Private equity may offer a wide variety of early-stage opportunities, but transparency and liquidity concerns may favour listed sector.
The ideal scenario for any modern-day asset owner is to both drive financial returns and deliver positive social and environmental impacts. However, it remains challenging for responsible investors to navigate public markets that still heavily feature legacy industries such as oil and gas, not to mention their financiers and customers.
With this in mind, many investors are increasingly looking to grow their private market exposures, partly to meet their climate-related targets through investments in cutting-edge solutions.
This is adding further momentum to an established shift. Institutional investors allocated nearly 12.3% of their assets to private equity (PE) in 2019, according to a report by global management consultant firm McKinsey, representing a 24% increase since 2008.
“The vast majority of companies around the world are private,” points out Joshua Brunert, ESG Senior Associate at global financial services provider Apex Group, noting the potential for untapped opportunities.
In terms of investability, the balance remans in favour of public markets. In 2019, there were 41,000 listed companies in the world, with a combined market value of more than US$80 trillion, according to the Organisation for Economic Co-operation and Development (OECD). In comparison, total AUM across private markets grew by 5.1% to reach US$7.4 trillion last year, according to the McKinsey report.
But investing via PE allows asset owners to specifically target up-and-coming, scalable companies offering innovative climate solutions and more easily secure a larger stake than in public markets. This is appealing when considering the rapid growth of the renewables sector – and the innovative solutions that will help the world transition away from carbon-intensive industries.
For example, technology-focused impact investing PE firm EV Private Equity previously invested in Halfwave – a platform aiming to transform maintenance of pipelines transporting oil and gas and improve offshore wind farm efficiency by further reducing greenhouse gas (GHG) emissions. Halfwave uses innovative proprietary technology in an automated inspection service that quickly alerts clients to outages, leaks and under-performance.
Big names are homing in on private markets to achieve sustainability objectives. Lead singer of U2 Bono entered the PE space in order to bolster impact investments in 2016, when he co-launched a US$2 billion impact fund, Rise, with TPG Capital. Earlier this year, Bono recruited former US Treasury Secretary Henry Paulson to join the team managing the TPG Rise Climate fund as Executive Chairman.
The TPG Rise Climate fund has announced its first close at US$5.4 billion in subscriptions, and aims to invest in a wide range of commercially viable climate technologies backed by early-stage investors, researchers and climate innovation accelerators. Investors in the fund include AXA, the Ontario Teachers’ Pension Plan Board, Universities Superannuation Scheme (USS) and the Silk Road Fund.
Although private is an increasingly popular path, investors are not yet discounting lower risk listed routes to fledgling companies that could make a positive difference in the renewables market.
Big money, big opportunities
Sometimes unfairly perceived as laggards in sustainable investing, more PE firms are incorporating ESG into their risk analysis and actively looking for ESG-related solutions.
Investments include “start-ups working towards lowering the carbon footprint of buildings, precision farming technologies and autonomous maintenance technologies in forestry”, says Peter Dunbar, Senior Specialist of Investment Practices for UN-convened Principles for Responsible Investment (PRI). Last month, the PRI launched its Climate Hub for Private Markets, providing investors with guidance on how they can support the path to net zero through private investments.
A growing number of PE firms solely invest in sustainable themes. For example, Miami-based asset manager Hudson Sustainable Group developed a PE arm that looks for opportunities in renewable energy, battery storage, grid infrastructure, electric vehicles and related software applications. Investments include Recurrent Energy, a developer of distributed solar photovoltaic projects for utilities and GSEI, a China-based operator of solid waste to energy services.
“We absolutely see further opportunities to invest in private organisations that are explicitly developing green infrastructure or technology as a means to quicken the transition,” says Callum Stewart, Senior DC Consultant for investment consultancy firm Hymans Robertson.
With US$11.3 billion invested into PE-funded renewables projects last year, according to Fitch Ratings, asset owners will likely continue looking for private market opportunities that contribute to the sustained growth of the renewables industry.
“There’s especially going to be a lot of private investment in renewable infrastructures,” agrees Denise Molina, Director of Equity Research at Morningstar. “It will be really challenging to maintain the renewables market without backing new products and software.”
Competition between PE managers in the renewables space will soar, says Stewart, “meaning they need to show institutional investors that they are able to positively influence companies on sustainability-related issues, as well as identify the fledgling companies that have the capacity to drive strong returns over time.”
As noted by the Global Impact Investing Network (GIIN), PE is already popular with impact investors, but impact and sustainable investing is still a small but growing part of the PE universe.
A survey conducted by Big Four accountancy firm PwC noted that 17% of PE respondents have dedicated impact funds or are planning on setting up an impact fund in the next year, with 14% planning to investing for impact in the future. A further 45% said that, while they don’t have an impact fund, they are already measuring or managing for impact, using screening frameworks to seek out investment opportunities delivering on environmental factors.
As competition intensifies, many PE firms may seek to offer wider future exposure to renewables projects based in emerging markets. These could, says Dunbar, deliver impact at a level “much higher than in developed markets”.
This is already beginning to happen. Between 2008 and the first half of 2015, PE general partners (GPs) raised an aggregate US$32.3 billion for power-dedicated funds and power-inclusive clean technology and infrastructure funds in emerging markets, according to the Emerging Markets Private Equity Association (EMPEA).
Control versus transparency
Potential opportunities abound for renewables investment, but what about the risks in reality? Big investments via PE typically afford asset owners larger stakes in private companies. This translates to asset owners having a more “direct hand” on company direction, says Brunert.
This is an attractive prospect for responsible investors looking to dramatically decarbonise their portfolios and prioritise climate-related performance.
“Most PE investments are either majority control deals or influential minority investments. Given the degree of influence PE firms can exert over portfolio companies, they are in a strong position to help investee companies understand the importance of net-zero and help them through the process of making their own net-zero commitments,” says PRI’s Dunbar.
Climate-focused or not, PE firms have a track record of being able to move quickly, responding to new and evolving expectations from asset owners and enacting changes within portfolio companies.
However, private markets are typically a lot less transparent, meaning that asset owners must conduct comprehensive ESG-related due diligence before investing in an unlisted company to ensure that climate-conscious pledges (like net-zero targets) are supported by evidenced action, experts warn.
“The caveat is that, once an asset owner is invested [in a private company], it’s a lot harder to exit, leaving them vulnerable to increased risk,” says Brunert. Although, with a typical PE investment time horizon lasting four to seven years, long-term investors may be relatively sanguine if they’re temporarily trapped in a PE fund that doesn’t work for them.
Nonetheless, the world’s largest asset manager BlackRock issued a note in 2019 calling for PE firms to consider a longer-term approach to ESG-related investing to capitalise on performance, meaning asset owners could risk being stuck in that fund for a longer period of time.
In contrast, public markets are generally both more transparent and more liquid, lowering an asset owner’s risk of being overly exposed to companies not delivering on climate targets. With many asset owners preferring engagement to divestment, the liquidity risks between public and private investment strategies may be small.
Finding the right balance
Given their respective pros and cons, climate-conscious asset owners could benefit from a strategy that targets a mixture of public and private investments.
Established listed firms still offer significant opportunities for investment in innovative solutions that reduce emissions and support use of renewable energy sources. According to a recent Morningstar report, two examples include energy management solutions for buildings and streamlining “bidirectional and volatile energy flow” from sustainable energy systems like electric vehicle charging points, also known as grid edge automation. Both of these markets are expected to grow by 30% over the next five years.
By measuring the performance of four European listed utility and automation companies – Siemens, Schneider Electric, Legrand and ABB – Morningstar predicted organic revenues will grow by 5-6% over the medium term because they have “significant revenue exposure” in these areas.
With private market solutions expected to become a bigger part of investor portfolios over time, much comes down to how much of a risk the asset owner is willing to take. After all, PE investors have to be confident that a narrowly focused solution offered by a fledgling company is actually going to be successful, warns Morningstar’s Molina.
“If nobody is buying that solution, or only a small number are, then you’re not really having the impact you wanted, especially when compared to big established public companies that offer a broader exposure,” she says.
With the International Energy Agency (IEA) 2050 roadmap predicting that almost 90% of global energy generation will come from renewable sources by 2050 (with solar PV and wind accounting for around 70%), asset owners can be confident that investing in renewable-driven solutions – public or private – will deliver strong financial performance in the longer term.