Several asset managers, including private equity groups, have committed to embedding sustainability and environmental, social and governance (ESG) considerations into their compliance and risk practices, as demonstrated by the large number of signatories to the Principles of Responsible Investment. We think there is an opportunity for asset managers to tie ESG/sustainability more directly into their approach to value creation.

Outlined below are 10 recommendations with practical guidance on how asset managers can do just that.

Asset managers can bolster their robust due diligence practices—beyond straight financial considerations and multiple operational factors—by incorporating ESG due diligence.

ESG due diligence has a different frame of analysis that focuses on identifying stakeholders and isolating material ESG topics within the industry, geography and performance in these areas. This exercise analyzes the alignment of a company with its stakeholders and any key risks that require adjustments to the valuation model.

How is this value accretive? Identifying and quantifying ESG-related and red flag risks, if any, can enable an asset manager to negotiate a better deal with the potential client or walk away from a deal. Indeed, not making a wrong investment decision is often the most effective way an asset manager can add value for its investors.

Societal megatrends are broad, long-term trends that reflect societal objectives and guide government policy, affecting the flow of capital and investment decisions made by asset managers, financial institutions and retail investors. They take time to develop but have a radical aftermath.

Climate change, biodiversity loss, environmental degradation, aging populations, government and corporate transparency, technology and artificial intelligence (AI) and others comprise the most prominent societal megatrends.

Carbon pricing is one such factor affecting business decisions as governments look to address climate change. Businesses will further be affected as carbon prices proliferate and increase. For instance, we expect the minimum carbon price in Canada to increase to $130 per ton by 2030. Mining, transportation/logistics and manufacturing industries could implement decarbonization strategies to decrease costs.

Understanding these megatrends and their business implications can help asset managers bolster their value-creation approach.

Regulations are tightening globally to standardize ESG disclosures. For example, in the U.S., the Securities and Exchange Commission (SEC) and California have introduced climate disclosure requirements, and the European Union (EU) has expanded sustainability reporting requirements, including validating supply chains in specific industries.

Using technology-led solutions can help companies address these requirements cost-effectively to avoid fines, penalties and/or a loss of business.

The Inflation Reduction Act, for example, has dramatically expanded incentives linked to green energy, energy efficiency and decarbonization. Likewise, asset managers can utilize additional tax incentives, including state-level programs, to support decarbonization and energy efficiency efforts.

Optimizing infrastructure, production inputs and natural resources can lower operating and capital expenditures and improve societal outcomes.

ESG helps companies think holistically about their value chains and, in turn, increase collaboration to strengthen resource efficiency and generate shared value: value generated by actors across the value chain working together to solve shared challenges.

For example, adopting more circular production methods can significantly reduce waste while improving resource efficiency. Additionally, collaborating with suppliers to address logistical challenges can improve productivity across the value chain and lower greenhouse gas (GHG) emissions.

Consumers value sustainability now more than ever.

Assessing the extent of this sustainability premium—often considered a proxy for quality—depends on multiple factors that asset managers should discern, including substantiating their products’s sustainability and integrating them into their marketing strategies if warranted.

Differentiation can be particularly value-accretive in highly commoditized and competitive industries.

Financial institutions are significant proliferators of ESG; not coincidentally, sustainable companies are associated with better financial performance.

Over the last decade, the sustainable loan market has grown exponentially. Global sustainable lending activity grew from $6 billion in January 2016 to $322 billion in September 2021.

Asset managers can utilize sustainability-linked loans to decrease borrowing costs where the loan terms are proportional to the sustainability performance. Taking a portfolio-wide approach can be a particularly value-accretive strategy.

Industries like mining, energy and manufacturing depend on building and maintaining a social license to operate. This dependence reflects the extent of community and local support a company must develop to maintain its operations.

A change of ownership of a company that may not have a strong social license can be an opportunity to do things differently, and proactively building social capital can be critical in these situations. Building a presence can be as simple as utilizing sentiment tracking software to determine what community members are saying about the undertaking and taking steps to address concerns. Engaging local suppliers can also be a powerful way to build social capital and community support for a company and project.

Better ESG ratings are associated with improved financial performance, particularly over the long run. Companies that embrace ESG are better protected from downside risk, and corporate sustainability initiatives are associated with improved risk management practices.

Asset managers with an initial public offering (IPO) exit strategy should improve their company’s ESG rating. Early assessment can help asset managers prioritize initiatives in the value creation plan and implement the necessary governance structures to integrate ESG considerations into a company’s DNA. Come IPO time, a positive ESG rating can lead to higher exit multiples.

Finally, asset managers must communicate how and to what extent they have built ESG into their value-creation methodologies while providing tangible examples. It serves as a valuable element to showcase differentiation in order to attract investors and streamline fundraising efforts.

Asset managers, however, need to be sure they can substantiate their claims and should be careful not to oversell the plan.

As ESG continues to proliferate, asset managers will face increased pressure to make ESG disclosures and build them directly into value-creation strategies. This practical guide provides 10 steps, but several other avenues may exist. ESG, if done effectively and strategically, can be a significant differentiator and competitive advantage for companies globally.