equity group at Mercer Investment Consulting.

“The majority of LPs have some sort of ESG factor or at the very least looking at it or have an understanding of it, it is rare for one to have a blind view point,” she said. “But where it’s impacting decisions is pretty low – I would say it is a factor [one of many] but not a deciding factor. If it’s a strong manager, who has a good track record doing well, its unlikely an LP would pass on them just because they had a lower ESG score.”

However, “driving change” at the very least is a “conversation starter”, Ridge said.

“ESG is driving change at the manager level and if it is something they don’t take into consideration or take seriously, it can be the start of a conversation, with the LP having the tough talk and putting pressure into doing more reporting on ESG.”

One of the sticking points when it comes to ESG and D&I is that it is hard, if not impossible, to grandfather in new ESG standards into previously made commitments.

“It is really hard to go back – you can assess but unless you’re going to sell on the secondary market just because of an ESG deficiency, it is much more of a go-forward approach,” Ridge said. “It is more likely to be talked about during a re-up, as managers appreciate honest candour and they don’t want ESG to prohibit an investor coming into the fund, so they will work on fixing the issues as long as they are aware of them, or it’s going to cost them.”

The other hard part is that the priority of importance of ESG differs by state, organisation and manager.

“It is hard to say when or if it will ever become a deciding factor,” Ridge added. “ESG evolution is happening, as it is now a component and one of the things that should be assessed along with performance, team, strategy, etc. The ESG conversation is headed in the right direction but still has a long way to go.”