Skin in the game: will Morgan Stanley IM’s carry linkage blueprint find more takers?

Corvus Energy operates in a niche segment of climate technology. The Norway-based company specialises in maritime energy storage solutions. The company supplies 50% of what it calls the world’s ‘net zero vessels’. Think ferries, cruise ships and tugs.

The company estimates its technology has avoided nearly 11MT of carbon emissions since its founding in 2009. Its avoidance numbers are now drawing institutional attention. The latest evidence of which is a $60m growth equity round led by Morgan Stanley Investment Management (MSIM).

MSIM’s participation was channelled through 1GT - a $750m private equity fund targeting growth-stage climate tech companies.

In what is quickly becoming a competitive market, the fund’s incentive structure is what MSIM hopes will differentiate it. 50% of the 1GT team’s financial incentives are linked to its emissions avoidance.

Speaking with Net Zero Investor, Vikram Raju, managing director & head of climate investing private equity at Morgan Stanley Investment Management explains the fund’s building blocks.

The clue is in the name

For those wondering about the fund’s objectives, the name is a give-away. The fund, which was classified as Article 9 under the SFDR, is aimed at avoiding or removing one gigaton of CO2-equivalent emissions by 2050.

The name, Raju points out, was a deliberate choice. “Very few climate funds out there will tell you how much impact they intend to create”, he says.

Even when they do, the industry currently lacks an equivalent benchmark. “There’s no benchmark for climate impact funds. With 1 GT, we wanted to boil it down to one KPI which is CO2e emissions avoided”, notes Raju.

“1GT is an ambitious number, but we felt it was important to be ambitious given the scope of the problem and to hold ourselves accountable”, he told Net Zero Investor.

It is an ambitious goal indeed. For reference, the fund goal is equivalent to Japan’s total emissions last year. It would take 17bn tree seedlings over a decade to sequester that much carbon.

The incentive

A quick glance across the climate funds universe yields a widely known reality – there is no dearth of ambitious targets out there. Not surprising, given that investors seem to appreciate it.

Yet, what matters for the fund market’s clientele is delivery against ambition. The 1GT model raises the bar on how ambition is held accountable.

50% of the 1GT’s carried interest – or ‘carry’ in industry parlance - is linked to the team delivering on the fund’s ambition. Carry linkage is not new but the threshold of 50% is.

“We are not market pioneers in terms of linking carry to impact but by setting the threshold at 50% doing so, we create a significant penalty for not delivering on impact”, Raju says.

The portfolio

For managers hoping to go down the 1GT path, the question quickly becomes - where will such large-scale, longer-term emissions avoidance come from?

Partly, the1GT answer is growth-stage companies. Preferably those with firm financial footing.

“The strategy invests in later-stage growth stage opportunities. For us, the point of entry is when a company starts delivering double digit revenue growth. Companies we look at are usually profitable or at the cusp of profitability”, Raju explained.

The 1GT expectation, seemingly, is that by investing in ready-to-scale or already scaling technologies the strategy maximises both impact and returns. Choosing those select few technologies, amidst a widening array of products reaching growth stage each year, is perhaps the 1GT model’s most challenging proposition.

So far, the 1GT portfolio includes methane detection (Insight M), battery-based portable power (Instagrid), a B2B circular economy software platform (Amcs), plant-based meal replacement (Huel), a supply chain risk management software (Everstream Analytics) and an oceans data provider (XOcean).

Private equity logic dictates that a few of these will deliver outsized returns for investors backing 1GT. That, under the 1GT model, is not all. The ones who do deliver returns must also deliver impact.

By linking carry to the latter, impact becomes financially material for the fund manager. Ultimately, if asset owner demand for that materiality rises, the number of takers for the 1GT model might rise too.