This article is sponsored by StepStone Group.
What is your approach to climate risk as a firm?
Suzanne Tavill: At StepStone Group, we take climate risk into consideration in every investment because, ultimately, we believe that leads to better decision-making and better outcomes. We are aligned with the Task Force on Climate-Related Financial Disclosures framework in our due diligence processes, which means we are evaluating how the GPs we work with are approaching climate change. It is also an important component in our evaluation of direct investments.
There has been a clear shift among our clients over the past three years and this has accelerated in the past 12 months. Asset owners globally are increasingly conscious of their responsibilities, which are manifesting not only in their ESG policies but also in specific climate policies and net-zero commitments. That, of course, then flows down into the questions they are asking of their managers. It is exciting to see this momentum building throughout the entire ownership chain.
What are some of the challenges that investors face in meeting those climate ambitions?
ST: One of the first hurdles for an investor or asset owner looking to establish climate change policies or net-zero commitments, particularly in the context of private markets, is that it starts with a need to obtain carbon footprinting data from managers, at both a GP and underlying portfolio company level.
What we are finding is that data is relatively scarce, and as a result, there needs to be a lot of advocacy around this. Investors are having to encourage their managers, even to conduct Scope 1 and Scope 2 measurements. Scope 3 measurement approaches are still being developed.
Fortunately, we are starting to see a number of industry initiatives led by GPs, or by a collaboration of GPs and LPs, that are all working towards the rapid development of guidance documentation for managers on what best practice is around carbon footprinting measurement and reporting. However, at the moment, that data challenge remains.
How do you take the social implications of climate change into account and why is that important?
ST: That social angle is critical, but often less discussed. There are multiple dimensions on which the social impact of climate change should be considered. There is the direct impact of displacement because of physical climate change, which is creating climate refugees, as well as exacerbating existing social inequities among the uninsured or under-insured.
We are also seeing whole swathes of people having their employment affected by the energy transition, including workers in historically ‘dirty’ industries. So, there needs to be a focus on retraining and re-education, financial support and employment. That is becoming an increasingly pressing issue.
The work being led out of the EU around the social taxonomy, which is currently in development, is going to be important in elevating these considerations. Even the current refrain of a ‘just transition’ and leaving no one behind is imperative. Fundamental to the EU taxonomy is the idea that you cannot further one Sustainable Development Goal at the expense of another, and that is where social considerations come in. However, there is still a long way to go before this concept is infused more broadly across the investment universe.
What opportunities are emerging from the energy transition?
Bhavika Vyas: We are seeing opportunities around the energy transition in everything that we do, from venture capital and growth to natural capital and infrastructure. The breadth of the platform we have at StepStone Group allows us to capitalise on all of that.
‘Climate tech’ today is a particularly exciting area. The cost of enabling technologies has come down dramatically in solar, wind and battery storage. In fact, costs on a kilowatt-hour basis have come down by between 70 and 90 percent over the past decade, according to data from the US Energy Information Administration and BloombergNEF. That means business models that were previously in development are now commercially viable.
The investments we are making today in the venture and growth space are primarily focused on capital efficiency and paths to market, rather than betting on experimental technology.
Many of the advancements we have seen across the world of technology more broadly are having an impact on these sectors. We are seeing improvements in marrying hardware to intelligent software, which is impacting things like behind-the-meter storage and demand response systems, which are all necessary when you think about the broader global transition that needs to happen.
We are also seeing interesting opportunities with fintech that can enable better pricing of climate risk or carbon credits, in materials science, and biotech, with the development of plant-based food and new agricultural technologies. The opportunity set that constitutes climate tech is far broader than it was during the last cycle.
On the infrastructure side, we are seeing renewable energy opportunities in both existing assets and new development, across emerging and developed markets. Power purchase agreements are becoming more prevalent and merchant pricing is becoming more attractive, which is helping to drive momentum behind the transition to a cleaner grid. The commitments that we are seeing from governments, as well as large corporates, are helping to support that transition as well.
At the same time, we are seeing new technologies, such as green hydrogen, creating additional opportunities. What used to be called waste-to-energy has now become waste-to-value, a model based on the circular economy. It is recycling on a commercial scale.
Finally, on the real assets side, we are increasingly seeing synergies between higher yield and environmental impact. While historically there may have been a trade-off between agricultural yield and use of resources, for example, today new technology and business models are allowing these things to move in concert, providing long-term financial sustainability and environmental sustainability as well.
Given the level of interest in these areas, how do you think about competition and valuations and what that means for your ability to achieve your target returns?
BV: This is an opportunity set being targeted by specialist and generalist firms. We tend to partner with specialist firms or specialised teams within broader efforts. We have seen these groups bring unique sourcing angles and value to the management teams they work with, enabling them to win deals in more competitive situations. We have also seen them add more value post-investment, helping drive overall returns.
I would add that the volume of capital required to reach global net-zero targets is vast. We try to ensure we are partnering with managers that have the discipline, capacity and capability to execute the strategies they are targeting, while also recognising that the scale of the opportunity is enormous.
Where are managers at today in terms of compliance with reporting and disclosure guidelines, and which frameworks are going to be most relevant going forward?
ST: I would divide my answer to that question into two sections. There are the self-regulated industry efforts and then there is the regulation that is coming from governments. The challenge for investment managers is that both the investment disciplines around sustainability and the reporting requirements are relatively new, so managers are having to move up steep learning curves.
Industry efforts have been commendable. These efforts stand on the shoulders of all the work done by the TCFD. While the TCFD is voluntary, it is a framework that most groups look to today. A lot of regulation being developed at a national level is also based on the TCFD and it is good that we are starting to see that consensus and alignment emerge.
The EU’s Sustainable Finance Disclosure Regulation, meanwhile, with its various article designations, is an important piece of regulation not just for the EU but globally as most national regulators are either working to mirror these efforts or align broadly.
Today GPs are getting to grips with what this regulation demands. The regulation has been rolled out fairly rapidly and we are now seeing waves of clarifications coming through, which exacerbates – in the short term – the challenges that managers face in complying.
Overall, I would say that these industry-led efforts, combined with government regulation, mean we are seeing increased awareness across private markets of the need for measurement and monitoring to feed in to the required reporting disclosures. This in turn is leading to an understanding that more resources are required to tackle these different levels of complexity.
Biodiversity is starting to play a more important role in responsible investing. How do you see that trend evolving?
ST: It is exciting to see that biodiversity has started to become a more mainstream topic of conversation. It is early days, of course, but we see two clear themes emerging. First is the inclusion of biodiversity as an investment consideration. Just as climate risk has become an established consideration, over time, we expect biodiversity to be routinely considered as well. The work being done by the Task Force on Nature-related Financial Disclosures will be important in establishing a framework.
The second angle to this involves a growing interest in the idea of channelling capital towards nature-based solutions. There are investment opportunities in addressing the enhancement of nature, be they land- or ocean-based. While such opportunities may also provide revenue streams around carbon credits, these projects elevate a focus on enhancing biodiversity.
For example, we expect real estate developments to increasingly be twinned with the enhancement of marshland, which is used to protect real estate from storm surges, but which is also of significant importance from the perspective of carbon sequestration, as well as providing potential value to residents and local communities. This is all still very nascent, and people are trying to wrap their heads around what a focus on biodiversity will look like, but we are hopeful that more capital will be directed into these areas.
Suzanne Tavill is a partner and global head of responsible investing at StepStone Group and Bhavika Vyas is a managing director and leads the firm’s impact investing effort