Asset owners take different approaches to ESG investing in private markets. Some apply environmental, social and governance principles across their entire private portfolio, others target companies or sectors that lend themselves to this type of investing.

Different asset owners must also comply with specific regulatory mandates, executives from BPKH and Asia Capital Advisors said during a panel discussion at the AsianInvestor Mandating Change Week on Wednesday (October 26). 

DIFFERENT MANDATES

“Our investments must be Shariah compliant. Our strategic asset allocation and tactical asset allocation are all actually laid down by the law,” said Hurriyah El Islamy, executive board member, foreign investment and international relations at BPKH, Indonesia's largest haji fund. 

BPKH's regulators impose mandates, Islamy said, which means that 30% of the firm's roughly $10.5 billion AUM must be cash in the bank; 20% direct investments; 10% other investments; 5% gold, with the 35% that remains invested in ‘Sukuk’ — an Islamic financial certificate, similar to a bond in Western finance, that complies with Shariah law.

When considering ESG in asset allocation to Sukuk and negotiable instruments, BPKH  makes sure it undertakes diligent KYC.

“But for direct investment we feel that it is not enough just to stop at the KYC process, we have to do more and would like to see the impact,” said Islamy. “For example, in our investment with the ISDB (Islamic State Bank), we ensure that we have at least one seat on the supervisory committee — we currently have two — so we have significant votes, and we can determine the policies at the highest level and at the operational level for our investment.”

Catherine Shiang, managing director, Asia Capital Advisors (ACA), a private single family office, said that since it was founded her organisation has incorporated in its due diligence mandate principles that would now be considered ESG.

“Insisting the portfolio is compliant with environmental regulations, that they are responsible within the framework of their culture and regulations socially, whether they have good governance, that's just good due diligence,” she said.

Asia Capital Advisors takes a five or 10 year view when constructing its portfolio

“Integrating ESG as a portfolio theme, that's something different that we have slowly integrated, because there are more opportunities currently. But as far as our mandate is concerned, that hasn't changed,” she added.

ESG FRAMEWORKS

Embedding an ESG framework in an approach to private market investment is hard as investors need criteria that they can understand and adapt easily. They must also be able to assess the results of the due diligence on a consisent and measurable basis if they are to achieve their targets. 

ESG does not change the level of return ACA requires from an investment, Shiang said. She added that even if an opportunity has more impact and makes a measurable difference, it has to fit into its mature portfolio, which has already had ESG due diligence built into how it was put together.

“Say hypothetically we are overweight in US real estate and a new opportunity comes along like a 'green city' — we're going to pass on it, not because it's a green city or we don't like green cities, but because we're overweight in that sector and class. Just because it's focused on ESG doesn't mean we're going to change our portfolio construction,” said Shiang.

Islamy affirms that Shariah-compliant investment, as her sovereign wealth fund is under a mandate to observe, is already “99.9% ESG” compatible.

“We generally set our target in terms of our required return on investment. When we have this target as long as we meet the target, we actually are meeting ESG requirements and fulfilling the SDGs (UN Strategic Development Goals).”

DOES ESG OUTPERFORM?

Islamy said BPHK data on the impact of investment with an ESG focus runs counter to American economist Milton Friedman’s view, set out in 1970, that a company has no social responsibility to the public or society and to take on this additional responsibility would create further costs. Referring to a BPKH investment in the food industry, she said ensuring sustainability can help investors reach their financial targets.

“For example, setting up the factory to be environmentally friendly, so the water that has been used will be automatically recycled and reused. From the analysis we have done, this will actually reduce costs, reduce overhead and will actually increase the profit margin,” she said.

Shiang said that although investors have formed a consensus that an ESG focus has "no negative impact” on a portfolio, “the jury is still out on whether ESG opportunities outperform non-ESG opportunities on a risk adjusted basis.”

Pointing to how ACA has put its own portfolio together, Shiang revealed that while it does not have “a whole lot” of purely ESG-focused investments, the ones it has gone for have outperformed during this downmarket cycle. However, she said that could be “because we picked opportunities that are health related and with Covid.”

“I think for people to say over eagerly, that ESG focus is outperforming — I can't see that. It could be that we're not picking the right ones, but we are seeing even with the surveys here that that there is no negative impact,” she said.