We teamed up with Unquote for a live briefing in July, discussing whether LPs are using this unprecedented time to scrutinise their portfolios and perhaps look to sell positions that do not align with their values and ESG criteria. Our Head of Strategy, Claire Woolston Commons, spoke with Paul Newstone, Partner and Head of Investment Solutions at Unigestion and Chris Varco, Managing Director in the ESG and Impact Investment Group at Cambridge Associate, in a debate moderated by Denis Ko Genovese, Associate Editor at Unquote.
Denise Ko Genovese (DKG): Unigestion has almost $20bn under management - $7.5bn of which is in private equity. Paul, can can you talk us through your environmental and social governance (ESG) journey and where you are at now?
Paul Newsome (PN): It has been quite a journey and if I go back to 2010 when we launched our first environmental, sustainability-focused fund-of-funds, it made sense to have an ESG process as part of that. We partnered with an external foundation to provide us with the expertise. We learned that ESG was a great tool for controlling the risk in investments, identifying the risks before investment and then engaging with your GPs of underlying portfolio companies during the holding period, to drive positive change and improve standards. It was no coincidence that the best performing managers had the best standards in the end. Since that crash course at the beginning we have really embedded this into our overall PE strategy – including secondaries – and see ESG as a driver of returns, and another tool in the value creation box.
DKG: With Palico being a funds marketplace, where LPs can list the fund stakes they want to sell, Claire, you presumably see the secondaries market used for many different reasons – have you seen much in terms of ESG trends?
Claire Woolston Commons (CWC): The secondaries market is used for many reasons and has had very interesting growth over time. In 2001, there was only a couple of billion in transacted volume each year and on the sell-side there were some elements of distress. But what is exciting is that it has now become more of a portfolio management tool and, as private equity portfolios mature, investment strategies evolve - what was an interesting and appropriate investment in the 1990s and 2000s might not be the right strategy for today. We see the secondaries market becoming a powerful tool to reposition your portfolio and we see sellers for different reasons, including ESG. There is a big opportunity because we all see ESG investment criteria differently, so I might have something that does not fit with my ESG programme, but it might fit and be positive for you with yours. And on the buy-side, there is more clarity and control since investors are not buying a blind pool, but can actually see into the portfolio and make sure that the individual assets match up.
DKG: Paul, how do you feel at Unigestion about the use of secondaries to rebalance a portfolio? Is rebalancing for ESG a realistic use of secondaries or do you think people are fighting real-life fires at the moment and disposing of assets that are affected by the coronavirus crisis?
PN: We absolutely and wholeheartedly use secondaries. It is usually to sell tail-end portfolios, but we had an instance four to five years ago when one of our maturing portfolios became very US-dollar heavy and, since we thought we were over-exposed, we sold a chunk of the dollar denominated portfolio on the secondaries market so we could crystallise returns. On ESG, I can think of two discreet examples where we had funds that we had fallen out of love with for governance reasons, so we extracted them from our portfolio through the secondaries market.
"We see the secondaries market becoming a powerful tool to reposition your portfolio and we see sellers for different reasons, including ESG”
Claire Woolston Commons, Palico
DKG: It seems fairly easy to see how you could use the secondaries market to do some retrospective ESG analysis and get rid of what does not line up – like when Georgetown University said in February they wanted to divest fossil-fuel related investments. What about buying into more impact-related assets? Chris, are there enough of these to go around?
Chris Varco (CV): There is now, and that has been a big trend. We have clients aiming for “net-zero” portfolios going forward. Divestment [in fossil fuels] was always a bit black and white where we see transition risk in the producers but not the burners of fossil fuels, but we now have clients building private programmes entirely around climate alignment. It means a very different allocation to real assets and infrastructure, with more focus on sustainable agriculture and renewable power where we are thinking very hard about 21st-century infrastructure rather than 20th-century. The opportunity set keeps growing.
DKG: Claire, have you seen more investors on Palico using technology as a tool to make investment decisions? Is there a link between Covid-19 and sustainability in terms of investors’ decision-making behaviour?
CWC: Covid-19 has been the dress rehearsal for all the ESG things we need to do and we are being forced to adapt to a new normal, where you do not get on a plane for a meeting and you do not get in the car to see the doctor, as its Zoom and telemedicine now. And even the tech-phobic, institutional investment management industry that we are in is starting to change. We are moving towards more sustainable habits and behaviour, and we have all been surprised at the positive change around how much work we can do (and how efficiently we can do it) using technology. At Palico, we have been a huge beneficiary of this change in activity, and we have seen more activity and traction in the three months after Covid-19 compared with the three months before. We feel like we are the future in terms of investing in a digital platform. For example, on the small end of secondaries transactions, having a digital platform that easily connects people takes the guessing out of the processing and admin. It is the future and we are happy to see we are part of it. It is a trend that has done better with all of us working remotely.
DKG: Can you talk a bit about how the secondaries market in general has evolved and now offers much more choice for sellers and buyers – perhaps making it easier to choose assets that align with their values?
CWC: Last year the market was pushing $100bn [worth of transactions] and with that has come this wonderfully rich assortment of buyer and seller desires and needs, and a more liquid and efficient market that has been created. On our platform, we have sellers that are perfectly happy with fund relationships, but they are tail-end funds which do not move the needle in terms of performance, so sellers are just looking to clean up their portfolios; or shift from mega-funds to smaller funds, or create some vintage-year diversification. There are just as many reasons under the sun if you have a portfolio management tool as easy to use as in the public markets. On the buy-side, a lot of the users have diverse needs; some really specialise in bigger deals and some in smaller deals, and others in young funds or a hybrid between primary and secondary. We feel like having this marketplace becomes a win-win situation because both buyers and sellers can get what they need out of the transaction. And to hone in on the smaller end, which is where we see the growth, especially in the use of a digital platform, this is where you want an easy process and connection between buyers and sellers. We think that a third of LP stakes have not transacted because there has not been an easy tool through which to do so, and that is where we see technology adding massive value: through the matching and document standardisation and digitisation.
"ESG was a great tool for controlling the risk in investments, identifying the risks before investment and then engaging with your GPs of underlying portfolio companies”
Paul Newsome, Unigestion
DKG: Do you think that what is defined as impactful is changing, given that the coronavirus pandemic has shown us that the likes of online education, telemedicine or online delivery can have massive impact?
CV: It is a spectrum. We are building out some private portfolios that are totally focused on sustainability alignment with [the UN’s] Sustainable Development Goals (SDG) having a positive impact, aligning with family office or endowment values. We will probably end up at about 25% of GPs explicitly labelled around sustainability and impact and 75% mainstream managers that are converging on these themes, be it in healthcare or venture, or the convergence of clean tech and venture capital. What Covid-19 has heightened is the ‘intangible’ and ‘digital’ taking market share over the ‘tangible’ and ‘analogue’. This is a massive area of convergence in venture capital and there are lots of venture managers who are very aligned to a low-carbon and more equitable society. Within impact, things have evolved a lot and, if you look back at the Cambridge Associates benchmarks, the early vintages underperformed. We were comparing private equity in micro finance in sub-Saharan African with Sand Hill Road venture capital returns, whereas the convergence has meant that there is now a lot more in the mainstream. We have some very interesting data on impactful companies, be they impact funds or mainstream GPs, and the degree of change from underperformance is huge. If you look at which companies would have qualified for Cambridge Associates’ clean tech benchmark, whether they were in a conventional or impact fund, from 8,000 funds in our database, turnaround in the later vintages is amazing: 33.4% pooled IRR for clean tech companies in the PE/VC pool compared with 23% for the mainstream in 2017. Turnaround in performance has been extreme. Everything is converging quite fast and coronavirus is accelerating that.
“What Covid-19 has heightened is the ‘intangible’ and ‘digital’ taking market share over the ‘tangible’ and ‘analogue’”
Chris Varco, Cambridge Associates
PN: I agree, if you look at how we invest, we have nine investment themes that cut across the SDGs and this is intentional, because our underlining ESG investment philosophy is that driving positive change is consistent with driving positive returns. So, SDGs to us represent important tailwinds and both consumers and policymakers will continue to push in the same direction as the SDGs. We have investment themes – such as future of work, resource efficiency, healthcare 2.0 – that are completely aligned to the SDGs so, to some extent, since we are playing these investment themes we are making an impact in these areas. We are doing it primarily because we see financial returns, but also because we think that the two are linked.
Palico is the leading digital marketplace for private equity primaries and secondaries. Our digital platform is designed for LPs, from single family offices to large pension funds, to streamline investing in PE funds on our Palico primary marketplace and for buying and selling PE fund stakes through our Palico secondary marketplace.