Across Asia, ESG and impact investing initiatives are comparatively more nascent than in the US and Europe. According to Mayer Brown’s Sustainable Private Equity in Asia report, the ESG-related PE regulatory regime in Asia is still at an early stage of development, with only 25 percent of Asian managers consulting with their LPs in order to align their sustainability priorities.
However, some Malaysian institutional investors have incorporated ESG guidelines into their deal sourcing and investment requirements, with the expectation that fund managers will see the need to make changes to their own processes as a result. One of these is Kumpulan Wang Persaraan (KWAP), a M$184.5 billion ($38.7 billion; €36.6 billion) pension with significant private markets ambitions. Over the next three years, KWAP plans to increase its private equity exposure from 4 percent of its assets to 12 percent, reports affiliate publication Private Equity International.
KWAP seeks GPs that are signatories of the UN’s Principles for Responsible Investment. Managers under the programme are required to annually report on their responsible investment activities and integrate climate risk into all their investment processes.
“We do look at ESG perspectives and ESG integration of the GP,” chief investment officer Hazman Hilmi Sallahuddin tells PEI. “One of the favourite questions [asked] by the investment committee… when we look at funds [is], ‘Are they signatories to the UN PRI?’ That will always be the question. And if they’re not, when?”
Transparency and consistency in ESG reporting is another issue Sallahuddin hopes to see improvement in, as different jurisdictions can have vastly different reporting standards. Hong Kong and Singapore have detailed requirements for PE managers on issues relating to climate change and environmental issues. However, in South Korea, China and Japan, ESG guidelines are either still developing or are only applicable to the public market.
When KWAP evaluates deals and commitments, ESG reports are key components of the decision-making process. Sallahuddin says a touch of flexibility is also needed during this time of transition, rather than strictly rejecting companies that haven’t outlined their ESG incorporation plans.
“We need to recognise there is a transition period,” he says. “If there’s intention that [the managers] want to transition then perhaps we can reconsider [the deal], but if there’s no intention and they’re really totally opposite of what we are doing then definitely better for us to avoid.”
Moving beyond ESG, KWAP is exploring the possibility of participating in impact investments more broadly. “As a pension fund, we do believe in ESG and impact investing,” says Sallahuddin. “We have invested in impact funds, we have invested in direct companies that do impact, and we intend to do more.”
Sallahuddin is clear that making impact investments does not mean compromising on financial returns: “When we talk about impact, it does not mean philanthropy – you don’t have to compromise returns… You just need to find the right impact deals, or curate the right impact deals that give you the return as a pension fund.”
KWAP’s first impact investment was through an impact fund by a “big brand’, according to the CIO. “When we look at their first three funds, they all provide more than 20 percent net IRR. I think perhaps the common perception when we talk about impact – [that] you always have to give up returns – is no longer valid.”
As a pension fund, KWAP’s fiduciary duty has always been to deliver returns. However, Sallahuddin says that rather than just focusing on financial gains, the pension fund is now strategically aiming for “sustainable and responsible” investments. ESG and impact investments seek to make fundamental improvements and create value in underlying assets, and that in turn drives long-term consistent returns. This combination is what aligns with KWAP’s goals.
“ESG and impact investments are meant to address the systemic risks over the long run,” he says. “There’s no point if you get 30 percent IRR now in the first five years, and the next five years you’re going to get zero.”
Looking ahead, Sallahuddin says the pension fund is also thinking about whether ESG and impact investing should be considered a separate asset class, and therefore be allocated to through an individual bucket.
“One thing that we are doing at KWAP lately is trying to address this question: should we create a separate asset class that does ESG and impact investing that has a lower threshold?
“No doubt there will be some opportunity where the returns are below our threshold. I suppose that’s where we need to be flexible and see whether we can participate or not.”