The entrepreneurial approach to supporting the low carbon economy

For private equity investment managers, investing in the low carbon economy can take many forms: from acquiring non-listed companies whose products or services help reduce emissions, to developing large-scale renewable energy platforms or public transportation projects. In this report from Swiss Sustainable Finance, "Financing the Low Carbon Economy", Partners Group talks about how private equity investment managers are not only ideally positioned to invest in businesses or projects that support the low carbon transition, but also to better manage the environmental impact of their portfolio assets compared to their public market peers. This is largely due to the nature of private equity investments and their inherent corporate governance advantages. A private equity investment manager typically has a strong influence over how assets are developed and managed, which is particularly true for direct investments, where an active, hands-on ownership model provides opportunities to work closely with portfolio assets to implement sustainability initiatives, such as energy efficiency and waste management programmes.

Assessing the opportunity

As the low-carbon economy is still underdeveloped, it represents an interesting investment opportunity for many investors, as well as the chance to support global action on climate change. For instance, the global shift towards clean and more efficient energy is a key trend that is expected to continue to generate attractive investment opportunities for private equity investment managers for many years to come.

The agreed international goal of reducing greenhouse gas emissions is at the heart of energy policies almost everywhere and is likely to be achieved through a combination of improved energy efficiency and a higher share of renewables in the energy system. It is estimated that USD 11.5 trillion will be invested in new power generation assets between now and 2050, of which 86 %, or USD 9.9 trillion, will go to zero-emissions technologies. This means around USD 300 billion is required per year for clean energy investment. The bulk of this investment will happen in non-OECD emerging economies.

Irrespective of any political or policy developments, OECD developed markets will also continue to add new clean energy capacity, fueled by new demand drivers such as the boom in electric vehicles, among others. Another important contributor to demand is the increasingly competitive cost of renewable energy compared to traditional energy sources. Between 2009 and 2018, the levelized cost of electricity of solar and wind energy dropped approximately 80 % and 50 %, respectively. Today, these technologies are already cheaper than building new large scale coal and gas plants in many major markets, including India, Germany, Australia, the US and China.

Besides the build-out of renewable generation capacity, private equity investment managers will also need to focus on investments that tackle the issue of renewable intermittency in order to ensure greater energy reliability. A range of strategies and technologies will be required to tackle the intermittency challenge, including battery storage, additional peaking gas-fired generation, smart meters, and increased interconnection.

Improving the ESG strategies of portfolio companies

While there is a wide range of opportunities for private equity investment managers to support the low-carbon transition through direct investments in these new technologies, the governance structure in private equity also provides the opportunity to optimize the use of resources across all types of assets in a portfolio.

Compared to public markets, private equity firms generally have smaller boards for their portfolio companies that meet more frequently, are more deeply ingrained in the business and work closely with management to direct companies towards value creation. This governance framework means that private equity investors have both the power and the mandate to take the lead on environmental, social and governance (ESG) improvements within a portfolio company.

During the due diligence process, most private market firms would exclude a company that was found to be materially underperforming in its ESG practices. But unlike in public markets, private market firms often make use of the option to invest in and engage with companies that are only moderate underperformers, so that improving these practices becomes a focal point of the value creation plan. In fact, in private equity, a company’s ESG practices are typically assessed not only in terms of their potential risk, but also in terms of their value creation potential.

As part of the value creation process, private equity firms may establish ESG engagements with their portfolio companies to improve the measurement and management of material topics that help support the low-carbon transition, such as initiatives to improve energy efficiency, waste management and supply chains. These topics are important for building businesses whose respect for society and the environment goes hand-in-hand with enhanced financial performance.

Assessing impact

Properly assessing the impact of direct investments that have the potential to support the transition to a low-carbon economy requires a suitable impact assessment methodology. For its dedicated impact investment strategy, Partners Group has identified the Sustainable Development Goals (SDG) as a useful framework, both simple enough for a wide range of stakeholders to understand, and robust enough to inform an investment strategy.

Partners Group assesses low-carbon investment opportunities against the SDG targets during due diligence, beginning with a logic model that sequences how each company or asset creates impact, both positive and negative. Next, each investment is scored on a five-point scale using our proprietary SDG target rating, which is based on the Impact Management Project’s five dimensions of impact. Finally, relevant impact metrics are identified based on the logic model created, the Global Reporting Initiatives’ Business Reporting on the SDGs and the Global Impact Investing Network’s IRIS metrics.

Once Partners Group has invested in an asset that has been classified as low carbon, within the first hundred days of ownership its ESG & Sustainability team presents the portfolio company management team with the proposed impact goals and metrics, along with risks identified during due diligence. During this time, the team works with the management team to agree on impact metrics, address how to manage risks, and establish systems to collect impact data.

You can read the full report on our website:

https://www.partnersgroup.com/en/news-views/in-the-media/detail/article/ssf-how-private-equity-is-supporting-the-low-carbon-economy/