Views expressed are those of the author and are subject to change. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. Any forward-looking estimates or statements are subject to change and actual results may vary. For professional or institutional investors only.
Michael Carmen, co-head of Private Investments, and Hillary Flynn, director of ESG, Private Investments, discussed the role of ESG research in private equity investing, including in portfolio due diligence and engagement with private companies as they map their path to the public market.
Where do you see the intersection of ESG analysis and private equity investing?
Michael: In the private market, our analysis is typically focused on three things: a company’s management team; its business model, competitive positioning, and products; and its viability as a public company. ESG issues can directly affect a company’s business model and therefore its viability, so we believe it is essential to engage with management to assess ESG-related risks. We have passed on deals where transparency on these risks has not been adequate to evaluate the long-term growth potential of a company.
In addition to requiring transparency during due diligence, we think we are in a position to help guide the way a private company addresses ESG risks and opportunities. In the private market, company management teams often look to our firm as a thought partner for insight on issues that may affect a company’s future competitiveness. This often includes the most material ESG issues, even if they are not labeled as such.
In short, this is not about screening deals based on values alignment. It’s about having a more holistic due diligence process and it’s about being a partner to help guide private companies so they can be better received by the public market when the time comes.
How are you addressing the need for ESG analysis along these dimensions?
Michael: We are leveraging Wellington’s extensive ESG capabilities, including our 12-member ESG Research Team. Importantly, we are also adding resources that specifically serve our private-market investors. Case in point, Hillary recently joined our privates team in the newly created role of director of ESG, Private Investments. She joined Wellington in 2002 and has spent the majority of her career working on the firm’s ESG research, with a specialty in global consumer and health care companies. She has extensive experience assessing issues such as climate change, supply-chain management, and executive compensation.
Hillary, can you provide some perspective on how Wellington has approached ESG research and how that will carry over to private equity with your guidance?
Hillary: Our portfolio management and ESG Research teams view ESG analysis and integration as potentially return enhancing and risk mitigating. Each of our portfolio management teams develops its own investment approach, integrating ESG considerations into research and decision-making processes to the extent that they believe these issues may affect the long-term success of a company and investment returns.
Wellington’s ESG Research Team resides within the broad investment research resources of the firm and brings in-depth ESG expertise to the investment dialogue. The team produces ESG company research and ratings, conducts ESG portfolio reviews with investment teams, and engages with companies on ESG issues for the benefit of our clients. To give some sense of the scale of this work, in 2019, the ESG Research Team engaged with the management teams of 407 portfolio companies from 29 countries around the world — on topics ranging from carbon emissions to cybersecurity to executive compensation.
Over the past decade, ESG has become an increasingly important part of the investment process across our industry and in all asset classes, and I believe private equity is no exception. My goal as a member of our Private Investments Team is to help ensure that it happens in a formal, systematic way.
Can you give some examples of how you will apply the firm’s ESG capabilities within private markets?
Hillary: Sure, there are a variety of ways we think ESG can be incorporated into private-market investment and ongoing oversight processes. For example, Michael mentioned the importance of management teams in the private market. During the due diligence process, we may meet with the company’s key stakeholders, including employees and customers, to get a better sense of how the management team operates and whether the company is being thoughtful about things like talent retention, which can be integral to a private company’s future success, and corporate governance, which can impact the success of a private company’s exit strategy. For portfolio companies considering an IPO, we may encourage management to implement governance practices that public-market investors expect, such as issuing a single share class and improving board composition and independence.
We can also use our ESG lens to help identify risks specific to certain industries. Financial technology companies, for example, manage large volumes of confidential personal information, and a data breach can damage a company’s financials and its reputation. We can focus our research on the adequacy of data privacy and security programs. Or take consumer companies, where key ESG risks often lie within the supply chain, particularly when products are being sold directly to consumers. The quality and responsible sourcing of raw materials, labor management practices in factories, and the safety of the end product are all important to a company’s reputation and customer loyalty. Since customer retention is central to the long-term potential of a company’s products, balancing cost with quality may be part of an investment team’s ongoing dialogue with company management.
Learn more about Wellington Management’s approach to ESG engagement.