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  4. Episode 29: Bespoke ESG Materiality Data vs Broad ESG data

Guest speaker:

Meg Starr, the Global Head of Impact at The Carlyle Group.

Bespoke ESG Materiality Data vs Broad ESG data: Why We Need Both?

Episode 29 | Duration: 17 minutes

Materiality is one of the most critical aspects of ESG for many investors. The key question is whether investors should only look at those ESG issues that are material for a given company or consider a broad set of ESG factors that are comparable across businesses?

  • Keesa Schreane [00:00:10]  Materiality is one of the most important aspects of ESG for many investors. But the key question is whether investors should only look at ESG issues that are material for a given company or if they should consider a broader set of ESG factors that are comparable across businesses. Now, what happens when investors focus on material data exclusively? Do we need to adopt a different approach? Joining us for this discussion is Meg Starr, the global head of impact at the Carlyle Group. Meg, thank you for joining us.  

    Meg Starr [00:00:48] Thank you so much for having me.  

    Keesa Schreane [00:00:50] So let's kick off the conversation with just the fact that people really love talking about ESG data. But when you break it down, what utility is there for an investor?  

    Meg Starr [00:01:02] I love starting with this question, because when we talk about ESD data, I think it's really important to ground the conversation in the question. What's the point of ESG data? I'd say we focus on two main use cases. The first is how do you use ESG data to make better investing decisions. The second is how do you use data to convey important information to investors and shareholders. I think if ESG data collection isn't oriented towards one of those goals, it can quickly become a marketing or a compliance exercise, which really plays into the worst stereotypes of what ESG is. I think the interesting question is how do you use ESG data to draw better insights, mitigate risks, capture growth markets and really drive financial values? As private markets become more and more efficiently priced, I think in ESG as an underutilized lens for finding inefficiencies and ultimately alfa. But to do that, well, you need good ESG data, which tends to be quantitative performance data, not binary indicators of yes/no this company has a diversity policy or yes/no they disclose it.  

    Keesa Schreane [00:02:18] And I'm glad you mentioned that sometimes these things are perceived as marketing opportunities or marketing campaigns. So thanks for clarifying that. I want to look specifically at bespoke material data. So is this primarily the data that matters for investors?  

    Meg Starr [00:02:40] I would say this isn't the only data that matters, but it is really important for driving financial value within individual companies. So at Carlyle, we use SASB, the Sustainability Accounting Standards Board, as a materiality framework to design a core set of quantitative ESG KPIs. The reason those data are important is first, that data can really help target interventions to reduce costs and drive value. I think energy is a pretty obvious one. If you're tracking energy use, if you're tracking carbon dioxide emissions, it can help you find inefficiencies in areas where you can really drive down costs. But there are other areas that you can track and monitor as well. Employee health and safety is a great one. We work with one of our portfolio companies, Paradigm Precision to focus on, reduce lost time instances across their manufacturing facilities. They reduced lifetime instances by about 55 percent over two years. Huge social win for the safety of employees at a huge cost win as well. Similarly, there's a lot of interesting data around health care, Veritas Technologies, other portfolio company of ours, a tech company with about 7000 employees. We help them move from a traditional healthcare carrier model to a healthcare navigator model where their decentralized person that helps their employees navigate the healthcare system. Over a couple of years of using that model, they had a far higher than average annual physicals, which led to earlier disease detection and lower specialty drugs. And that that coordinated approach not only helped them improve the outcomes for their employees, but reduce health care costs by about 25 percent per employee over a two year period. But the number one is it can really help target interventions or reduce costs. The second driver is that better ESG data tailored to a company can help a customer acquisition increase. Increasingly, the next generation of customers really values sustainability traits. So you can use data to get differentiated certifications, palm oil free products, EPA favor, choice products. And in fact, a lot of ESG data is now required by many of the larger retailers in order to sell into their stores and can really determine your shelf space. If you have a cleaner, greener products, increasingly you get front of shelf space. And I think the last thing I would say is that material, bespoke data is increasingly being valued by the public market and other investors, which is really important to us. As we look to potentially exit investments, we did some research in February, for example, and saw that if you can take a typical oil and gas company and transition it from zero percent of revenue from renewables to 30 percent of revenue from renewables, you could double the results. But there are some really interesting ways that by tracking very bespoke, very tailored ESG data that can help drive much more insight to our investment decisions around cost basis or growing revenues, increasingly around the value of a company.  

    Keesa Schreane [00:05:59] And those are such great nuggets there. I am actually still on your point about the shelf space that is. So I just think is that something that you would say was not the case maybe five years ago, that you did not have to have that branding and the message and the reality of the issue behind your brand to get that premium shelf space?  

    Meg Starr [00:06:20] Definitely. I think that's been a real shift we've seen in terms of consumer preferences, but also increased transparency around what is in the products that consumers are purchasing in certain regions. That's driven by legislation. So, for example, the user reached legislation. But I'll give you an example of a U.S. portfolio company of ours, a company called Wineman, which makes specialty cleaning products for the home. We acquired them in early twenty nineteen. And a growth thesis we identified was this shift in consumer demand to a cleaner, greener products. And we had a couple of things right off the bat. Wineman had a really strong approach and was already focused on this area. But one of the first things we did in partnership with them was to put a sustainability expert, put a background in chemical engineering on their board of directors. We also worked on getting a bunch of their products certified under these different regimes. So, for example, getting a product certified is EPA safe or choice, or getting certain materials and the EU reach customer lists. So we were reformulating from the chemical ingredients to make sure that the products we're getting were certified. An interesting way to your point about the retailers. We help them with their sustainability scorecard for Wal-Mart, which Wal-Mart requires of all their suppliers now. And in one year, their scorecard went up 24 percentage points, which again, really helps. That's a great example of saying it's a really strong company that was focused on this growth theme. But some of the tools of private equity, making acquisitions, bringing in board expertise, and really helping develop the internal capacity is what helped create the need to adapt to this increased consumer demand for these products.  

    Keesa Schreane [00:08:25] So Wineman is a great example, you talk about the shift in consumer behavior and really consumer attitudes, as well as how the board can influence in that way. I want to talk a bit about another use case that we actually spoke about right before the podcast, which was a Spanish jeans producer. And basically, I will let you share the background. I was really interested in how consultation could lead to something as tangible and real as reduce water usage or gas usage. Tell us more about that.  

    Meg Starr [00:08:57] Yeah. So Jenealogia is the company you're referring to and it's one of my favorite companies and I'm probably not supposed to say that. But Jenealogia is a Spanish company that finishes denim. And so they have a special technology that helps finish garments as part of the global fashion industry. And so the technology that they have actually saved a significant amount of water, energy, and chemicals relative to peers. They use about 85 percent less water relative to the other technologies in the market. And you know, this technology is used to create about 15 percent of the world's six billion jeans that are produced every year. The huge footprint there. In 2013 alone, the firm's technology saved about 10.7 Million cubic meters of water.  

    Meg Starr [00:09:49] So we've been tracking these bespoke ESG KPI because it's really core to the business. Number one, if you're using less energy, less water, less chemicals, that reduces your cost basis. Number two, it also really increases your revenues because increasingly people are going to want to buy that technology because it's more efficient. And it also helps demonstrate the sustainability characteristics which end denim consumers are increasingly valuing. Then the third piece, which I think is the most interesting, is that we actually use those ESG KPIs to link that data to financing that we did at the end of last year. And Jeanologia data was linked to that ESG criteria, which I think it's pretty interesting. So the cost of their debt was linked to the water reduction target. And the company hit the annual water savings target, then the price of their debt goes down. If they miss that target by 15 percent or more, the pricing ratchets upward. I do think Jeanologia is a really great example of that material data helped reduce costs, increase revenues, and now led to a pricing premium on their debt.  

    Keesa Schreane [00:11:10] So great example there. And I'm just wondering, we think about the differences across sectors. I'm wondering if we can compare ESG data across companies and across sectors. I want to call out here that the concept of materiality might differ from sector to sector first. Right. For example, Refinitiv's materiality matrix scores takes into account the fact that not all metrics have the same importance to every industry. So with that being said, Meg, how can we look at standardizing and really looking at a comparable approach when you have different sectors that have different issues or challenges?  

    Meg Starr [00:11:52] I love this question because I think it represents a really interesting moment that we are in the ESG space. And I think there's sort of two schools of thought here. And I'd like to posit that both schools of thought are right. So one school of thought says we need this material, bespoke ESG data, because that helps us really understand a company target interventions, build a better business. The other camp says, yes, but we need standardized ESG data that is relevant across industries, across sectors, because investors need principal data. If we're really going to move flows of capital here, they need metrics that look like things like IRR or Moic that we have in the traditional financial side.  

    Meg Starr [00:12:35] And my response to that is that neither side is wrong. But we need both. And I think the approach that makes a lot of sense is to take this barbell approach of saying, on one hand, we need the material, bespoke data. But you also need to complement that with portfolio-wide metrics that are comparable across companies. I'm so I'll give one example of the data that we're tracking across our portfolio companies. I think diversity and inclusion is increasingly an issue that is material across a whole host of companies, regardless of the industry and the geography, etc. So we track data across our portfolio. Companies use the diversity of the boards of directors, management teams, and direct reports to the CEO and the broad-based workforce. What I think is interesting is that it really helped us get a better sense of where we are across our portfolio and importantly, where we can find real financial correlations between ESG data and financial performance. So we did some research and we published it recently. Carlyle's 20/20 Impact Review came up two weeks ago at Carlyle.com/impact if anyone wants to read this report and get more detail. But we basically looked over the past three, four years of our portfolio companies. And because we have that detailed diversity data, which we can then tie to the detailed financial data, we track these portfolio companies, we could start really pursuing it in an interesting way. And we found that our portfolio companies that had two or more diverse board members have nearly 12 percent faster-annualized earnings growth than our companies that don't have diverse boards of directors. An interesting thing. we could go even deeper. So we controlled for industry fund vintage year and found that each diverse board member is associated with a 5 percent increase in annualized earnings growth. And so there is a kind of a clear correlation for each additional diverse member. Data like that is vital because it helps us demonstrate empirically the tie between ESG factors and broad-based financial performance. And that, in turn, helps us set goals across our portfolio and really start driving more systemic change and the issues we know that are material broadly, such as diversity, inclusion in the energy transition. Engaged employees, etc..  

    Keesa Schreane [00:15:06] And it's great to hear the numbers that are attached there, and I think the more that we call off the numbers, the better off we'll all be. In terms of linking ESG KPI to pricing targets, in terms of linking ESG KPIs to performance. How are we able to do that?  

    Meg Starr [00:15:27] I think the real shift we've seen in the field is that ESG data in its earliest forms, I hesitate to even use the word "data". A lot of times it was scores or ESG reporting and so, again, it was these binary indicators. Yes. No, we have a diversity policy. Yes. No, we disclose it. We really know in advance in our understanding and maturity of what data looks like. And so instead of just focusing on do they have a diversity policy? We can actually get in the weeds and measure the diversity of the workforce and leadership teams. And I think a real shift has been saying that if we want to use this data with the rigor that we use financial data, we need to shift towards performance-based, numeric ESG data. And that in turn then can be used to link to financing so linked to financial performance. And I think it just represents the next generation. You see data and ESG data in its best version of itself, you know, being used to help drive better investment decisions and real financial value.  

    Keesa Schreane [00:16:36] What a great way to end, performance-based numeric ESG data is the next generation of ESG data. Love that. Meg Starr, thank you so much for joining us.  

    Meg Starr [00:16:47] Thank you very much for having me. This is was very fun