Northleaf's Jeff Pentland recently sat down with Private Equity International to discuss the nuances of developing an ESG policy that spans multiple asset classes.
How much progress have you seen in the adoption of responsible investment principles in private markets?
Significant progress has been made, at least partly due to investor demands and increasing interest, but also because ESG considerations are a natural place for private markets managers to be focused, particularly given the long-term nature of these asset classes. As a long-term owner, it makes sense on every level to pay attention to the sustainability of the environment and the communities into which you are investing, and good governance has always been fundamental to the benefits that private markets ownership brings. There is a natural alignment between private markets investing and responsible investing principles.
Are there differences between the asset classes in terms of the progress achieved thus far?
Infrastructure feels the most advanced, which is probably natural given the nature of the investments in the asset class. These tend to often be larger, conspicuous investments with potentially greater impact on the environment (whether positive or negative). We are seeing some good progress being made in the other asset classes as well, but infrastructure is probably in the lead.
We also see differences across the various geographies in which we operate. The Europeans and Japanese tend to be at the forefront. ESG issues are prominent across these societies and that is reflected in the investor base as well. Australia is also very advanced. The US lags behind slightly, while Canada is probably somewhere in between.
Has COVID-19 impacted attitudes towards ESG issues within private markets?
It has certainly reinforced interest in these issues. For example, there is increasing recognition that human economic endeavours that encroach on the environment and destroy biodiversity create the potential for more health issues and, in particular, new viruses to emerge. Meanwhile, on the social side, COVID-19 has highlighted everyday challenges, such as the ability to take sick days. People are being forced to make a choice between their livelihood and doing the responsible thing and staying at home. Cybersecurity is yet another ESG consideration, the importance of which has been reinforced during the pandemic. These are real-world impacts that COVID-19 has brought directly into the limelight.
What role does an ESG policy play in determining the scope, governance structure and management of a responsible investment program?
An ESG policy is critical to those endeavours. Having a clear articulation of intent is important for investors interested in understanding how managers are approaching these considerations, but also, internally, for our investment teams as well. The investment teams need to be fully cognizant of the risks and opportunities associated with environmental, social and governance factors and the ESG policy really sets that tone. Such a policy needs to be a living document that can evolve with the times, as different ESG considerations develop. We crafted our first Responsible Investment policy in 2011 and there have been several iterations since then. Most recently, we looked at some of the core documents published by the Principles for Responsible Investment to ensure we are tracking against the considerations that have been identified. That has been helpful in making sure our approach is current. Among the recent changes we made was reinforcing our commitment to First Nations rights, for example.
For ESG policies, is it a case of the more detail the better?
I think there has to be a balance. It’s a policy, not a manual. Yet it is important that the document is thorough and considered. Our policy starts with general statements outlining why we believe ESG factors are important, from both a risk and opportunity perspective. We then detail the types of factors that we consider across each of the asset classes in which we invest – infrastructure, private credit and private equity. We specify how those factors will be considered at each stage of the investment cycle, from sourcing and due diligence, through to ongoing management and monitoring and, ultimately, exit. We also detail how those processes will differ for each asset class.
Why might those processes differ across business areas?
The transaction types we focus on differ in each of the asset classes. In our infrastructure program, for example, we make direct equity investments in mid-market opportunities across OECD countries. We have control, or joint control, over the entities in which we invest, so we can take a more direct approach in terms of ESG considerations. We also make some direct investments on the private equity side, and there our approach is similar. However, we also make secondaries and fund investments, where we are a step removed from the underlying portfolio companies. There, the articulation of ESG considerations is a bit different. It is important to recognize those differences within a policy.
What are the challenges associated with integrating ESG considerations in a multi-asset class firm?
Actually, I wouldn’t say that there are challenges. I would say that there are a great many benefits of being a multi-asset class private markets platform because there are synergies that can be achieved by facilitating information flows across investment teams. We can leverage developments in one asset class, in terms of ways of diligencing, managing and monitoring ESG considerations, across the other asset classes.
We use our ESG governance structure to try and capture those synergies. We have an ESG committee, made up of senior members from across each of the investment teams. Each of those members then heads up asset class-specific sub-committees. We make sure those groups come together regularly, not least when completing the annual PRI survey responses. That can prove a useful time for making sure learnings are shared across the different business units.
Do you view climate change as part of your environmental considerations, or does it warrant attention of its own?
There are different ways of looking at climate change. Some managers see climate as a double click into the ‘E’ in ESG while others treat it as more of a standalone set of considerations. At Northleaf, we are doing the latter. We view it as imperative that climate risks and opportunities – both physical and transitional – are being adequately considered both in origination and in ongoing management and monitoring.
There was an immediate need to support portfolio companies during the pandemic, but how have you addressed COVID-19 demands at the firm level?
At Northleaf, we always make a point of turning the ESG lens on ourselves as managers. That covers everything from making sure we are complying with environmental regulations in our various office locations, to having robust diversity and inclusion policies, or procedures to support new parents. In terms of governance, external audits are conducted to ensure we are complying with our own policies and our limited partnership agreements. When COVID-19 struck, we made sure we employed that same degree of introspection, as well as working to support our portfolio companies.
We set up a COVID-19 working group – our “nerve centre” – and activated our business continuity plan which has now been in place since March 2020, when we moved to remote working. We made it clear there would be no staff reductions as a result of COVID-19. In fact, we have continued to hire and onboard remotely throughout the pandemic. We provided work-from-home support ranging from equipment allowances to an online health, well-being and productivity resource centre. We also brought forward a percentage of year-end bonuses to alleviate financial concerns, and we provided additional paid time off.
Finally, to ensure that as a firm we all felt we were contributing to the broader pandemic containment and relief efforts, we donated to the World Health Organization and made a series of donations to charitable organizations in each of the communities where we have an office. In lieu of the gifts that we traditionally give to our investors during the holiday season, we made additional donations to these grassroots charities. We did that because it is the right thing to do. It also sends a clear message to our client base and our employees while demonstrating our commitment to connecting with a wider purpose.
What does the future hold for responsible investing in private markets? Will we reach a point where being a responsible investor is the norm rather than a differentiator?
I believe we are on the path to achieving that. As I said earlier, it makes complete sense for private markets managers to take ESG considerations into account, both in terms of risks and opportunities, as they are long-term investors in the environments and communities where their assets reside.
As investors continue to lean into these issues, I do think it will become an accepted norm. At the same time, however, I believe it will remain possible to differentiate based on the rigour of a manager’s policies and processes, and the way in which ESG factors are considered at each step of the investment journey. ESG is rapidly becoming table stakes, but there will still be a spectrum based on how committed and thorough firms are in their approach and execution.