VX2011 Panel: Climate Finance—Show Me The Money!
Allan Emkin (PCA): Recognizing that we’re capitalists and we’re fiduciaries, we still believe that it’s a good idea to invest in this space, whether it’s to save energy, to clean the air, conserve water, or a variety of other things. The three panelists represent three different perspectives in the capital markets.
Brian Rice (CalSTRS): We have about $145 billion in assets under management right now. We invested in equity, fixed income, real estate, and private equity. We also have an innovation and risk group, which test drives new investment ideas, and we’re starting a new absolute return strategy, which I believe will focus primarily on infrastructure. We have a lot of policies and principles in the investment department, and one of those principles is that we try to invest in companies and assets that have a positive effect on the environment.
For a bit of background, in 2004, as part of what was called the green wave, the board of directors had CalSTRS make a commitment to develop environmental-related investments across the portfolio. Because we’re here at the beginning of 2011, it might be appropriate to tell you where those investments stand in our portfolio. In our equity group we have a sustainable management program, which is about $600 million right now in value.
As Allan pointed out, we’re fiduciaries, so this was started with the intent to make money, so there was what they call a double-bottom-line goal of environmental and investment performance or out-performance. They’re doing pretty well inception (2006) to date. Our non-U.S. portfolio has about 650 basis points of alpha, and our U.S. portfolio has about 250 basis points. On fixed income, we’ve just started to buy into green bonds, which is something that’s starting to be developed right now.
What they also do, which is interesting, in that asset class is a sustainability overlay: they look at their existing portfolio, they’ve taken a composite index, looking at the Dow Jones and the MSCI sustainability index, taking components of those, the U.N. principles, the equator principals, and coming up with this hybrid index. They lay it over their existing portfolio to see the degree to which that portfolio is sustainable. In real estate, the focus has been on building efficiency. We’re looking to make our properties more efficient, and than that’s a criteria in investments going forward. Eighty-five percent of our separate account office buildings are now EnergyStar certified, and about 40 percent of them are LEED-certified. We’re working to improve those numbers. In private equity, we have a $600 million commitment to clean and green technology. About 80 percent of that is buyout, and 20 percent of that is venture. At the same time, part of this commitment was not only for investment opportunities, but it was to take a look at the risks. At the time, our board felt the climate risk was something that could be quite material to the portfolio and something that we needed to learn more about and develop a program to manage that risk. That’s one of the principal responsibilities that I have there.
We do several things. One of them is supporting organizations that promote climate or environmental risk awareness. We invest in the Carbon Disclosure Project, we’re members and signatories to that. The United Nations principles of responsible investment—we’re participants there. We’re active in the INCR. Really we’re engaging other investors, government officials, regulatory bodies, and our portfolio companies on what they are doing to manage environmental risk and how they are disclosing that. We tend to focus on companies that have high carbon risk. Water is an issue we’re looking at, and we’re also looking at what we call extracted risk, offshore oil drilling, oil sands, and coal ash disposal. We file shareholder proposals. We’re one of the more active public pension funds in the United States. The half dozen proposals we’ve filed are all seeking improved disclosure on environmental risk or asking for the company to prepare a sustainability report.
Lastly, it’s important that we have a green initiative task force at CalSTRS, which was started in 2007. Each asset class is responsible for compiling and reporting on what their unit is doing to take advantage of investment opportunities or to try to manage risk. We report annually to our board, and that is available on our website as are all of our investment policies and principals. www.calstrs.com.
John Babcock (Rustic Canyon): The scale of what I do is sort of one comma to the right of Brian’s, with $145 billion under management. My name is John Babcock, I’m a partner at the firm called Rustic Canyon Partners. We’re an early stage venture capital firm. Our typical first investment in companies is $1 million to perhaps $10 million. We have $600 million under management today, investing out of Rustic Canyon III, which we raised $210 million for in 2008. It is a slightly smaller scale.
The investments out of Rustic Canyon III are actually in two areas, digital media (i.e., Internet) and clean tech, so we’re not an exclusively clean-tech focused firm, but we have a team, including myself who are quite focused on it. To set a little context of, I’m sure you’ve got from this conference, but there is an incredible breadth of what fits as a clean tech investment area. It is not an area we went into because we had limited partners saying they wanted it as part of a corporate initiative. We went after it because we thought it was an area to develop out-sized returns. That’s proven to be the case. For example, a company called Serious Materials. We did the first investment in them, and made the investment in 2007 of $5 million. They make green building materials. It’s a fair question to ask, “What’s a green building material?” It’s either something that reduces energy consumption within the built environment or which has reduced embodied energy, that is, the energy that was necessary to produce it is lower. The wedge of energy consumption for our buildings in the United States is not a trivial number.
The bigger area is energy consumption within the built environment, trying to reduce that. The easiest example for that is the Empire State Building, which recently retrofitted all 6,514 of the windows with windows from Serious Materials, with a substantial impact on the building heating and cooling, which for the Empire State Building is not a small number. Another company is something called Transonic Combustion, which was a very early stage company that makes injection systems for higher-efficiency internal combustion engines. Our initial investment was $1.5 million. We’ve looked at a number of electric companies, and the most aggressive forecast for electric vehicles for 2020 is that they are 20 percent of the market in 2020, with most people putting that number lower. We continue to think that internal combustion and liquid fuel is the only way to transport a lot of power, and still one we’re going to use. They are in testing right now of two of the five largest OEM’s in the world. I think it’s notable for this discussion, but it’s not in a production vehicle. That was an investment made in 2007. One other one, Fulcrum Bioenergy, which is a company that makes ethanol out of municipal solid waste. They have off-take agreements from waste haulers for 20, 25, or 30 years, at no cost, for about 7 million tons of municipal solid waste. The cost of their feed stock is the same as solar, but it produces ethanol. That’s an interesting technology, and it was recently selected for a DOE loan guarantee. The impact the government has had there has been meaningful to a lot of companies and certainly for Fulcrum.
Allan Emkin: Do you have an estimated payback on the windows for when break even might be? Is it five, 10, 20 years to break even?
John Babcock: I don’t know that the Empire State Building’s owner published it. I believe their model forecast was six years.
Jon Naiman (Light Green Advisors): Light Green Advisors if one of CalSTRS’s managers in the sustainable manager program. We have a relative value approach to looking at environmental value within public markets. We seek to invest in companies that have green advantages throughout the economy, not just in the renewable space. One of the things that we have in common with Serious Materials is that we also see energy efficiency as something that operates across every single industry. Every single business in the country uses energy. Very few companies focus on it systematically, and it is a source of value that typically provides faster paybacks than renewables. We invest in large cap companies that have the scale to deploy a variety of products and services with environmental advantages. Some of our portfolio holdings are ones that you may not think of as pure green companies, but that’s why were a light green advisor. One of them is General Electric. They produce some of the highest efficiency turbines in the world. Another is United Technologies, which has pioneered several technologies leading to zero or net-energy-positive buildings without the use of solar. For instance, they have elevators that generate power while braking as they go down. We essentially believe that we can add value over time by finding firms that have competitive advantage over their peers. Over the last 11 years, we’ve out-preformed our benchmark, which is the S&P 500, by over 13 percent, so we’re pretty confident. The last few years we’ve done quite well. Looking forward, there are a lot of macro drivers that will make energy efficiency and resource efficiency even more important. The demographic changes in Asia and the developing world, particularly the rising income, is leaving pressure on commodity prices, which means that if you have a 1 or 2 percent advantage over a competitor in terms of the efficiency with which your building or process component uses energy or water, which is also a resource under stress, that becomes much more important as the price of oil goes from $90 a barrel toward $150. We see that dynamic operating for the foreseeable, and the relative value approach to adding value in the public equity space has legs as a result.
Allan Emkin: Just to put some of John’s comments in context, in the institutional investment world, a lot of the people measure themselves by what’s called a universe. They compare themselves with their peers. Beating your benchmark, in this case the broad U.S. market as measured by the S&P 500, which is pretty much what John has done over last few years...would put him in top quartile, or better than 75 percent of his peers in the whole world. And he did that doing a systematic approach to looking at the opportunities of the risks of something that other people weren’t looking at. That sort of superior performance, as more people start looking at this space, will become harder and harder to get because the more it gets efficient, other people are going to start looking at some of the factors... Where do you see the capital coming from and the speed of that capital increasing, decreasing or staying the same?
John Babcock: Those statistics have been published, to some extent, and it’s decreasing meaningfully. To use Brian as a scale of the amount of capital, the entire venture capital industry, for most of its history, ticked along at about $15 billion per year. In 1999 it was about $50 billion, 2000 was $110 billion. It has come back down and started to stabilize at $24 billion. I think this year was $16 billion. And so, clean tech was off from 2009 to 2010 by 52 percent. The market is contracting. As someone who raised a fund in ‘08, I find that reasonably attractive. If you’re familiar with the venture business, typically we raise funds every five years, which is different than what the other John does—when he sells shares in a company ,he takes the capital and recycles it. We invest each dollar once, and every five years we run out and need to raise another fund. Capital is definitely contracting and is starting to have an attractive effect for new investors on pricing. But the impact of the recession was felt, for sure.
Allan Emkin: I’m going to rephrase that in my language. That means the people who are coming up with these new companies are having to give more to investors to attract the capital, which will make it that much more interesting for the Cal Teachers of the world and, in fact, for the venture capitalists. But it makes it more difficult and much more painful for the creators of these ventures. They just aren’t going to get as much money because it’s a function of supply and demand.
What many of you may not understand is that big investors like Cal Teachers, it’s not just how they put the money to work but also what they do. Brian, maybe you can give an example of a campaign you were involved in on an issue related to the corporate governance space.
Brian Rice: Well, probably the most significant is the oil spill in the Gulf of Mexico. I pointed out the extracted risk management, and we sort of said, “Ok, what other processes do you see within our investment portfolio that have that type of low-probability but, when the incident occurs, pretty high cost.” We narrowed it down, and said “Everybody’s looking at offshore oil and gas drilling.” Onshore oil sands is something we’ve been involved with. We filed a proposal two years in a row now with ConocoPhillips asking for them for more disclosure on the financial impacts of their oil sands operations. Look at natural gas extraction, hydraulic fracturing—what are the risks there? Is it as big a risk as everybody seems to think it is? And then looking at things like coal ash disposal. You look at things like what would happen in Europe, where a containment pond that broke.
That got us looking, asking what companies we should be talking too. I spent the past six months talking to perhaps 25 or 30 companies in various sectors about whether there were risk management programs in place, how far up the company does it go, is compensation part of the safety, and how do get RESG into your overall systems.
Allan Emkin: Why that is so important is that, as little as 10 or 15 years ago, anyone who would have raised those issues would have been called pinko, weirdo, or an environmental nut. Now it’s coming from an institution with $150 billion, and they’re not alone. Those organizations acting in concert truly make a difference. You hear about it all the time, but corporate boards are more sensitive to their investors than they ever have been, because investors are willing to do things didn’t do before: vote on proxies, put proxies on the ballot, and actively advocate for their payoff. •••
Naiman: You mentioned the BP spill earlier. That was a company that had a very articulate CEO, who was the first CEO to acknowledge climate change and sign several documents. We analyzed the firm, concluded that it actually had the worst safety record in the industry, and got out of the stock in 2004 as a result of that. So we’ve probably benefited from our having an independent analysis of the safety that we did as part of our routine diligence on oil companies. We want to own companies in that sector, but we try to find the ones that are better able to mange their risks. One way of thinking about it is that BP doesn’t have half of the oil facilities in the United States, but they have over half of the criminal violations over the last few years. So that’s a clue that it’s more than policies. There is actually an operational fitness component of this analysis, and it’s just another way of getting an insight into management quality, which is what all public equity managers really are seeking.