ESG and emerging managers

Despite a lack of infrastructure, emerging managers are stepping up on ESG and diversity.

Two-thirds of emerging managers have a formal ESG policy in place, according to the sixth annual Buyouts Emerging Manager Survey, conducted in partnership with Gen II Fund Services LLC. Furthermore, more than half of GPs and LPs believe ESG positively correlates with performance. 

Meanwhile, the majority of investors believe that, despite their relative youth, emerging managers compare favorably with their more established peers when it comes to ESG reporting. Indeed, Paul Newsome, private equity partner and head of portfolio management at Unigestion, says he increasingly finds emerging managers to be superior in their approach to ESG, because they understand from the outset that it is a key component of value creation as well as a requirement for LPs. “Emerging managers can also sometimes be nimbler in implementing the right processes when compared to more established players,” he adds.

Carolina Espinal, managing director at HarbourVest, agrees: “We have been pleased to see that a number of emerging managers are coming to market fully prepared when it comes to ESG and [diversity, equity and inclusion]. They are doing so because they know it is an increasingly important consideration for investors.” 

A lack of resources can prove an obstacle, however. “ESG and DE&I requirements are all adding to the cost of starting a new firm today,” says Joe Benavides, managing partner and co-founder of emerging manager OceanSound Partners.

But this is something that investors are realistic about, says Christine Winslow, managing director at Grafine Partners. “ESG is an important area generally, but it is difficult for emerging managers to have as strong a program out of the gate as an established manager who has been able to invest in people and process over an extended period of time. It is nonetheless important for emerging managers to incorporate ESG into their strategy and lay out a plan for where they want to go with it.”

“We are cognisant of where a manager is on their journey and the scale of their fundraising,” Espinal adds. “They may not have all the infrastructure and systems in place to track and report on ESG from day one. But we are looking for the same focus and attention on these themes in an emerging manager as we are with an incumbent relationship.”

Newsome, meanwhile, sees an immature ESG program as an area where Unigestion can add value. “Even if emerging managers are not all that advanced, they tend to be willing to learn and take on board best practices, which is something we like a lot.”

Diversity progress

Just under half of emerging managers surveyed have formal policies in place around diversity and inclusion. But this is clearly an area that is growing in emphasis. “Unsurprisingly, since the pandemic and events surrounding George Floyd, DE&I has become a more tangible issue,” says Benavides.

In particular, Benavides says, this has led to an increase in opportunities for emerging managers from disadvantaged backgrounds. “Capital is being specifically allocated to this theme, which is a new phenomenon. Ultimately, of course, investors are looking for returns, and there is plenty of data to suggest that emerging managers from non-traditional backgrounds outperform. There is a compelling argument to suggest that this isn’t just the right thing for investors to do, socially, it is also a means of generating great performance.”

However, despite a demonstrable focus on ESG and DE&I issues, it is still relatively rare for investors to decline an opportunity based on failings in either of these areas. The survey found that just 16 percent of LPs have rejected an investment for ESG reasons, while 18 percent have done so based on a perceived lack of diversity.