In focus

How sustainability works in private asset investment


Some investors assume that sustainability practices are not as developed in private markets as they are in listed assets. This is partly a result of the lower levels of transparency (and so, scrutiny) in private markets. But also due to some past instances of highly questionable practices at some private companies.

However, there are many reasons that private assets are naturally aligned with sustainable investment. For a start, investment timescales are typically longer and engagement with companies is generally higher.

Some ESG characteristics are shared by all types of private assets. But some areas have unique characteristics which bring benefits to diversified portfolios, particularly in mitigating risks.

Private equity

Nils Rode, CIO Schroder Adveq:

The way investors integrate ESG into private equity is similar to how it is done for listed equity. But there are important and valuable differences.

The first layers of ESG assessment are comparable, examining key social and environmental trends and assessing companies’ preparedness to adapt to them.

While far less information is published by private companies, the thorough and lengthy due diligence that private equity investors can conduct allows for a truly deep dive into companies. You can get a comprehensive understanding of a private company’s exposures and performance through unrestricted access to their information.

Additionally, private equity can play a more active role in controlling ESG-related risks as a result of the depth of the engagement. Private equity allows a continual discourse with every portfolio company to improve areas of weakness. Private equity investors often own controlling stakes in a business and typically hold portfolio companies for many years. This enables them to ensure that a company adopts robust and continually improving ESG practices.

Private equity investors also have hundreds of thousands of privately held companies to choose from, which means they can be highly selective.

Infrastructure

Jerome Neyroud, Head of Investments, Infrastructure Debt:

Infrastructure is the backbone of most economies – comprising almost any structure that is needed to move people, energy or information. As a consequence, infrastructure investment is intrinsically linked to a functional society, and investors in the market have the potential to ensure the next steps for our cities are responsible ones.

Infrastructure investment finances tomorrow’s world, and the fact is not lost on governments seeking a sustainable future.

As an example, there is a great and ongoing push from the European Commission to reinforce green infrastructure projects. A rebalancing of the energy mix towards renewables is inevitable. Indeed, renewable assets currently account for around 50% of investments in Europe’s infrastructure pipeline in number and around 30% in value. There is a lot of money being directed at the theme of renewables energy just now.

Of course, applying ESG considerations also means comprehensively assessing the challenges associated with achieving a sustainable future. For example, the energy transition towards a zero carbon economy has to go hand-in-hand with security of supply. It may mean, for instance, investing in storage assets to tackle the issue of intermittent supply, which has long hindered the uptake of renewable energy.   

Infrastructure debt finance may also be directed to both help the energy transition and avoid “stranded assets”. For example, it can finance the conversion of fossil fuels boilers into biomass-fired boilers, to supply sustainable and renewable heat to homes.

The more sophisticated ESG frameworks that have emerged over the past few years are valuable in providing a comprehensive “checklist” of sustainability criteria. Infrastructure investing will remain all about essential assets and sustainable performance.

Real estate

Mark Callender, Head of Real Estate Research:

The built – or human-made – environment is the single biggest source of carbon emissions - around 40% of the global total according to a United Nations Report. Roughly 10% is generated by new building and the manufacture of construction materials, but the vast majority is due to people consuming energy in existing buildings for heating, cooling, lighting, etc. Real estate is therefore key to cutting carbon emissions and achieving the targets set in the 2015 Paris Agreement.

To close the gap between design and actual building performance, a lot of work is being done on carbon impact through design, construction, use and to end-of-life. This means integrating photovoltaic materials, LED lighting and solar control glass to moderate internal temperatures, as well as motion sensors and a host of other smart building technology.

There is also growing emphasis on recycling old building materials to cut the “embodied” carbon in new buildings. City planners are encouraging developers to build denser, mixed use schemes and reduce urban sprawl. Yet, while these initiatives are important, the slow pace of development in Europe means that the biggest challenge is to improve the energy efficiency of existing buildings. This is leading to upgrades to heating and ventilating equipment, as well as adding more insulation, and charging points for electric vehicles, etc. 

One of the advantages of private real estate is that investors have control over their assets. Here at Schroders we are on course to cut energy consumption and greenhouse gas emissions in our UK real estate portfolio by 18% and 32% respectively by 2020/21 compared with five years ago. We have committed to using renewable electricity in all our buildings. We are a signatory to the Better Buildings Partnership Member Climate Change Commitment to achieve zero net carbon emissions by 2050.

Finally, we are assessing how our buildings need to adapt to cope with the challenges of climate change, which in western Europe include higher temperatures, water shortages, and more storms and flooding.

Sustainable investment is not only about climate change and saving energy though. Real estate investors also seek a positive impact on the health and well being of the people who use or live nearby.  This may mean maximising natural light and ventilation in buildings, or encouraging people to cycle to work by providing supporting amenities.

Insurance-linked securities (ILS)

Beat Holliger, Senior Product and Solutions Executive ILS:

Insurance is essentially about the transfer of risks. When you take out an insurance policy you are transferring the risk of something happening to the insurer, and paying a premium to do so. As such, according to the Geneva Association, insurance benefits society by offering a sense of security, encouraging loss mitigation and increasing prosperity.

Insurance Linked Securities (ILS) are a sub-segment of the insurance risk transfer market and are primarily linked to the (re-) insurance of natural catastrophe, mortality and pandemic risk. These are extreme events that can cause severe disruption to individuals’ lives and the communities they live in.

A fundamental concept of insurance is to provide financial security and protection against unforeseen events by spreading the cost of events affecting a few across a broader group.

The larger the pool of risk sharers (policyholders), the lower the cost of risk transfer. Reinsurance and ILS help to broaden the pool of potential risk sharers to make the transfer of risk more efficient, and can therefore make insurance more affordable. ILS can help reduce the cost of purchasing protection for individuals.

In addition, the performance of ILS is positively correlated with the experience of the policyholders. In other words, when nothing happens, the policyholder remains unaffected and ILS investors make a return. When disaster strikes, the proceeds generated by the payments under ILS help families and communities rebuild their lives.

Before investing, we examine social and environmental trends we believe will emerge over our investment horizon and consider their potential impact on returns. For example, we adjust the risk modelling tools that we use to reflect our own views on the frequency and severity of extreme weather events and climate change.

In non-weather related ILS, we seek to avoid investing in risks that may contain ethical or social concerns. For example, there are some ILS instruments whose returns depend on the payout of lottery jackpots. We avoid those instruments, which could be a concern for investors with an aversion to gambling.

Regarding the ‘G’ of ESG – governance - this might mean due diligence on the sponsor of an ILS transaction, the structure of the transaction or understanding the beneficiaries.

The importance of insurance and ILS will continue to rise in step with the growth of population and (consequently) the assets - buildings and structures - that are insured, as well as demographic trends and environmental changes. ILS as part of insurance, demonstrates socio-economic benefit, positive impact and overall sustainability and resilience.

Impact investing and microfinance

Philipp Müller, CEO, BlueOrchard:

ESG analysis and impact investing are in essence, two sides to the same coin. ESG allows us to understand how a company positively or negatively affects the world, and whether it is on a trajectory of improving areas of weakness. Impact investment seeks to proactively drive positive change, prioritising societal and environmental improvement.

Impact investing takes in a wide array of investment themes. It spans areas as diverse as renewable energy to affordable housing, education, quality jobs and “client smart agriculture” (CSA), an approach to sustainably managing landscapes.

Private equity, infrastructure and real estate can all play important roles in impact investing.

Microfinance is an especially direct line to making a difference, championing financial inclusion and sustainable wealth creation in frontier economies. It presents the longest track record in impact investing.

By showing that profit and social and environmental benefit can run hand in hand, the field of impact investing is revolutionising responsible investment.

As a growing asset class, impact investing taps into new and creative sources of capital, and unlocks the potential to solve today’s most difficult environmental and societal challenges. To that end, impact investing plays a key role in achievement of the UN Sustainable Development Goals (UN SDGs). These are the interconnected set of 17 goals that call for public and private participants to take action for people and the planet by ending poverty, reducing inequality, protecting the environment and ensuring collective peace and prosperity by 2030.

Impact investing aims for measurable positive impact, in either social or environmental areas. Impact investors are driven by defining their contribution in terms of measurable impact and financial return, which are regarded as equally important components. Key elements in impact investing are therefore tailored impact management and associated measurement tools and practices, which ensure that the investments create tangible, measurable and sustainable social and environmental benefits for people and the planet.

Get closer to change

Private assets have in the past often been regarded as opaque. So it is perhaps not a surprise that as sustainability rose up the investor agenda, the focus initially fell upon listed assets, where data and information is typically higher. However, the much greater proximity that private asset investors have to their portfolio holdings means positive change can be delivered with precision, and with visible, real world results.

Schroders has committed to full environmental, social and governance (ESG) investment integration across all of our managed assets by the end of 2020, which includes our private assets business. Our firm’s sustainable investment journey is well established, and continues to move forward.

From integrating ESG factors into our analysis, the next stage of our sustainable investment journey focuses on measuring the impacts of the investments we make on social and environmental challenges. Here, private assets are particularly well positioned.

The views and opinions contained herein are those of Schroders' investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.'s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.