Ares Management on digging into data in climate investing

This article is sponsored by Ares Management

How has Ares’ approach to climate investing evolved over the past few years?

Andrew Pike: When we launched Ares’ infrastructure investment strategy 10 years ago, it was a diversified strategy capturing some of our team’s legacy experience in the field of natural gas generation, as developers and owners of those assets. We found the skills that were used historically in the fossil fuel arena could be useful to the energy transition, and there were elements of the toolkit that were valuable to climate solutions specifically.

As we saw an increase in wind and solar opportunities, we could see a gap in institutional capital with a complementary skillset akin to a strategic owner. So, we began transitioning to focus less on thermal energy and more on renewables. And, while decarbonisation is a critical component of the energy transition, so is making better use of limited resources. To this end, resource efficiency is a bigger focus for large parts of the economy and therefore of particular focus for Ares.

As we have advanced our climate investing strategy, we’ve evolved not only what areas we invest in but also how we invest. Our team today encompasses a flexible capital approach, including people with equity backgrounds, debt backgrounds, and everything in between.

As flexible capital providers, we provide solutions that fit the needs of the deal counterparty – it is not one-size-fits-all. That flexibility allows us to invest in industries that may not be obvious, or into businesses that have perhaps outpriced themselves on the equity side but still need a capital solution. In short, our debt experience drives focus on structure and downside protection while our equity backgrounds complement this with an eye toward growth and appropriate risk taking.

Meaghan Conway: Our investing focus has broadened from simply decarbonising the power sector to identifying and executing on infrastructure opportunities that advance the decarbonisation of the broader economy. In parallel, we have sought to share our climate investing knowledge internally so other asset classes can prioritise decarbonisation for capital preservation and value creation purposes.

One way that has manifested is through a firmwide group of climate champions that share energy transition-related resources and best practices. We believe the learnings we’ve gleaned from climate infrastructure investing and partnerships with portfolio companies across sectors like renewable energy will continue to underpin our firmwide efforts and potentially help accelerate the transition plans of many of our portfolio companies, regardless of sector.

For example, several investment teams across Ares have exposure to data centres. Supporting our data centre businesses in sourcing renewable power can serve as a competitive advantage as they seek to win business with large technology companies that prioritise sustainability and resiliency in their supply chains.

How can ESG and climate considerations be integrated into the evaluation of different deal structures?

MC: If we are are not coming in as control equity owners but are instead providing debt financing or a structured equity solution, we like to evaluate whether there is a way to incorporate sustainability-linked ratchets into documentation. For loans, we design ratchets to create economic incentives for portfolio companies to improve performance across a set of pre-defined sustainability targets that are tailored, tangible and measurable.

This is typically in the form of a two-way ratchet, so the interest margin on a loan either increases or decreases depending on the portfolio company’s performance against the targets. Strong performance in these areas is not only beneficial from a societal perspective, but also drives financial success. For example, energy efficiency and an accident-free culture lowers expenses and increases the value of a business.

What role does ESG data play in the investment process?

AP: A core tenet of our strategy is cultural alignment with portfolio companies, so when we get into ESG analysis and implementation, we want to make sure we are beginning from a shared commitment with our partners. From there, we believe we can more effectively deliver on our goal to help portfolio companies improve and perpetuate their sustainability strategies.

Further, the energy transition and the opportunity set around it continues to expand. In order to confirm our belief in certain asset classes and their appropriateness for a climate infrastructure strategy, we are often peeling back the layers on ESG benefits and metrics to demonstrate whether these are fundamentally consistent opportunities for our investment strategy.

Fibre-to-the-home, for example, is a growing business and is now being called the fourth utility. While the social benefit is fairly obvious, the environmental benefit of fibre-to-the-home is less well-known. In fact, the transfer of data is about three times more efficient across fibre than across traditional copper, so if we can invest in businesses that are helping to reduce energy consumption, those metrics help reinforce our enthusiasm.

Data collection and data analysis now happen on a daily basis, and they have become critical elements of the investment process. It’s important to consistently look at how to improve data collection and apply the best available technologies and processes to do better.

Ultimately, our goal is to acquire assets, make a demonstratable positive contribution and help generate value for stakeholders both from a climate and financial perspective. If we are doing all of this well, we believe we are positioning our investments for stronger financial outcomes.

How can impact be quantified in transition-related investments?

MC: While significant progress has been made on quantifying the overall impact of investments, there is still a long way to go in terms of converging around a set of common metrics that will help us better demonstrate to our investors what we’ve accomplished. There are emerging regulations focused on these topics and varying investor preferences as it relates to data collection.

Meanwhile, we have a portfolio that is incredibly diverse across a number of different sectors. What we are trying to do is to help portfolio companies cut through the noise, so we are not burdening them with data requests but helping them identify gaps in performance, providing resources for improvement and tracking outcomes. We believe time and money spent on improving sustainability performance during our hold period has the potential to create significant value in the long term.

AP: This has become an easier request because it is front of mind for everyone. At the same time, it has also become more sophisticated and complex to implement. Our team has a climate-focused investment strategy, so naturally our sourcing and investment decision-making already includes ESG metrics, and our entry point with portfolio companies is often much more advanced. It becomes more challenging when we get to quantifying benefit, where we need to ensure transparency and consistency as we look at each investment.

What is your view on the amount of capital chasing the energy transition?

MC: Depending on which study you look at, the estimated amount of capital needed to achieve net zero by 2050 is in the neighbourhood of $275 trillion. We are nowhere near that as an industry, so there is plenty of opportunity to go around.

AP: The market opportunity is ever-expanding, and the associated capital need is extraordinary. To this end, the amount of capital available today is still well below what is required. From our perspective, the more investors in this space the better, as that provides for a better likelihood of meeting the 2050 decarbonisation goals.

I would say most of the capital we see in the market today has a different perspective and skillset to our team. We are a value-add investor bringing these assets to life, but most of the capital we see is looking to own assets over their useful life, with more of a core strategy. I personally believe that to make the impact we aspire to in accelerating the energy transition, our sector needs more managers with broader skills and greater dedicated capital.

Andrew Pike is a partner and co-head of Ares Infrastructure Opportunities, and Meaghan Conway is a principal on the Ares’ ESG team and ESG lead for infrastructure