EP 51: Is ESG Just Good Business?

Josh Green: Hello and welcome to Sustainable Intelligence, where we discuss all things sustainability for the private markets. I am your host, Josh Green Co-CEO of Novata, and today I’m joined by Evan Greenfield, Managing Director and Head of ESG at BCI Private Equity. Evan and his team recently released new research demonstrating how ESG factors can contribute to measurable value creation in private equity investments. Today we’re lucky to have him on to talk through the findings.

Evan, thanks so much for joining us today.

Evan Greenfield: Thank you, Josh. Great pleasure to be here.

Josh: So Evan, you have become something of a superhero in sustainability land of late and, you know, I think it’s for good reason because you’ve delivered research talking about how sustainability can be a lens for thinking about value creation at a moment where the sustainability community’s feeling the pressure, feeling the heat, and feeling the need to justify the work that it does.

And so I think having your research arrive with a clear and compelling argument that sustainability can create value, I think it’s just what the doctor ordered to mix our metaphors. So I wanna get into the research, wanna hear about it but I wanna do the superhero origin story first and hear how you first got interested in ESG in the private markets.

How did you first enter this space?

Evan: Thanks Josh. And I think that’s the first time the word superhero and my name has ever been associated. So I’ll make sure to duly note to my children who will be duly unimpressed with that. But I started my career as a private equity investment professional some decades ago prior to the financial crisis, a decade or so prior when in many respects, the private equity model was predicated on not only having very good investment diligence and having very good entrance multiple into an investment opportunity, but doing something in the three to five years between entrance and exit, and that was portfolio monitoring, maximization, value creation. So that’s always stuck with me as a core part of the private equity concept.

That has changed somewhat during the decade post the financial crisis when rates were at such a low point and it wasn’t terribly challenging to have strong economic return emanating from leverage which are the very limited cost of capital. We reverted back to the days where you actually have to imply value in a serious sense in the intertwining period between entrance and exit, where you are doing a heavy lift in operational enhancement and value creation. 

But I started to get involved in sustainability post the financial crisis when I was working with the asset and wealth management platform of Deutsche Bank and started to recognize that there was a means to leverage a whole suite of financial information discerned from a different angle, emanating from what we today consider to be ESG characteristics and the material lens emanating from sustainability. It was around the time that Professor George Serafin at Harvard Business School put forth his research in 2016 first evidence of materiality, looking at sustainability in the public markets, and that by integrating in material factors from a ESG standpoint yielded economic outperformance. But if you’re integrating in the material and immaterial factors, you may have some underperformance because we weren’t able to distinguish between the signal and the noise. And it was at that time that we recognized that there was a burgeoning interest in this topic, especially amongst the wealth management community, and it allowed us to have different conversations beyond just talking about investment performance.

I helped to oversee the ESG and impact investment platform in the Americas for Deutsche Asset and Wealth Management. And certainly from an impact standpoint, the conversation would progress beyond just the investment return. You had to have good enough investment performance, but you’d have a conversation that became very sticky about the impact and the quantification of the impact emanating from an impact related strategy. And I thought that that was a very unique and differentiated approach to wealth management. So that’s when I started to get involved in the industry.

The great aspect of that time was that it was burgeoning. There wasn’t as much focus and interest, so there was a wonderful opportunity for experimentation, trying new things, and obviously ESG and sustainability has evolved over that time period and has gone through iterations of great interest and then some great critique in the last several years.

And I think we’re pivoting back to that period of great interest largely from the research that we’ve been able to put out there and others that have demonstrated the ability to leverage sustainability, particularly within the private markets for quantifiable, attributable financial return.

Josh: So Evan, tell us a little bit about where the research came from. How did you first go down the path of doing this type of research?

Evan: The catalyst for the research came about, so BCI is the public pension program of British Columbia, Canada, where we represent around 32 different pension plans in the province [in addition to insurance and special purpose funds], have around a million or so underlying members. And I sit within our private equity vertical, where we are allocating half of our assets as an LP into general partners, various private equity firms. And then the other half of the capital is allocated as direct active investors, later stage buyout opportunities on a global basis across six main sector areas financial services, business services, TMT, healthcare, industrials and consumer.

So what we classify as the traditional domain, and in many respects, we had established, early on in my tenure here at BCI Private Equity, that we can leverage these macro tailwinds behind sustainability or enhance risk adjusted return for our clients. And that thesis came about, given my earlier days as being a private equity investor, was recognizing that we weren’t tying the two together. ESG, in many respects, felt like a extracurricular activity outside the parallels of investment processes. And so we steadfastly focused on how we can leverage ESG for quantifiable and attributable economic return in dollars and cents, and we were able to accomplish that. And we’ve spent an inordinate amount of time with our GPs to demonstrate the model that we’ve built, and we put together conferences on ESG value creation for our BCI Private Equity ecosystem.

And at a conference two years ago, several of our GPs had said, we would love if you can codify in writing the approaches that we are discussing. And that was a multi-year process to do that. Probably around half that time was coming up with the title of our paper “ESG Value Creation in Private Equity: From Rhetoric to Returns.” So I was a big fan of that “Rhetoric to Returns,” but it really encompasses in many respects what we’re seeing in the environment. There is a great amount of noise, and we feel that we’re steadfastly focused. Our fiduciary obligation and responsibility is to have enhanced risk adjuster to turn for the pensioners of British Columbia. And so all we do, whether it’s ESG or otherwise is focused on that objective. But we clearly felt that ESG has an outsized influence and ability to accomplish enhanced risk adjuster returns. But we felt that it was necessary to codify that and to provide case studies and to quantify and provide dollars and cents attribution in those case studies such that the broader market and the private markets ecosystem could take forth this new evolved approach to sustainability relative to just a reporting and disclosure exercise.

Josh: So I wanna push you on how you were able to see around the corner because take the timeframe that we’re talking about. You know, that sounds like it was ’23, ‘24. This was still a time where sustainability was flying high and people were doing sustainability to say they were doing sustainability without having to necessarily justify it.

But you seem to intuit maybe that there was going to be a time where there was going to be more of a need to justify the work that’s being done here. Is that what happened? Or is was it more luck? How did you get the timing so right?

Evan: I didn’t have the foresight in terms of the justification, but most importantly, I have the unyielding passion and desire to enhance returns for our clients. And I strongly feel that there is an outsized advantage to leverage sustainability to mitigate risk and enhance returns leveraging upside potential as well. And we are so fortunate to be in the private equity, private markets asset class because we have so many effective tools to leverage to execute on that belief in the respects that we are long duration holders of the assets. We are having significant minority or majority economics. We have active governance where we generally have board seats and as I said earlier, in between that entrance and exit time period, there is a critical three, four, or five years where you’re necessitated to embed operational value enhancement. And I see sustainability as a key driver of that. That has not been leveraged as much as other areas, whether it be pricing or distribution or digitization or cost rationalization. It is certainly part and parcel in that domain, but the really exciting aspect is that there’s completely wide-open space because it hasn’t been leveraged in that domain. Largely, ESG has been the purview of certainly being in within the guise of regulatory compliance, which is a non-starter—one has to obviously fulfill the regulatory requirements of the regime they fall under.

But for many GPs, it’s an exercise in terms of fundraising to demonstrate to their LPs that they are collecting this data. 

We’re not in the business of collecting data just to collect data that is a significant burden to one, GPs, and then ultimately to their portfolio companies, our indirect portfolio companies or our direct portfolio companies if it’s within our active direct book. But what we want to be able to collect is data and information services that give us a more holistic understanding of that asset where we can help to better understand the risk, mitigate them, reduce them, and then look to understand where there’s alpha generative aspects on the upside opportunity equation.

Josh: One more question about the superhero origin story, and then we’ll get into the framework itself that you laid out. Why go down the research path and why publish it? Why not just keep it to yourself, this framework that you put your finger on that you think can drive value?

Evan: Well, one, we were steadfast in the respects that we wanted to put this together. And we wanted to put it together with the folks at Stanford because we wanted to bring in an independent arbitrator of our methodology and our approach to give forth that view and that consideration. Two, we wanted to have a guide for our underlying GPs to leverage in their investment process such that they can replicate this model. And three, we want to help evolve the broader private markets ecosystem. We feel that that is a tremendously important responsibility that we have, that it is not as if you’re providing your competitive advantage in demonstrating it to the world and opening it up. We strongly believe that this is important to be transparent and to provide that guiding lens.

And in many respects, it’s also given that in the last several years that there’s been pressure in sustainability, and we feel that sustainability just hasn’t been looked at from the right vantage point. And we have management team members in our direct active portfolio that obviously have different political or ideological views. But I’ve yet to find a CEO or senior member of management of any of our portfolio companies on any side of the political ideological spectrum that isn’t steadfastly focused on enhancing their management incentive plan, their MIP and ultimately the returns that we’ll be able to get from asset at exit. And if we do find that, then they’ll likely not be part of the portfolio. Because we deal in the language of finance, we deal in the language of business. 

And so I’m frequently asked, what’s your central KPI on ESG? And I say it’s very simple. It’s something called EBITDA, which we all should know if we’re in the capital markets business. And so once we put it in the language of dollars and cents, it’s a very different discussion. You remove the ideological debate around it and you steadfastly focus on the economic returns that are achievable.

And as I’ve said, I’ve yet to find a management team that is not steadfastly focused on those objectives.

Josh: Let’s talk about the framework that you laid out in the research. I always appreciate and respect people who think in threes. And you’ve got three phases, diligence, post deal operations, and exit. And you’ve got three value levers, cost reduction, risk compression, and growth. All feels straightforward when you lay it out that clearly.

I’m curious what in practice this feels like. Does it feel like these are three distinct phases and three distinct levers? Does it feel more organic than that when you’re engaging with companies?

Evan: So, one, I didn’t come up with three to impress you, Josh. I came up with three ’cause I couldn’t think of a fourth, right? But, I broke the investment process down into the three relevant stages in private equity, which is investment diligence, portfolio monitoring/value creation, and exit. And what we do is in the three stages, how we’re integrating sustainability has some differences, but there’s a lot of overlap.

So in the first phase is the investment diligence part of the process. And I’m steadfastly focused on ascertaining the material ESG risk for the industry the company is operating in, but even more importantly for the company itself, right? So I can be in an industry which has some ESG challenges, but I can have a company that is much more advanced or I can have the inverse. So I’m really focused on the company.

And when I ascertain those ESG risks, my responsibility is to ensure that our investment professional colleagues have a clear understanding of where those risks are emanating from. And we determine what we will do with those risks. And they’re like any other risk that you’ll find in that investment diligence process. We can mitigate those risks vis-a-vis purchase, price adjustment reps and warranties, post-close operational value enhancement plan or stepping away from the transaction, but It’s what I call the “eyes-wide-open” aspect of the diligence. We’re also spending some time with management to demonstrate the upside potential emanating from ESG value creation and identifying some of those areas early.

The reason to do that is to set the culture and tone that ESG is a source of upside value, relative to solely risk mitigation. Post-close, to the extent that the investment materializes, we’re focused on continuing to understand those risks. And I like to make the very poor analogy, the investment diligence stage is like dating, the post-close stage is like being married and during marriage, everything starts off great, but then, you know, challenges naturally surmise. But what you see is that you get a better understanding of the risk that you may have missed during diligence. Maybe you’ve overstated a risk or you’ve understated a risk, but your tools have changed to solely being operational.

They’re no longer transactional. That transactional aspect went away once you close the investment, but you always need to stay abreast and to stay close to the evolving material ESG risk. Secondarily, and we’re now spending an inordinate amount of time of leveraging sustainability as a source of competitive strategy and value creation and the quantification, looking at how we can leverage it for product diversification supply chain enhancement, operational leverage, enhanced customer stickiness, EBITDA growth, margin expansion, capital efficiency, and eventually uplift and return at exit. Which brings us to the third stage, is that exit process.

And at exit, what we wanna do is to demonstrate how sustainability is a core part of strategy, the quantification of it, such that sustainability becomes an ESG is not the appendix of the confidential information memorandum at exit, but it’s slide three because it’s a core part of competitive advantage. And we ultimately believe there’s the potential for multiple uplift emanating from the fact that we’ve enhanced buyer confidence. We also believe over time, assets with greater sustainability will have a much greater demand and there won’t be as much supply. 

Now there’s a part of the process that I wanna dive into, but I wanna just bring us back to that second stage in terms of that operational enhancement, value creation. What I think is the most critical part of the whole three-stage process. Certainly the critical part is having a compelling exit return. But short of that in terms of the operational component is cultivating a strong relationship with management. I think we negate to understand that private equity, just as anything else, is very much a relationship management business.

We do not oversee day-to-day management. We’re not in the business on a day-to-day basis. We can only use our ability to provide perspective, to provide guidance, and to be a trusted partner. But what we need to ensure is that we’re cultivating that strong relationship with management, not just at the board level, not just at the C-suite level, but at that middle management level, which is doing the day-to-day execution in addition to the frontline workers. And what’s critical from a sustainability lens is that relationship management is really critical. So we’re not going in on the first day post-close and asking for ESG KPIs. First thing I’m trying to do is to establish a personal rapport with management, to build in confidence, to build in trust, and over time we’re developing that trust level where management recognizes that we have the ability to enhance their ultimate management incentive plan, and ultimately our exit value emanating from leveraging sustainability. But in that process, we, as I said, I’m not asking for ESG KPIs.

What I’m asking for is a better understanding of that business. Why does that portfolio company win business? Why does it lose business? Why does it gain share? Why does it lose share? What’s its competitive advantages? Where are there levers to create additional areas of value? Where are there levers of value that may be disrupted in the future? Where are the risks? Where are the opportunities? Where are the moats in the business? 

And then once we distill these material issues that are encompassing the company, it’s at that point that we apply a very different lens. If there are longstanding issues in a company, it’s likely that we’ve applied a financial lens from the traditional sense or a business lens from the traditional sense, and yet we haven’t found a solution. But time and time again, if we leverage a sustainability viewpoint, we’re able to determine solutions to that problem in a very differentiated manner and bring about economic opportunity leveraging a sustainability footprint. And that’s what we’ve demonstrated in the case studies, is how we can leverage sustainability to solve the operational challenges, the systemic challenges of a business in a very different angle.

And that’s why consider it to have so much wide-open space from a value creation standpoint, because many of my colleagues in the industry are not looking to solve these problems from the sustainability lens. They’re looking at it from very different vantage points. But the sustainability lens gives a very different angle.

Josh: Really interesting. And I think you’ve anticipated one of the things that I wanted to push you on. In the research, and I quote, you say collectively they demonstrate—the case studies—that ESG when treated as a financially material operating discipline can surface risks and opportunities that traditional processes may overlook and can translate into measurable value creation over the course of ownership.

And I do feel like at the crux of your argument, you’re saying that these are not fundamentally different things. Sustainability and value creation are one and the same. It may not be that all value creation is sustainability, but sustainability practiced properly is value creation. So the question that raises for me is, well, isn’t this just good business? And do you really need to think of this as sustainability? Do you really need to think of it through the lens of sustainability? And I feel like if I’m understanding you correctly, the argument you’re making is, it’s not so much in the diagnosing of the problems that the sustainability lens is so crucial.

It’s in the development of the path forward to remedy the problems, to seize the opportunities where that sustainability lens may bring something unique to bear. Is that right?

Evan: That is a hundred percent right, Josh. You know, it’s interesting there, I’ve had a couple of folks review the paper before it went out. And a dear friend reviewed it, and he said, Hey, listen, this is great, but this is just operational enhancement. So I thought about it for couple days and that’s when I developed that paragraph that’s in the concluding section that you’re quoting from. But, we’ve honestly found that time and time again leveraging that explicit ESG lens, that explicit ESG expertise has uncovered material issues and opportunities that traditional processes may have overlooked or underweighted time and time again. And this applies—

Josh: Why do you think that is?

Evan: Because I think that, as I said earlier, a problem that materializes, we’re all looking at from this finance lens, from this business lens, that’s the traditional approach. The problem is still there because it hasn’t been figured out because we’re all looking at it from the same angle.

But if you look at it from this very different angle of sustainability, you can have a very creative approach to solving that problem. And it’s differentiated ’cause most of us haven’t been looking at it through that angle and that lens. And this applies to companies. We’ve been able to roll this out in our direct portfolio, to companies in any geography, any stage, any industry, any sector. And while value creation may not be the day two initiative to work on post-close, it is certainly something that’s happening within the year or two post-close because we found a return on investment emanating from this, from a very different approach and a different process. And so we are very encouraged by that. 

But there’s one thing to keep in mind is that yes, we do lay out somewhat of a framework, but the challenge is that there is not a one size fits all cookie cutter approach to all of this. You have to go in and what I call, kick the tires. Kick the tires with management, and most importantly, kick the tires with middle management to understand where the challenges lie and to be able to come up with a differentiated solution set. But it’s not as if you can apply the same case that we do in case one is the same as what we’re gonna do in case three, it’s very different. But the overarching benefit of that is that if you do, if you are able to figure out a differentiated approach, then this becomes an embedded part of strategy and a highly competitive advantage in the business because it’s not cookie cutter.

So that’s a real value in the business. But from a scale perspective, you’re engaging one-on-one with each company that you’re engaging with. It’s not collecting data, putting it through, you know, an AI sync and then coming out with a solution. It’s quite involved from a relationship management standpoint as well.

Josh: I once heard way back in my business school days that all alpha is temporary. When you think about sustainability as a source of alpha, as something that is a unique perspective, that can create unique value, do you think that’s for a limited time? Do you think it’s for a couple more years and then it’s gonna be just part of the way of doing business?

Or do you think this is something that is gonna have staying power over decades?

Evan: I think that the last decade, we’ve seen tremendous structural shifts in climate, supply chain regulation, geopolitics, and energy. I think that in the decades to come, those shifts will get much more outsized; they’ll get much greater focus. And those shifts have ushered in this element where sustainability, ESG went from the margins of enterprise value to the center of it, especially for long duration of liquid assets where adaptability and resilience are paramount. And so I think that we are in the earlier stages of this shift, and it will grow exponentially in the decades to come because of what we’re seeing from the climate standpoint, from the emission standpoint.

It’ll take the recent geopolitical challenge that we’ve seen emanating from initially the Russia-Ukraine war, and more recently we’re seeing in the Gulf region. Every sovereign is going to look to have energy independence given those two geopolitical hotspots, even if they get solved tomorrow. I think that is a huge catalyst, in addition to the great energy demands that are emanating from AI. 

Now, emanating from that will be obviously the implications of climate that we’ve yet to deal with that will give about significant disruption risk to every company from the traditional on up in any sector. And what I’ve said to my clients and to our portfolio companies is that on our watch, on my watch, we’re going to ensure that our portfolio companies are the disruptors and they’re not the disrupted. And that is any industry, energy, financial services, TMT, healthcare, every industry that we touch upon. But so I see these factors as increasing and areas of which there are great risks that will materialize and areas which great opportunities materialize as well.

Josh: Fascinating. Evan I know we’ve taken up a fair amount of your time today. Thank you. A couple of quick questions just to wrap us up. First, anything that really surprised you through this process of doing this research or the reactions that you’ve gotten to it?

Evan: The research didn’t surprise me because I’ve been doing this work for the last four years, so I knew the outcomes. We had the case studies up and running, took a fair amount of time to write the paper, but the response to it has been stunning.

I would encourage those if you haven’t had a chance to read the paper, it’s called “ESG Value Creation in Private Equity: From Rhetoric to Returns.” It’s on a platform called SSRN. But within two months since publishing, we’ve become the most downloaded paper on the topic of ESG in private equity. And I think it speaks to the desire of those in the industry, those that are learning about the industry, to have a new narrative as it pertains to sustainability and to look at sustainability, as we’ve said earlier, as a core part, a critical part, a differentiated part of value creation, especially within a private market company. And so that response has been really overwhelming in terms of the feedback and the reach out.

But there are many folks. Those that are in our portfolio ecosystem, our GPs, and those that are outside of it, that are looking to learn more and to replicate this model, which I think is very overwhelming for us because it is beyond what we set out to do. And we are excited that this conversation is happening with platforms like yourselves, Josh, and others. So we can move from this ideological discussion and we can talk about the dollars and cents. Listen, we’re in the business of capital markets. The business of capital markets is focused on enhanced risk, adjusted return. That’s the business, right? For those that are not focused on that, there’s other ways to contribute.

There’s policy, there’s nonprofits, there’s government work. But in this capital markets domain, it needs to tie within the economic returns spectrum or it will be castigated away, it’ll become irrelevant because my investment professional colleagues, that’s what they focus on, the investment professional colleagues at our GPs, that’s what they focus on.

Enhanced risk, adjusted return. And by the way, it’s a very worthy ambition. In our case, we’re providing enhanced risk adjuster return for about a million pensioners in British Columbia. These are retired firefighters, municipal workers, educators, et cetera. And empowering and enhancing the retirement, it’s wonderful to contribute in that regard. So I think that that response has been incredibly exciting and we hope to continue the dialogue and to allow others to replicate what we’re putting forth here.

[00:30:22] Josh: Well, Evan, I, I’d like to ask you as I wanna ask each of our guests for one, one thing that is worth reading, but I think today the answer’s obvious. It’s your paper, “ESG Value Creation in Private Equity: From Rhetoric to Returns.” One final question. Your last name, two syllables, Green and Field.

Which of those is more important?

Evan: Well, I think that there is a wide expensive greenfield opportunity

Josh: Yep.

Evan: in sustainability. So I may go with Green because your surname is Green, so we’re gonna double down on the Green.

Josh: Nice.

Evan: But they can go together. There is no conflict. They are commensurate together.

Josh: Like, sustainability and value creation.

Evan: There you go. Like Josh and Evan together, forever.

Josh: Thank you so much for being with us today. This has been a real treat and I think the work you’ve done is vitally important.

Evan, thank you again for the time today.

Until next time, let’s keep building sustainable intelligence together. Find out more at novata.com.