Institutional investors are probably the least likely of revolutionaries, not the type of people envisioned by The Beatles (see Revolution by The Beatles on YouTube). But recently it appears that institutional investors are driving the green economy investment revolution through billion dollar investments in Europe, the US, Latin America, India and China fueled by the pursuit of high risk-adjusted and uncorrelated returns.
The solution is conceptually very simple
At its core, taking humanity to the promised land of a zero carbon, global green economy is really pretty simple. We already have many of the proven cleantech solutions — wind, solar, biofuel, geothermal, electric cars, green buildings, smart grid and energy efficiency technologies — all we need to do is replicate and scale these solutions through proven green economy companies, projects and substantial investment capital. However, historically this development hasn’t taken place at a sufficiently rapid scale to reduce emissions to levels considered safe by climate scientists.
The “Valley of Death” for cleantech companies and project development firms
Another related challenge is that new cleantech companies and project development firms often face the Valley of Death after receiving initial funding from angel investors or VCs. Cleantech companies with great leadership teams, innovative and disruptive technologies as well as an attractive portfolio of patents — intellectual property or IP — will often receive VC investments to finance the initial operations of the company and its first plant or project. However, once the technology has been proven and the company needs to build 10, 100 or 1,000 plants the VCs typically run for the hills. At this stage, traditional private equity firms often will not get involved since they invest in companies with a long track record of predictable profits and cash flows — something the early stage cleantech company by definition will not have achieved at this early stage.
Green economy project development firms face a related but separate challenge: because they focus on developing proven technologies (such as solar and wind) from third party providers they typically don’t have any IP and are therefore not attractive for VCs. As an “asset class” early stage project development firms thus face challenges that are distinct from early stage cleantech firms. Once the green economy project development firms get off the ground, they can access investments from project finance investors. Capital from this type of investors has been more difficult to access after the global financial crisis.
A crisis is a terrible thing to waste.
As Paul Romer once famously said, “A crisis is a terrible thing to waste.” In the midst of the sovereign debt crisis many institutional investors have substantially decreased their allocation to government bonds. But investments in green economy projects such as offshore wind farms provide a surprisingly attractive alternative. For example, DONG Energy, Denmark’s state-owned electricity producer, has secured investments from pension funds such as PensionDanmark — a pension fund which has 618,000 members and $21 billion in assets under management. According to Torben Moger, managing director of PensionDanmark: “I think this will…develop into a standard investment case for many pension funds because the alternative of investing in government bonds provides such bad returns that you are obliged to identify alternative investments.” Mr. Pedersen — a colleague of Mr. Moger at PensionDanmark — states that “We expect a return with a spread of between 300 and 500 basis points above a government bond, but with a risk profile very much less risky than listed equities… So the risk/return ratio is very attractive.”
Investments in green economy projects generate uncorrelated returns
In his classic book, “When Genius Failed: The Rise and Fall of Long-Term Capital Management” Roger Lowenstein eloquently argued for the importance of uncorrelated returns — a point also made by Yale Chief Investment Officer David F. Swensen and innumerable other investment experts. It is therefore notable that, according to Reuters, David Jones, CEO of Allianz Specialized Investment, said returns on wind and solar projects are now around 7 percent — much higher than many other asset classes —and are totally decoupled from the ups and downs of the financial markets. It is this “uncorrelated nature” of the green economy investments — combined with returns that outperform many other asset classes — that bring them into the rarified realm of financial nirvana. Mr. Jones should know because Reuters also reports that Allianz, as Europe’s largest insurer, has invested over $1.6 billion in wind farms and solar power plants in Europe since 2005.
A billion here, a billion there, and pretty soon you’re talking about real money.
Everett Dirksen has often been attributed with saying “A billion here, a billion there, and pretty soon you’re talking about real money.” Although Mr. Dirksen may never have said this, the underlying insight is very applicable in this context because there is a significant number of major institutional investors that have made billion dollar investments in green economy projects and companies — or have announced substantial commitments to do so in the future. Below you will find a list of some of the most important examples:
- In July 2012, according to BusinessWeek, China Development Bank committed to invest $3 billion in a 1,350 megawatts wind-power project in Argentina developed by Generadora Eolica Argentina del Sur SA. The project will be the largest in Latin America.
- In June 2012, as reported by Reuters, Bank of America announced “a new 10-year, $50 billion goal to provide loans and other financing for environmentally friendly energy projects.”
- In May 2012, according to Reuters, Goldman Sachs announced a commitment to “channel investments totaling $40 billion over the next decade into renewable energy projects.” This is “an area the investment bank called one of the biggest profit opportunities since its economists got excited about emerging markets in 2001.”
- In December 2011, as reported by Bloomberg, Warren Buffett’s Berkshire Hathaway Inc. (BRK.A) acquired a $2 billion solar project in California. The 550-megawatt Topaz project was acquired by Berkshire’s MidAmerican Energy Holdings utility unit. First Solar Inc. (FSLR) served as the project developer.
These examples clearly demonstrate an emerging trend for institutional investors to drive a new billion dollar green economy investment revolution. Much of the intellectual underpinning for this strategy has been launched by the Investor Network on Climate Risk (INCR). The group has grown from 10 institutional investors managing $600 billion in 2003, to 100 members managing nearly $10 trillion in assets today. Members include BlackRock, Deutsche Asset Management and TIAA-CREF, as well as public pension funds in California, Florida and New York.
As The Beatles said, You say you want a revolution, and this is a remarkable revolution indeed. From Warren Buffett to Goldman Sachs, from Allianz to PensionDanmark — from Argentina to China, from Europe to the US and the 100 INCR members managing $10 trillion in assets — the leadership of the green economy revolution has been passed to a new generation actors: institutional investors with a commitment to high risk-adjusted and uncorrelated returns.