Are net-zero investors prepared to take big bets?

As investment flows in recent years have shown, there is a growing appetite for investment strategies that incorporate ESG investment themes. Increasingly, investors are willing to invest in areas that aim to tackle some of the biggest challenges that the world faces.

Despite greater appetite for investments with a positive environmental impact, it can be challenging for investors at the start of their journey or looking at areas that do not necessarily fit with their investment approach.

John Auckland, co-founder of Seafield, which uses sargassum seaweed to draw carbon dioxide from the atmosphere, says companies in early-stage industries will always face questions.

“Nascent, pioneering industries like space travel and electric vehicles require massive amounts of cash influx to become thriving industries,” he says. “Investors had to ride the success and failure waves on the journey.

“Innovation is susceptible to risk, but in pioneering sectors, the risk is an unfortunate but necessary part of the journey.

To meet the challenge of net zero, new and unproven technologies are emerging. Therefore, investors are changing the way they think about risk, particularly when investing in transition technologies.

A changing understanding of risk

Alongside their environmental mandates, net-zero investors in early-stage transition technologies must also consider the potential financial returns of their investments.

Steve Crolius, president of Carbon Neutral Consulting and a former climate adviser to Bill Clinton, says asset owners and asset managers have a different understanding of risk than other stakeholders because of their fiduciary duty to investors.

“The goal is to generate returns that are attractive not in absolute terms but relative to the amount of risk embodied in an investment,” he explains. “Too little risk, which generally means too little chance of a substantial upside, is as unacceptable as too much risk.”

Peter Bachmann, managing director of sustainable infrastructure at UK asset manager Gresham House and a senior associate at the Cambridge Institute for Sustainability Leadership, says investing in the transition to net zero is more complex than it has been in the past.

“If you want to do solar, that is great,” says Bachmann. “You could deploy potentially really large chunks of capital, but it has quite a different risk-return profile to earlier-stage transition investments that command higher returns and greater risk.”

Faith in nascent technologies can often lead to the potential for “amazing returns”, says Andreas Schwarzenbrunner, partner in the industrial tech investment team at pan-European seed-stage investor Speedinvest, particularly as decarbonisation accelerates around the world.

“Financial markets are built on risk and return, and the parameters of acceptable risks are constantly in motion. Naturally, we will shift into new paradigms of risk, return and impact,” says Schwarzenbrunner. “However, the effects of climate change, as well as climate measures, will play a more important role when evaluating the risk component.

“A lot is still to be defined in that regard, but players on the financial market will price risk differently in the future, and companies need to adapt by decarbonising and protecting their assets.”

Remaining diligent

While the way some investors think about risk when it comes to transition technology might change, it does not mean they should change the way they invest, however.

Indeed, Speedinvest’s Schwarzenbrunner says it is only natural that investors carry out due diligence on early-stage transition tech companies as they would in any other sector.

“Investors need to ensure that the start-up team has a credible background, and relevant experience and skillset to build and scale a deep tech company,” he says. “The next area to explore is the defensibility of the start-up, ensuring that they have the correct patents in place or strong technological USPs compared to competitors.

“The next focus should be on current partnerships and sales. Investors should also verify if start-ups have the potential for front-loaded agreements with potential customers, if they are ready to ship their products, with the right partnership agreements in place.

“With these due diligence practices in place when investing, risks can be partially mitigated.”

Rubén Lubowski, chief carbon and environmental markets strategist, and Lorenzo Bernasconi, head of climate and environmental solutions, at Lombard Odier Investment Managers (LOIM), say risks can be spread through a multi-sector approach to investment in decarbonisation.

“It is important to remember that we are not talking of the need for a ‘bet’ on any single technology but on a wide range of technologies and solutions, including in agriculture and nature,” says Lubowski.

“We therefore need to take a multi-sector and multi-technology approach, including a focus on natural climate solutions over the coming decade to keep the world on a reasonable transition path.”

Bernasconi adds that assessing climate change and the climate transition impact on corporate earnings has only just begun and will require new models to assess the underlying effects on business and profitability.

“A rethinking of investment risk is needed that rigorously considers the risks of not being aligned with the climate transition, including the exposure that portfolios may face to rising carbon costs,” Bernasconi explains.

Investing with a ‘contrarian view’

Ultimately, transition technologies for a decarbonising economy are no different than other ‘less proven’ innovations that investors have backed in the past, says Lydia Guett, investment director at global investment firm Cambridge Associates.

“It is true that many investors have been burned in the very early cleantech boom, which mostly focused on solar, wind and other renewable technologies,” she says. “This meant that investors have been reluctant to invest early in hardware-focused climate solutions, but this is exactly the innovation most needed to decarbonise the economy.

“We view this as an opportunity to invest with ‘a contrarian view’ in technologies that have first prototypes in place and require growth capital to scale.”

This has led to new opportunities to invest in technologies with first prototypes in place that require growth capital to scale their business, says Guett, allowing clients to benefit from the steep growth curve of commercialisation and mass adoption.

And where favourable investment cases exist, there is always likely to be willing investors, says Carbon Neutral Consulting’s Crolius.

“The robust rate of investment flowing into the energy transition, strongly suggests that availability of capital will not be the factor that limits our ability to hold off the catastrophic effects of climate change,” he says.