Climate funds are rethinking asset class boundaries

Schroders’ launch of the UK’s first Long Term Asset Fund almost exactly a year ago was interesting for three reasons.

First, Schroders’ Climate+ – which addresses themes such as climate change mitigation, climate resilience, biodiversity protection and Just Transition – was first out of the gate after the LTAF structure was introduced by the UK’s Financial Conduct Authority in 2021 to open up access to private markets for DC pension funds and individual investors.

Second, Climate+’s impact messaging has the added benefit of encouraging policyholders to save more for their retirement, according to private pension trust Cushon, the fund’s cornerstone investor. The impact stories are more effective than purely financial arguments, Cushon’s then-proposition director Danny Meehan told New Private Markets at the time.

And third, Schroders has taken a multi-asset-class strategy for Climate+, investing across private equity, infrastructure, real estate, natural capital and more liquid assets. This derisks the offering for investors, creating paths to early distributions and early liquidity.

As the climate mega-theme finds its feet as a standalone strategy, we’ve been seeing more funds on the market that can invest flexibly across the traditional asset classes in pursuit of climate impact.

Bending asset class norms

Commonfund’s pooled fund management business, CF Private Equity, has an Environmental Solutions strategy that is perhaps as diversified as Schroders’ Climate+. It has a mandate to invest across private equity funds, direct and co-investments, secondaries and real assets. And impact firm Blue Earth Capital has a multi-asset mandate similar to Commonfund’s: its newly-launched developed markets Integrated Solutions strategy, which will mostly invest in climate-themed opportunities, can invest in private equity funds, direct and co-investments and secondaries opportunities.

Generate Capital, a $10 billion investment company focused on sustainable infrastructure and real estate refurbishment projects, has no set allocations for different strategies. Instead, it takes on projects on a case-by-case basis and can provide equity, project, debt and contracts-for-difference-type financing structures, its CEO Scott Jacobs tells NPM.

Other examples involve fund mandates with flexibility to invest across, or between, two asset classes. Brookfield’s Global Transition Fund, which closed on $15 billion in 2022, is the most prominent example. It bridges buyout and infrastructure structures, with a mandate to acquire sustainability solutions businesses, asset-heavy, high-emitting businesses and renewable energy generation and storage infrastructure.

TPG’s $7.3 billion Rise Climate Fund – the second-largest climate impact fund that has reached a final close to date – has a similarly flexible mandate. TPG “takes a broad-based sector approach to investment types, from growth equity to value-added infrastructure”, according to the fund’s boilerplate.

Hy24, the joint venture between Ardian and FiveT Hydrogen, has a “load risk” sleeve in its debut infrastructure fund. Most of the €2 billion fund will be invested in greenfield hydrogen infrastructure projects, but up to 15 percent has been allocated to repurposing existing assets to put them into the hydrogen economy, Hy24’s CEO Pierre-Etienne Franc tells NPM. This has a much higher risk and return profile, he says, because the fund is acquiring physical assets without offtake or buyer agreements in place. “I say the fund is venture-to-infra,” says Franc.

Mirova’s fifth energy transition infrastructure fund, which closed at €1.6 billion in 2022, has a 30 percent allocation to “upstream” opportunities – private equity stakes in renewable energy development firms.

Just Climate, the impact firm established by Al Gore’s Generation Investment Management, has been pursuing a strategy for its $1.5 billion decarbonising industries fund that senior partner Clara Barby describes as “unusual”. It is a growth equity strategy that acquires asset-heavy businesses across a range of risk-return profiles, Barby tells NPM.

The case for LPs

“We have set ranges of allocations for each asset class,” says Blue Earth’s head of funds and co-investments Nick Muller. The fund is targeting between 13 and 17 percent IRR overall. The flexible approach is a way to provide a more diversified and derisked proposition for Blue Earth’s LPs. The vast majority of climate funds that land on Muller’s desk are from emerging managers raising small first-time or second-time funds.

And Blue Earth is targeting LPs that have new allocations to climate for this fund. “It can be very difficult for investors to select one of these funds when [the GPs] don’t have many realisations, their track record is still very nascent… It’s important for them to almost immediately gain an exposure to multiple different assets. They don’t want to be too concentrated if [climate] is a new asset class for them,” says Muller.

The secondaries sleeve in Blue Earth’s fund provides immediate visibility on assets and nearer-term distributions to LPs than a direct primary fund or fund of funds would, Muller adds. “That helps the investor build the case internally for creating their allocation to impact.”

Schroders’ multi-asset-class strategy can similarly ease clients into the risk profile and illiquidity of private funds. The LTAF structure was introduced to allow DC pensions and retail investors to invest in illiquid assets. For many of Schroders’ DC clients, this will be their first significant exposure to private funds.

“We’re combining the return-seeking assets like private equity with the more stable assets that produce predictable income with inflation-linked cashflows such as infrastructure,” Ped Phrompechrut, head of Climate+, previously told NPM. “We’re introducing high returns without disproportionately impacting the risk element.” The liquid investments, moreover, can facilitate any requests from clients to exit their investments.

Climate-led

For some of these managers, breaking with the asset-class-specific and risk-return norms is a way to maximise impact.

Generate’s Jacobs stresses the impact potential of this approach. “It gives us incredible flexibility to do whatever it takes to help build more sustainable infrastructure assets. We could provide debt, we could provide equity, we can provide operational services.”

Just Climate’s Barby describes a similar approach of starting with impact and then thinking about the financial structure. The firm describes its thesis as “climate-led investing”. It takes a theme within the climate sector and is “laser-focused on identifying the solutions that are going to have the highest positive climate impact that can also generate attractive financial returns”, says Barby.

For Just Climate, these solutions are not moonshot technologies or new renewables developments. For decarbonising industries, a theme which became its $1.5 billion debut fund, the most impactful opportunities are “asset-heavy business models that need growth capital. Those solutions become your opportunity set. And then you ask, what do those solutions need to thrive from a capital perspective?”

This is an “unusual” strategy for a growth equity fund, says Barby. “Most often, PE gravitates to asset-lighter business models and infrastructure focuses on asset-heavy. But infrastructure investors like ‘rinse and repeat’ [models]. They don’t like the growth stage.”

Even more unusually, Just Climate did not pitch a target IRR to its LPs, Barby tells NPM. “There would be slightly different risk profiles of assets in that portfolio. We have the flexibility to do both higher-risk, higher-return and lower-risk, lower-return opportunities, all broadly within the growth equity class.”

Challenges

Just Climate expected this to be a challenging pitch for the institutional investors it was targeting. Amid its fundraise in 2022, Barby says pitching the flexible approach to pension funds was “a harder conversation” because they “will have a private equity team and an infrastructure team, and they don’t talk to each other as much as you’d think”.

Such pension funds would cling to “rigid” asset allocation buckets for private equity and infrastructure and would struggle with “whether the target IRRs [for Just Climate’s debut fund] are high enough for private equity or mature enough for infrastructure”.

But this challenge was not insurmountable for Just Climate. The decarbonising industries fund closed at $1.5 billion, having targeted $1 billion, with commitments from institutions such as California State Teachers’ Retirement System, PSP Investments, AP2, AP4 and Harvard Management Company.

For Hy24, on the other hand, the “load risk” sleeve was a draw for industrial corporate investors, says Franc. “Industrial players usually don’t need to invest in funds; they can do it alone. And yet they wanted to participate in this fund, because it has this pocket which is enabling them to share the risk with us and the financial investors.”

And this support from industrial LPs “gave financial LPs a lot of comfort”. That comfort was particularly because industrial co-investors are likely to bid for Hy24’s assets when the fund seeks to exit.

The portfolio construction aspect can be a challenge, too. Schroders has set an 8-10 percent net returns target, which is “really hard to deliver” across multiple asset classes, and much more complex than managing a single-strategy fund, David Seex, head of Schroders’ private asset solutions department, told NPM last year. It involves balancing “different jurisdictions, different cashflow profiles, different structures”.

Of course, conventional private funds have played, and will continue to play, a pivotal role in combating the climate crisis and capturing returns for their investors. Many of the world’s biggest impact managers focus on just one asset class.

For example, Actis and Meridiam – which came in second and fifth, respectively, in NPM’s Impact 50 in 2023 – are specifically infrastructure managers. Thirty-seven VC funds focused on climate tech raised $13 billion between January and August 2023, according to a CTVC report cited by affiliate publication Venture Capital Journal last year. But the scale and urgency of the climate crisis and opportunity has prompted a cadre of managers to rethink the approach.