October 02, 2019
Dmitri Sedov, Chief Product & Marketing Officer, Preqin
Dmitri Sedov leads Preqin's global products & markets group, spearheading initiatives to ensure that the company's products and services evolve to meet the changing market and client needs. He brings nearly 20 years of experience in strategy, product innovation and market development across public and private markets, having led innovation at S&P Global and co-invested in and advised tech startups at Evocado Ventures.
SVCA: In your personal journey from public to private market - what are the gaps you have observed when applying measurement tools used mostly for public companies on private markets?
Public and private companies have different journeys and drivers in addressing ESG issues. Therefore, measurement tools and frameworks for public companies oftentimes are a poor fit for the private market. ESG investing considerations have existed in public markets for several decades now, with new disclosure regulations and increased stakeholder engagement coming to the fore in recent years. What started primarily as risk mitigation – whereby investors avoided certain “problematic” industries, and companies devised processes to manage the unexpected – has evolved into a complex web of standards and frameworks.
ESG of today is not only about managing downside risk but also harnessing the opportunities that come with more sustainable and responsible business models, and better corporate governance. And this led the push to define and stimulate responsible investing.
Practically, it means meeting investors’ growing demand for ESG-compliant investments with the supply of sustainable and well-governed assets.
In public markets, emerging regulations mandating ESG-related disclosures, such as EU Directive 2014/95, are helping validate and grow this supply. And so do major indices and rating agencies. Offering robust methodologies and rigorous screening on a plethora of environmental, social and governance metrics, indices such as FTSE4Good, Dow Jones Sustainability Index and MSCI ESG Index, as well as S&P Global Ratings, Moody’s Investor Services, MSCI ESG Ratings and others are effective catalysts of ESG compliance by large, publicly-traded entities. Collectively, the evolution in how ESG is defined, greater stakeholder engagement, new regulations, and growing sophistication of sustainability benchmarks are the key forces that are reshaping how public market investors think about responsible investing.
In private markets, ESG drivers are different. Benchmarks and regulatory oversight are limited. And stakeholder pressures come mainly from the asset owners who already have ESG targets for their public investments and who expect, rightfully so, comparability across their portfolios. As capital allocation to alternative assets continues to increase, investors’ interest in how ESG risks and opportunities are managed by private capital fund managers (GPs) grows in lockstep.
For GPs, ESG is not a new topic either. Private capital fund managers routinely consider environmental, social and governance issues. Fundamentally, their rationale is the same as for their public market counterparts: assets that are better prepared for the unforeseen and are better governed perform better. However, a GP’s journey is very different: private markets afford fund managers a unique opportunity to engage directly with every asset and obtain ESG metrics throughout the investment lifecycle. From doing non-financial due diligence to driving operational efficiencies to improving how their portfolio assets are governed, many GPs are taking environmental, social and governance factors into account to create greater value for their investors.
SVCA: Perhaps for some operating in less developed economies, integrating ESG into a fund's thesis could arguably hurt returns on an investment. Doing the right thing may incur cost for portfolio companies, can a GP impose ESG on an investee?
ESG should not be viewed as antithetical to ROI but rather as one of the key drivers of value creation. In today’s world, not doing “the right thing” in sole pursuit of profits is no longer accepted by most investors, especially those with patient capital who allocate to private markets. Numerous studies demonstrate that companies with better governance and greater appreciation of environmental and social factors outperform their peers. Therefore, GPs who can demonstrate how they take ESG considerations into account are more likely to win investor mandates.
Now, does that mean that private capital will stop flowing into industries and countries with lower ESG scores, such as fossil fuel producers or businesses in China? No, not in the near future. However, more successful GPs are those who are a) transparent with their LPs about where their capital is deployed and b) what they do to improve ESG profiles of their investments even in those challenging sectors and geographies.
SVCA: What is Preqin's solution to encourage more GPs and LPs to integrate ESG formally?
GPs' engagement on ESG with their portfolio companies is the biggest gap. Having a simple and comparable mechanism for LPs, GPs, and portfolio assets to interact on these topics is the other one. Preqin intends to solve for both with our ESG scores and benchmarks.
We designed a scoring system product to be a common baseline to help LPs, GPs, and others get on the same page with how ESG considerations are factored into the fund allocation and deployment decisions. To establish this baseline, a fund's ESG profile is determined by its underlying assets and geographies. That algorithm generates an indicative score and the heat map of ESG exposures at the fund level. We intend to enrich our assessment with any relevant data that is asset-specific and, ideally, contributed by the GP. Funds managed by more engaged GPs would naturally get more granular and precise ESG scores from Preqin.
SVCA: What lenses did you used to build a solution? And is there a common denominator or standard that can be found amongst these framework/metrics?
The idea of a "common denominator standard" is appealing but impractical. Instead, Preqin decided to build its ESG offering around commonly used frameworks and then let investors decide which lens is the most appropriate for their ESG strategy. Our beta product relies on SASB, UN Sustainable Development Goals, OECD Better Life Index, and the World Bank Worldwide Governance Indicators to derive the quantitative measure of industry and country-level fund exposures. Over time, we intend to add other lenses and custom weightings for our clients to choose from.