The dawn of the climate-focused fund

The private equity (PE) industry is uniquely positioned to play a critical role in financing the low-carbon economy.

PE firms boast a consistent track record of delivering strong returns on investment. Protection from short-term fluctuations in stock market sentiment allows them to apply a longer-term strategy (typically over a 3-5 year holding period) to acquisitions. And the model of full ownership gives PE firms significant influence at portfolio companies.

Private equity is waking up to this reality. Their response? The so-called 'climate-focused fund'. 

Climate-focused funds – also marketed under 'energy transition fund', 'clean growth fund', 'sustainability fund’, and similar titles – seek to invest exclusively in businesses pursuing 'sustainable' technologies and practices.

Recent years have seen a climate fund arms race unfold among PE’s heavyweights, as a raft of such investment vehicles has been set up.

TPG made the headlines in 2020 with the creation of its Rise Climate Fund which aimed to provide $5 billion in climate-related investments. Months later, Brookfield’s Global Transition Fund, with a target of $15 billion, set a new benchmark. Blackstone, the world’s largest alternative asset management manager, changed the game in 2022 with the launch of an energy transition platform – a group of future funds – that aims to deploy $100 billion into clean energy investments over the next decade.  

The benefits to PE firms are clear: positive publicity, elevated demand from private investors, and support compliance in a fast-developing regulatory environment.

However, overreliance on the charm of a climate fund is problematic. Three negative repercussions are worth particular attention.

1. The Smokescreen Effect

Climate-focused funds act as a green façade that at best obscures, and at worst excuses, ongoing capital deployment into environmentally harmful businesses.

A 2022 report by Private Equity Climate Risks (PECR) on PE giant Carlyle highlighted this hypocrisy. According to the PECR, the value of Carlyle’s carbon-based energy investments outnumber those in renewable and sustainable investments at a ratio of 16:1. 

New York-based KKR, which in 2022 launched an infrastructure fund that it claimed would prioritize investment in renewable energy, is estimated to have supported transactions in oil and gas totalling over $14 billion in the past two years, according to PE Stakeholder. 

These two examples reflect a lagging wider industry. According to MSCI's May 2023 Net Zero Tracker, PE buyout funds contributed to over 70Mt CO2e in 2022, over 50% of all private asset emissions.

A standalone ‘clean’ fund, whilst a positive step, is insufficient alone to respond to the urgency with which PE funds must move towards lower-emission portfolios.

2. The Sunshine Effect 

The notion of climate-focused funds also creates a false duality between 'sustainable' and 'unsustainable' companies. 

A company's business profile has an inherent level of ‘green’ orientation: an electric car manufacturer is naturally more Net-Zero aligned versus its combustion engine-producing competitor.

However, the broad-brush labelling of companies as 'sustainable' and, in turn, worthy of inclusion in a climate-focused fund, risks overlooking or understating areas of their operations that leave a lot to be desired from a sustainability perspective. 

Electric vehicles and associated components, which attracted $9.5 billion in PE and venture capital investment during the first 10 months of 2022 (according to S&P Global), is one such sector with high sustainability credentials at face value, but which contains diverse ESG risks further upstream in the value chain. 

Climate-focused funds encourage PE firms to seek out these conventionally ‘green’ companies without looking beneath the bonnet.

3. The Shunning Effect

On the other hand, excessive focus on investing in energy transition darlings neglects the decarbonization opportunity that exists by reducing the carbon intensity of companies operating in heavy-emitting industries.

A sustainability transformation at a typically ‘unsustainable’ incumbent in the steel or fertilizer industries may sound less sexy than simply acquiring a solar developer. Yet it is these companies that often provide the greatest opportunities for material reductions in greenhouse gases: steel production alone is responsible for 7-9% of global CO2 emissions.

Success stories outside of the private investing landscape should offer inspiration to PE investors.

A leading example is Orsted, the former Danish O&G major, which has undertaken a major pivot towards clean energy production: they now own over 15GW in renewable assets, including the world's largest operational wind farm. Coupled with divestment from fossils, the company cut emissions by 76% between 2006 and 2021.

A limited number of PE funds have shown an appetite to support the transition of high-polluting sectors. Scandinavian firm Altor is an investor in H2 Green Steel, a Swedish firm specializing in low-carbon metal production. US PE firm Warburg Pincus has also acquired a division of Australian construction material company Boral. At Boral, they will look to integrate the low-carbon cement technology of another portfolio company, Eco Material Technologies.

Yet PE-led green transformations are few and far between. If climate-focused funds remain as the primary decarbonization strategy pursued by private equity, these companies will be left stranded. 

A higher hurdle: how can firms raise the benchmark?

The tens of billions pumped into climate-focused funds will no doubt accelerate the scaling-up and learning rate within sectors critical to the energy transition.

However, the use of these funds in isolation is problematic. It reduces the urgency with which firms must divest from fossil fuels. It places a cloak of invincibility around companies with ‘solar’, ‘EV’, or ‘recycling’ in the business description. At the same time, it spurns the need to collaborate with heavy emitters on their journey to lower-carbon operations.

Private equity can do better. And they can start this process with some quick-win actions.

Firstly, as well as in-vestment targets, PE firms should implement clearer di-vestment targets, increasing accountability for reducing exposure to fossil fuel players inherently incompatible with a low-carbon future.

Secondly, the industry should establish bespoke guidelines and reporting frameworks to increase transparency around sustainability standards in PE. Greater collaboration with leading initiatives, such as the Glasgow Financial Alliance for Net Zero (GFANZ), will facilitate this.

Finally, a screening of the emissions intensity and decarbonization levers within existing portfolios will identify companies with sustainability transformation potential. 

The pathways to Net Zero are taking form across sectors, but often remain unproven at commercial scale. Pursuing these pathways to reduce emissions, whilst also tapping into untapped profit pools, is a complex challenge that the experience, rigour, and innovation of the private world is ideally placed to take on.

It just may require more thought than a standalone climate-focused fund.