Why private companies need to catch up on sustainability

This article is brought to you thanks to the collaboration of The European Sting with the World Economic Forum.

Author: Fiona Dunsire, Wealth Leader, Growth Markets, Mercer (Marsh McLennan), Stefan Dunatov, Chief Strategist, Abu Dhabi Investment Council, Suni Harford, Member of the Group Executive Board; President, Asset Management, UBS

• Public companies are leading private companies in three interlinked areas: environmental sustainability, corporate social responsibility and people sustainability.
• A diverse and inclusive culture attracts and retains the best talent, which leads to competitive advantages for those companies that have inclusive cultures.
• We call for improved transparency from private companies and their owners for better ESG and DEI insights to ensure that proper progress is being made.

Sustainable businesses are focusing on three interlinked areas: environmental sustainability, corporate social responsibility and people sustainability. And their investors (i.e. ultimate owners) are increasingly looking at key metrics to assess progress across environmental, social and governance (ESG), and diversity, equity and inclusion (DE&I) factors in making their investment decisions. More needs to be done within DE&I particularly, as the pace of change is lagging behind public markets – and that matters.

Sustainability attracts and retains talent

We know that a diverse and inclusive culture attracts and retains the best talent. This leads to competitive advantages for those companies that have inclusive cultures versus their peers, as well as improved performance outcomes. These companies are also more likely to have a deeper understanding of their clients and evolve better to meet changing client demands and needs. These companies will also have better decision-making processes as idea creation, opportunity origination, risk identification and mitigation are all improved.

Public companies are leading in this due to public scrutiny, legislation demanding changed behaviour and increased shareholder awareness of the link between improving DE&I and ESG actions, and improved performance outcomes. Without the pressure of an annual meeting, proxy votes and public disclosure, a gap exists in the demand for similar disclosures from investors in private market companies.

Data from UBS indicates that infrastructure, direct real estate and private equity ownership accounted for between 7.0-7.5% of global market capitalisation in 2020. However, from the perspective of ESG, this is an understatement given these studies include debt. When we look at equity only – as equity control and influence drives change – the proportion of infrastructure, private equity and real estate in global markets is much greater. Excluding bond markets from the UBS data reduces the estimated global market capitalisation by almost one half, so that the private ownership slice of the global pie is closer to around 15% of total assets.

Private ownership matters, and it is a significant portion of ownership and influence in global markets today.

Addressing under representation of women as allocators and recipients of capital

Actions are required across the three key stakeholder groups:

• Asset owners: the pension funds, sovereign wealth funds, endowments, insurance companies and other institutional investors, such as family offices, who are the sources of long-term capital;
• General Partners (GPs): who manage the funds and allocate capital to underlying portfolio companies;
• Portfolio Companies: who seek capital to fund their business strategy and future growth.

There are material disconnects between the ambitions of asset owners and the GPs who take investment decisions on their behalf. For example, 65% of asset owners state they consider gender diversity important when investing, but only 25% of GPs report being asked about this during the due diligence process, with even fewer reporting ongoing governance from asset owners on diversity issues. Similarly, within GPs, significant perception differences exist between men and women as to the reasons for a lack of gender balance in key decision-making roles. Women are more likely than men to identify internal factors (such as leadership commitment and biased recruitment practices) as significantly more important than external factors (such as a lack of interest by women in these roles).

There is no question that asset owners are seeking to address these imbalances. Research by Mercer and the World Economic Forum showed that while fewer than 10% of advanced asset owners specifically allocate to women and minority owned firms and funds, one-third are considering making an allocation in the near future. In addition to these ‘bottom-up’ actions, more comprehensive strategies are required:

1. Diagnose using data. This means understanding the talent flows through the organization (hiring, promotions, exits) by gender to identify the areas to focus on and increase transparency. In many organizations, focusing on equalising promotions is the area of greatest impact. However, hiring practices in GPs are ripe for improvement as evidence suggests ‘cultural fit’ is significantly more important than experience in assessing candidates, and existing networks are most commonly used for referrals. Collecting hiring data will help to set appropriate medium- and longer-term targets and measure progress on gender imbalance.

The same process can be applied to investments in portfolio companies to understand the gender mix at each point in the investment process and address biases in due diligence. For example, in private equity, women entrepreneurs appear to have a lower probability of second stage funding compared to men, and report being questioned on different issues than men during due diligence. Since deal sourcing is frequently done through existing networks, this reinforces the need for diverse teams to access the widest possible pool of opportunities.

What’s the World Economic Forum doing about diversity, equity and inclusion?

The COVID-19 pandemic and recent social and political unrest have created a profound sense of urgency for companies to actively work to tackle inequity.

The Forum’s work on Diversity, Equality, Inclusion and Social Justice is driven by the New Economy and Society Platform, which is focused on building prosperous, inclusive and just economies and societies. In addition to its work on economic growth, revival and transformation, work, wages and job creation, and education, skills and learning, the Platform takes an integrated and holistic approach to diversity, equity, inclusion and social justice, and aims to tackle exclusion, bias and discrimination related to race, gender, ability, sexual orientation and all other forms of human diversity.

The Platform produces data, standards and insights, such as the Global Gender Gap Report and the Diversity, Equity and Inclusion 4.0 Toolkit, and drives or supports action initiatives, such as Partnering for Racial Justice in Business, The Valuable 500 – Closing the Disability Inclusion Gap, Hardwiring Gender Parity in the Future of Work, Closing the Gender Gap Country Accelerators, the Partnership for Global LGBTI Equality, the Community of Chief Diversity and Inclusion Officers and the Global Future Council on Equity and Social Justice.

2. Document commitments across DE&I. Public market organizations have shown that transparency of goals, metrics, and progress and persistence over time drives results. For example, in financial services more generally, 81% of organizations say they are committed to improving DE&I, yet less than half have a multi-year strategy to achieve this. Evidence suggests these figures are significantly lower in private markets.

3. Engage leaders to drive personal commitments. This includes ensuring they are personally responsible for their goals and incentives and are held accountable for results. The tone from the top can be effective, but it first needs to be authentic and persistent.

4. Take action. Implement a strategy, including making changes to investment processes and internal policies and practices, track progress, and be transparent in documenting results.

So, we end with a call for improved transparency from private companies – and those owners of private companies – for better ESG and DE&I insights to ensure that proper progress is being made. This is especially important given all areas of diversity are correlated with better investment outcomes for all members of the investment value chain. This goes for both public and private markets, and is worth working for.