Private market investors ponder transition investment

Public policy can impact investor returns. Take the returns from building EV plants in the US for example, heavily influenced by America’s Inflation Reduction Act. Investors might have to lower the discount rate on the future value of the business: if credits disappear, returns will be lower.

“Public policy does matter,” said Brian Funk, global head of private capital at MetLife Investment Management, speaking at the Fiduciary Investors Symposium at Oxford in a session delving into the risks and opportunities of investing in private markets to support the energy transition.

Monique Mathys-Graaff, senior director, head of sustainability solutions at WTW, stressed the importance private capital plays in decarbonising the economy given the scale of what is required.

Private markets channel capital into specific economic outcomes. For example, flows into renewable energy have benefited from sitting in investors’ alternative allocations.

Joel Probin, head of investment management at France’s Caisse des Depots, the investment arm of the French state which counts La Post, France’s post office, and extensive real estate and utility holdings, as well as a public sector investment bank in its extensive portfolio.

Probin explained that Caisse invests in private markets in accordance with its purpose. Investments include long-term loans to social housing and local authorities. In private markets, it puts capital to work in private equity and credit and has pledged to allocate billions to climate change over the next five years, encompassing loans, private equity solutions and green bonds.

Funk estimated that given the level of government debt, governments and supra-nationals will only provide roughly one-third of the trillions of dollars required to meet the energy transition. “Private market solutions are required,” he told delegates.

Huge need for capital

Funk noted the importance of capital being deployed to hard-to-abate sectors like steel or shipping. However, financing a corporate journey from brown to green requires huge amounts of capital. For these sectors that require capex over a long-term return, credit makes a lot of sense.

Private credit investment is accompanied by a relationship between the asset owner and the management team. Discussions centre on the business model and how companies plan to achieve their aims, and if the technology is available. “Engagement in private credit markets is an advantage,” said Funk. Meanwhile, borrowers in the public credit market are familiar with answering questions about compliance.

He added that with more transparency and disclosure, investors can encourage corporations to think differently about their business models. “They want to lower the weighted cost of capital and overtime there will be positive ramifications on this.”

“We think private credit plays a really big role [in the transition]. Corporate private placement is a big book,” he added.

The debate widened to discuss the extent to which private companies are meeting their net zero pledges. And the extent to which investors that have committed to net zero are struggling to find the investments. For example, tech companies have erased their net zero commitments because they require huge amounts of energy to fuel the data centres that support the rollout of AI.

Delegates heard how fossil fuels will not disappear from the energy landscape even if innovative solutions appear. Every source of energy that has been superseded continues to exist. For example, oil and gas came along, but coal hasn’t disappeared – coal-fired power stations are still being built in China and India.

Delegates heard that renewables are difficult to feed into the grid and fossil fuels will likely remain part of the energy mix. It means carbon mitigation and removal will become more important going forward and science and innovation will grow in size. The world is “not going in a single direction” and investors shouldn’t expect displacement of existing sources of energy.

Mathys-Graaff reflected on the challenge of managing fiduciary assets according to different mandates. Some WTW clients will have a 40 per cent allocation to private markets, others just 10 per cent, making investing more in alternatives challenging. Still, private debt offers a compelling first step on the ladder.

Panellists also reflected on the challenges of measuring performance with current benchmarks. The tracking error and duration mismatch of private credit versus the available benchmarks is complex, and the ability of investors to measure their investment on a risk-adjusted basis requires reform.