THE RUSH TO RENEWABLES: PART TWO

The weight of capital seeking entry into clean technology investment opportunities continues to grow as enthusiasm for the sector shows no sign of abating and as institutional investors become increasingly aware of burgeoning returns in this area.

Such is the interest in greentech that one might argue investors should start treating it as an asset class in its own right. Many institutional limited partners are already investing significant sums.

Just one example is the decision in February 2007 by the California Public Employees' Retirement System (CalPERS) to commit $400 million (€276 million) to private equity vehicles focusing exclusively on clean energy. And remember: Where CalPERS goes, others often follow.

Such is the interest in greentech that one might argue investors should start treating it as an asset class in its own right. Many institutional limited partners are already investing significant sums

The enthusiasm of investors is fuelled in part by increasing demand to invest in areas that help burnish the corporate and social responsibility credentials of themselves or their clients. It seems unlikely that the factors driving this urge to invest in clean technology will dissipate anytime soon.

Unfortunately, the money seeking entry into the sector is creating bottlenecks as investors struggle to find sector experts to help them invest it wisely. Private equity and venture fund managers, which can channel these funds effectively in more mature sectors – such as oil & gas, healthcare and ICT – are thin on the ground in the more nascent sector of green and sustainable opportunities.

This shortage of expertise, together with high levels of media coverage and the potential for misinformation, means that deploying capital in this area can be challenging and risky for non-specialists.

Many investors are already counting the cost of their naivety and lack of knowledge of the sector. Recent mini-bubbles such as the rush to invest in biofuel plants in the US in the second and third quarters of last year indicate a lack of sophistication in the green investment sector from the venture stage all the way through to large-scale infrastructure financing and fund of funds investors.

It's a reminder that committing assets on a large scale to a sector where there are capital-intensive opportunities within an immature and highly regulatory-driven market can be dangerous.

DON'T BACK FADING STARS
A worrying precedent that eager investors might bear in mind is the rush to invest in telecommunications infrastructure in the late 1990s. It is an episode perhaps best typified by the ill-fated $6 billion Iridium satellite communications constellation, which was eventually revived by investors who paid $25 million for it post-bankruptcy. Some mistakes made then could be repeated in markets which are dependant on infrastructural change to facilitate demand.

In light of such dangers, how investors choose to proceed depends on the expertise they have in deploying capital and on their appetite for divesting discretionary management away to other investment managers.

In the absence of specialised green sector asset managers, save for a few players such as Robeco's Sustainable Fund of Funds, institutional limited partners may want to commission sector-specific research on the long-term fundamentals of the space.

The picture will become clearer as the sector matures. In two or three years' time we are likely to see the advent of specialised green and cleantech asset managers who will be able to offer a full service to institutional investors.

In the meantime, there is an argument that the more cautious investors should stand back and wait for a couple of years and then seek to capitalise on the early mistakes of others who invest in projects that don't stack up and which will need to be restructured.

On the other hand, some undoubtedly some good investment prospects exist now and this value and opportunity window will not be around forever. For example, we are looking at promising opportunities in landfill gas projects in the US right now. It's relatively straightforward technology and capital needs to be allocated today as suitable landfill sites are finite and it won't be long before deals are done at all the suitable sites which have medium- to long-term gas generation capabilities.

Opportunities are arising all around the world, including in India, China and the rest of Asia – and those who understand the factors driving these opportunities and invest early will be best placed to benefit from their substantial growth prospects.

GRASPING THE FUNDAMENTALS
Whether investors choose to hang back and wait or proceed to invest however, it is clear that in order to put money to work wisely they must first understand the fundamentals of the sector.

There is an argument that the more cautious investors should stand back and wait for a couple of years and then seek to capitalise on the early mistakes of others who invest in projects that don't stack up and which will need to be restructured

We argued in the first part of this feature that for those wanting to invest directly in the sector, a ‘bottom-up’ approach to the market would offer insights into the viability of enabling technologies at the venture capital level that would inform any larger-scale funding of project finance opportunities.

In other words, the best investment strategies will be vertically integrated ones. If you're seeking to put money into large-scale waste-to energy or hybrid incinerator projects at the top end of the market you need to understand what's happening with new technology at the bottom so you can make informed investment decisions.

One way to do this is to identify investment managers with access to both the larger asset-based opportunities as well as the earlier-stage technology, which will underpin the real growth in this sector.

Investors who do this should find themselves well placed as regulatory effects on the market decrease and the industry matures. Some have already formed such relationships. For example, many of the limited partners in our Sustainable Technology Fund are also managers and/or investors in later-stage infrastructure financing in the waste and energy sectors.

Part of their incentive for investing with us was the opportunity to gain greater visibility on where the green investment sector was heading and also to provide access to earlier-stage projects that will require bigger financings as they grow.

E-Synergy was founded in 1999 by four technology entrepreneurs as an independent venture capital firm focusing on early-stage technology. The firm's Sustainable Technology Fund focuses on the green technology sector and will invest £30 million over the next few years.