For the private equity sector, the pressure to act on Environmental, Social, and Governance — ESG for short — metrics is rising. The demands for ESG data, reporting, and action plans have been mounting. Private equity firms are now prioritizing how to measure, report, and integrate ESG into their end-to-end investment processes.
So how does ‘Diversity, Equity and Inclusion’ come into play, and why is it a critical part of ESG?
McKinsey published a report, “The state of diversity in global Private Markets: 2022” which found that leading institutional investors would invest 2.6 times more capital in more ethnically and racially diverse firms. However, the lack of data prevented the study from diving deeper into the financial value of increased diversity.
Investors have an opportunity to improve the measurement and integration of Diversity, Equity, and Inclusion data into their investment and portfolio management strategies.
The Core DEI Data Challenge That Investors Should Tackle
Here’s the problem: Traditionally, the private equity sector has had a very fragmented approach to ESG data. They’ve struggled with diversity and inclusion, too. Where companies have had to report the data or have tried to be more transparent, they were not always using the same tools, definitions, and categories. They were sharing the data in various ways and on different schedules.
Common challenges that investors have with Diversity, Equity, and Inclusion (DEI) data collection are as follows:
- Not knowing what DEI data to collect. Most investors start at gender diversity but there are multiple forms of diversity that can be measured to give a more comprehensive understanding of a team’s makeup and activity.
- Compliance and data and security risks. Investors often are concerned about being compliant with global sensitive data and security laws. A lack of know-how about the regulations can deter investors from measuring this data entirely.
- Lack of in-house capability and resources to collect and analyze the data. Even if the desire exists, data collection in a secure, scalable, and efficient way is difficult to do in-house where an investment firm may not be equipped with the technical expertise to do so.
- Difficulty building trust and educating stakeholders on the value of DEI measurement and improvement. Without employee or portfolio company willingness to disclose the data, investors cannot have high-quality data to conduct analysis.
- Not knowing what to do once they have the data. Often, investors collect data to simply report on it but are sitting on an untapped gold mine of insights that could drive financial performance. Investors need the help of DEI experts to connect the dots between the data and strategy.
- Lack of knowledge on the value of a more inclusive team and/or portfolio. Increased diversity at the leadership level is correlated to financial performance across numerous studies. Investing in DEI can improve employee retention, productivity, and innovation — all of which have a cost savings or revenue generation impact. Investors are not looking at this as a value-creation lever.
In short, the need for more standardized data and reporting on ESG data, especially DEI data, is needed by the industry. Hence the ESG Data Convergence Initiative.
What Is the ESG Data Convergence Initiative?
The ESG Data Convergence Initiative is an open partnership of private equity firms, representing over $8T in AUM, or assets under management. Founded in the spring of 2021, the goal of the ESG Data Convergence Initiative is to streamline the way the private equity sector gathers and reports ESG data.
So far, there are over 250 general partners who have all agreed to measure and share the same data in the same way. This will hopefully pave the way for a robust comparison of metrics and real-world, actionable insights.
The data ESG Data Convergence Initiative is collecting includes:
- Greenhouse gas emissions
- Renewable-energy share
- Board diversity
- Net new hires
- Work-related injury
- Employee engagement
Currently, large enterprises such as CalPERS and the Carlyle Group are backing and taking part in the ESG Data Convergence Initiative. Their aim is to not just gather this data in a way that’s easy to understand for limited partners and all stakeholders but also to gather data that is then actionable.
How Will the ESG Data Convergence Initiative Impact What Is Expected of Investors
A group of the world’s largest GPs and LPs have come together in collaboration with global management consulting firm, The Boston Consulting Group to measure and share data from GPs to LPs in a standardized way.
The data collected will be anonymized from portfolio companies and aggregated to produce industry-wide insights to show the relationship and potential correlation between financial performance and ESG performance.
The impact of this ongoing study would meaningfully impact the way that investors are expected to collect and share data between GPs to LPs.
Today, GPs ask LPs for Diversity, Equity, and Inclusion data in the form of reporting questionnaires. Common questionnaires from GPs to LPs on DEI have been created and standardized by ILPA (the Institutional Limited Partners Association) and The Principles of Responsible Investment (PRI). Diversio collaborated with ILPA on the creation of their DEI Due Diligence Questionnaire (DDQ), which is similar to what PRI asks for.
The investment industry can expect to see new standards developed on how to measure, track and analyze DEI data as a result of the ESG Data Convergence Initiative. It would be wise for them to start thinking about how they would do this proactively.
There is already demand for ESG in Private Equity. One general partner (GP) researched by Boston Consulting Group reported receiving 37 separate requests for ESG data from LPs within just one week. GPs who want to ensure their portfolio companies are getting a strong ROI on DEI and are making progress on ESG KPIs and goals can choose to join the collection efforts of the ESG Data Convergence Project once they are ready to adhere to the defined set of metrics. It’s also possible for PE firms to join the ESG Data Convergence Initiative as members to contribute to the standardization of ESG data in the industry. Joining is one way to join the effort at standardization.
The ESG Data Convergence Initiative also publishes data that can shape investments for private equity firms. In their inaugural year, for example, the ESG Data Convergence Initiative reported that 45% of private firms had no women on their boards, compared to 12% of public firms that reported no women on their boards. Firms looking for investor intelligence can turn to the ESG Data Convergence Initiative as one source of information. This data can inform firms as to what metrics they may be gathering in the future.
It’s clear that the stakes are significant for portfolio companies and GPs. The McKinsey study concluded that Chief Investment Officers at some of the largest institutional investors reported that when comparing two similar private equity firms, they would allocate twice as much capital to the PE firm with more gender diversity.
How Can Diversio Help?
Diversio for Portfolios is designed to support investors who wish to measure and improve the DEI of their internal teams and portfolio. For firms interested in taking part in the ESG Data Convergence Project and those who are not ready to be members yet, Diversio is a resource that can encourage a positive return on investment in DEI efforts. Our solutions are structured for portfolio management, so investors can understand DEI within their portfolios at a macro and micro level.
Diversio’s DEI data collection, analysis, reporting, strategic plan generation, and support from DEI Experts provide all the tools necessary to measure and improve DEI KPIs. Diversio helps organizations in the finance sector benchmark DEI data and take actionable, proven steps toward change.
Diversio helps build diversity in finance sectors by educating investment teams on how to be inclusive investors. We also train teams about the return on investment and the benefits possible with sustainable finance and DEI. Finally, Diversio offers fund and portfolio certification. This public-facing statement showcases to LPs that DEI best practices are integrated into investments and internal teams.
To find out more about Diversio and how our solutions work, schedule a demo today.