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Using the SDGs as a Guiding Light: PEI Keynote Interview

The UN’s 17 Sustainable Development Goals are often referenced as part of efforts to promote social and economic development in developing countries. New York-headquartered Blue Wolf Capital Partners, however, also sees the goals as valuable in helping to guide its strategy for a portfolio that largely consists of US-based healthcare and industrial companies.

Adam Blumenthal, the firm’s founder and managing partner, tells Private Equity International that by providing a framework for stakeholder value creation, the SDGs complement ESG frameworks that emphasise quantitative reporting of key performance indicators. Blue Wolf, he says, has found that ensuring portfolio companies deliver on the SDGs puts these businesses on a stable long-term footing and helps generate returns for investors.

Question: Why is private equity investing suited to promoting ESG principles and the SDGs?

As a private equity firm, we design the strategy through which our portfolio companies generate value and secure returns for our investors. We take seriously the choices we make in doing that – there is more than one path to value creation. As a private equity GP, you have the ability to make those choices and to control critical aspects of how companies behave.

At Blue Wolf, we think of environ-mental, social and governance considerations as being a crucial part of our strategy for building companies that are going to have long-term sustainable value. Every time we make a decision to focus on ESG, we make a choice to create value for our investors – and I argue this approach has been critical to our ability to generate top-quartile re-turns over our history.

The Sustainable Development Goals represent a global consensus on what kind of companies and societies are going to support long-term sustainable growth. It is important to us that we take into account the SDGs, since these set the parameters for the long-term macro environment within which our businesses operate.

Question: What do LPs expect from you in terms of ESG?

There is a range of investor sentiment. We have LPs that are purely interest-ed in whether we are delivering on our return forecasts. They are less interested in the underpinnings of our strategy. All they know is that it works, and that is fi ne with them when we post the numbers.

Then there are investors for which the SDGs and other global regulatory or ESG frameworks are important. We have a sustained dialogue with investors that look for GPs to align their strategies with the SDGs while generating attractive returns – and some of these investors have become loyal and substantial investors in our funds. One of the great things about the strategy we have embraced is that we can draw a direct link between the achievement of ESG goals and financial performance.

Question: To what extent is a standardised framework helpful to private equity investors looking to manage ESG risk and opportunities?

There is a lot of discussion around frameworks in the ESG world. It is worth bearing in mind that some 2,000 years after the initial development of double-entry bookkeeping, we still have not come up with a standardised financial accounting framework that people accept across the globe. To get to a standardised framework for dis-cussing the ESG aspects of investment will take time.

It is positive that there is so much effort today being put into creating those frameworks. It is helpful that frameworks are emerging that allow for the quantification of easily report-able KPIs, because quantification and standardisation are important for the development of data that can be measured and managed. However, these frameworks are often not easily correlated with value creation.

The SDGs are a type of framework that can link to strategy, outcomes and value creation, considered broadly – that is value creation not just for the company, but for societies and economies as a whole. They provide a framework for stakeholder value creation and having a common language for discussing stakeholder value creation will ultimately be an important part of the maturation of the ESG movement. Of all the frameworks out there, that aspect of what ESG is about is extremely well captured by the SDGs.

Question: Looking forward, how can the private equity industry better align with the SDGs?

The growth of private capital markets and private equity into a significant force in the global economy has been one of the defining economic developments over the course of my career. As the private equity industry has matured, its responsibility to the broader economy has become more evident.

As it continues to mature, we need to focus more on the principles through which the private equity industry contributes to the global economy. For instance, many private equity funds – both at the largest level and in the mid-market – have been pursuing the idea of employee ownership as a way of addressing inequality. Over the course of the next five years, I think we are going to see that idea sweep through the private equity toolkit. After all, what is more in keeping with private equity’s reason for being than creating aligned incentives to drive growth throughout the portfolio? That is what the private equity industry is about.

Question: How has Blue Wolf operationalised its approach to ESG integration and alignment with the SDGs?

Like most private equity firms, we are strong believers that you cannot man-age what you do not measure. So, if we are committed to an ESG strategy, we need to capture core metrics, report them consistently over time, and drive them towards a value-creating outcome.

For example, we have established a safety, health and environmental programme that seeks to establish top-quartile safety, health and environ-mental performance and compliance at every portfolio company. We have developed a disciplined, metrics-based approach to measuring our progress, and we tie progress to executive compensation. By doing that on a consistent basis, we have had a great deal of success in moving the portfolio in the right direction.

Aside from capturing metrics, we integrate core ESG themes into the creation of our investment strategies. We have identified seven core ESG themes – every one of which is easily linked to one or more of the SDGs – that are fundamental to our investment strategy, and we look at those thematically as foundational to the value-creation strategy in our portfolio. By linking the metrics-based and thematic approaches to value creation, we think we have created a broad and robust programme.

Question: Blue Wolf is mainly focused on the US market– are the SDGs as relevant in this context as in emerging markets?

There is a growing problem of inequality in industrialised societies. This is broadly recognised as something that needs to be addressed to sustain competitiveness and growth, and I think the SDGs are an excellent framework for discussing those kinds of issues.

About half of our portfolio is health-care-related and one of our principles is to support the healthcare framework Triple Aim – which means achieving better health, at a lower cost, with a higher level of patient satisfaction. An-other principle is to invest in under-served communities, both in rural and urban areas. Both principles are well aligned with the SDG goals of improving health and wellbeing and reducing inequality.

An example of this in practice is Blue Wolf’s investment in Modern-MD, a healthcare company in Brooklyn, New York. We established the company in a joint venture with a local hospital in 2014, after the passage of the Affordable Care Act. Our ESG scan highlighted that the influx of newly insured people would give us the opportunity to address the large unmet demand for primary care in Brooklyn and to create jobs in an underserved community. Fast forward to today, and that company has delivered primary care, plus covid vaccines and testing, to more than 225,000 people during the past year. Naturally, that makes ModernMD a vital part of the community. That is a great example of using ESG principles and the SDGs to have an impact while generating returns for our investors.

Question: Outside of Blue Wolf’s healthcare portfolio, how do you implement your ESG principles?

Our firm began life making industrial investments, so we have a long, proven track record of building companies through this strategy. Some of the in-vestments we made along this route have been in the rural American South, building sawmill companies. We initially invested in a sawmill located in rural Dixie County, Florida, which has one of the highest poverty rates in the state. The sawmill was a vital local employer, but it also had significant environmental contamination issues that had put the company at risk.

We had the opportunity to acquire the company and then put our capacity for brownfield remediation – which we developed in connection with our ESG goals – to work. We became part of a broader community effort to promote economic development and, as a result, became an employer of choice in the region.

That company then doubled profit-ability and became marketable because of the brownfield remediation. We did something similar with a closed saw-mill in Arkansas, which we reopened and revitalised. That generated great returns for our investors, and for those communities in Florida and Arkansas it created jobs and a clean environment for people who may otherwise have had to move away to find employment opportunities.

Finding Value Through an ESG Lens: PEI Keynote Interview with Blue Wolf Capital

New York-based Blue Wolf Capital, which has a portfolio made up largely of healthcare services and industrial companies, found itself on the frontline of the covid-19 pandemic in the early months of 2020. Adam Blumenthal, founder and managing partner, tells Private Equity International that the firm’s long-term focus on environmental, social and governance factors was fundamental to its ability to cope with the pressures brought by covid-19. Meanwhile, Blue Wolf’s attention to the ‘S’ in ESG is at the heart of its strategy to unlock value as it prepares for life after the pandemic.

Question: How has Blue Wolf been affected by covid-19 and how has it responded to the pandemic?

Due to the healthcare services aspect of our investment portfolio, we were aware of the likely impact of covid-19 very early. That insight meant we were able to educate our employees and put in place support across the portfolio to maintain safe workplaces and behaviours at our companies.

Through our longstanding Safety, Health and Environmental programme, we already had infrastructure in place that allowed us to not only roll out best practices but also to encourage broad cross-portfolio engagement of resources – which was necessary, because all our portfolio companies continued operating throughout the pandemic. All of them were deemed essential. We had to keep going and remain safely operational, despite the disruption.

Whether it was on the healthcare or the industrials side of the portfolio, we witnessed the heroism of frontline workers as they met the needs of society in the pandemic. We have a group of outpatient healthcare facilities that operate in areas of New York that were at the centre of the pandemic. Everyone around the world saw what was happening in Brooklyn. We had urgent care centres there, and people kept coming into work every day in the midst of covid-19, and had their workload increase.

The only good news is that now we have a year of experience on how you manage in a pandemic at a high-performance level, while keeping people safe and meeting society’s needs. We are far better prepared to do that today than we were a year ago.

Question: Blue Wolf has been focusing on ESG for many years; how did that contribute to the resiliency of its portfolio when covid-19 arrived?

We have always had a focus, portfolio-wide, on managing human capital and on employee health and safety. We think that engagement with our employees is an important driver of business success, and we have formal governance systems to ensure our portfolio companies are doing that – that is getting onto the ‘G’ in ESG. You need a governance process. Without the ‘G’, it just does not happen. You need to know what you are doing and measure it through board committees.

We have used the ‘G’ features of ESG to put in place supports for the ‘S’. Having emphasised employee health and safety at the board and C-suite level for many years, when the crisis hit we did not have any questions about what our priorities would be or need to invent any new tools. If there are no questions about priorities and if you have the tools, it is easy for people to do the right thing.

We were able to track covid-19 infection rates across the portfolio and we found that less than 5 percent of our employees who contracted covid-19 were infected at work. We were able to demonstrate that if you are focused on providing people with a safe place to work and with the tools and the education to work safely, then it can be done. We are extremely proud of our work to make that happen.

Question: The pandemic has highlighted inequalities in the US healthcare system. What is Blue Wolf doing to address these?

The American healthcare system is well known for its inefficiency. Although the US has some of the best healthcare in the world at the highest level, on average it provides lower-quality outcomes at a higher cost than in many other developed nations. Closing that gap is a driver of value.

Blue Wolf’s approach to healthcare can be summarised by something called the Triple Aim – having better health, at a lower cost, with a higher level of patient satisfaction. We believe that the way to tell if you are creating value in American healthcare is whether your strategy is delivering on the Triple Aim. That has led us to embrace distributed home and community-based services that improve population health.

An example of this is portfolio company FOX Rehabilitation, which provides home-based physical therapies to a geriatric population. We have been putting physical therapists – with adequate PPE and testing – into the homes of 80 or 90-year-olds during lockdown. We help keep these people healthy, even though their mobility is restrained. We have great partnerships with assisted living facilities and senior citizen advocacy groups, because we can deliver the care where it is not happening otherwise.

We think that the way to lose money in healthcare over the next decade is to provide high-cost luxury services. The way to generate value for society and for investors is to use the Triple Aim to provide quality outcomes at a lower cost, in the way that the rest of the world has proved it is possible to do. Since the pandemic, valuation multiples on homebased and community-based care have increased dramatically. Covid-19 has made it clear that they are a critical piece of creating value in the system.

Question: 2020 exposed various social problems in the US. Can private equity investment help neglected communities while delivering returns?

With some of our industrial investments, we are the largest employer in small towns in America. We have operated sawmills in Dixie County, Florida, and Glenwood, Arkansas; paper mills in Madawaska, Maine. When we make an investment in a place like that, the advantage we have is that we are the only private equity company around. Because we are off the beaten path, typically, we can invest at valuations that are quite compelling.

We use ESG as a lens to find value creation opportunities. The fact that there is a lack of investment capital in these areas creates the opportunity to acquire attractive assets at low values. You get talented people, low-cost inputs and do not have a lot of competition.

However, it is not an anonymous world in Glenwood, Arkansas – your plant manager is going to have breakfast at the same café as the janitor. When you are operating in that environment, you need to be a community partner if you are going to be an employer of choice for the most talented people in the community. We view that as a business strategy as well as the way businesses need to behave.

Question: Does this approach extend to partnering with your workforces?

We have successfully invested in unionised companies since our inception as a firm. In a regulated environment, like healthcare, working collaboratively with unions is important. We approach our relationship with unions the same way we do with sources of financing or customers, and over 15 years, we have conducted ourselves so that we have a relationship of trust with unions. We negotiate hard for business success, but we tell people the truth and we recognise that unions and their workforces have a vested interest in the success of the company.

The result has been that we see investment opportunities that other people do not, because unions will call us and say: “Hey, we’ve got a problem at this company, is there a way you can buy this and fix it?” Usually we can’t – but when we can, that is a really remarkable piece of off-market dealflow.

Question: Will disruption to supply chains during covid-19 encourage investment in US manufacturing?

In our mind, it is about balance. American business followed a model of outsourcing to low-wage economies for many years that created structural risk within their supply chains. What is happening now is not a 180 degree turn from there, but companies are acknowledging the risks and investing to mitigate them. It is tragic that it took a pandemic for people to recognise that risk. We have been trying to mitigate it for many years. For example, we bought a building products company in 2016 and invested in domestic manufacturing to make sure we can always meet short-term demand. We want to have that kind of balanced, robust, resilient supply chain.

Question: What are the main lessons from the past year? Can interest in ESG be sustained?

ESG is a lens for value creation – it forces you to see things that others don’t, in ways that others don’t. I believe the private equity community is serious about embracing this approach.

As an investor, you have to see problems that become evident today as opportunities to invest for the future. Certainly, the pandemic has highlighted problems in our society and economy, ranging from the vulnerability of our supply chains, to the quality of our public health infrastructure. At the same time, operating in the pandemic has made clear there is room for innovation to address those problems. The pandemic has taught many people how to operate in a safe and systematic way – that is an innovation that has been broadly accepted throughout our economy.