Forbes interviewed Jay Koh, Co-founder and Managing Director of The Lightsmith Group and the proponent of 2017 Lab instrument CRAFT (Climate Resilience and Adaptation Finance & Technology Transfer Facility). He talked about how private equity can help address the risks of climate change. “All investments will be impacted by climate risk, and investments in every asset class can help build resilience to climate change. Private equity is a particularly useful way to invest because it enables active investment and engagement in companies over a three to five-year period that can help those companies expand their focus to address climate risk and apply their solutions globally. Growth equity investing enables you to find and invest in the best companies, work with them to scale up their solutions and realize the value created by working together.” Read the original interview post here.
How Private Equity Can Fight Climate Change
By Ben Kerschberg, September 24, 2019
Guest Post by Jay Koh, Co-Founder and Managing Director of The Lightsmith Group
Many experts believe that the effects of climate change are already here. In 2016, the world experienced a record $175 billion in economic losses caused by natural disasters, a number that grew in 2017 to new record $340 billion. Northern California wildfires in 2018, exacerbated by the effects of climate change, destroyed 15,000 buildings, killed 91 people, and resulted in $11 billion of damages, as well as the bankruptcy of Pacific Gas & Electric (PG&E), one of the largest utilities in the United States. In 2019, Tropical Cyclone Idai destroyed 90% of Beira, the capital of Mozambique, and caused extensive flooding across the east coast of Southern Africa, destroying over 100,000 homes and 1 million acres of crops, displacing over 300,000 people, and leaving approximately 1,000 dead, resulting in $2 billion of damages.
Climate scientists project the trends of increasing warming; volatility of weather; and severity and frequency of extreme events to continue. The UN Secretary General is hosting the world’s leaders this week in New York at a new Climate Action Summit 2019, while the Global Commission on Adaptation released a recent report, “A Global Call For Leadership On Climate Resilience”, that concludes that $1.8 trillion of investment in five areas could yield $7.1 trillion in total net benefits. A key component is private investment. The Lightsmith Group is the first private equity firm focused on investing in climate resilience. I had the opportunity to speak at length with Lightsmith Co-Founder and Managing Director Jay Koh about how private equity can help address the risks of climate change.
Q: Many people are familiar with climate change – but what does climate change have to do with investment?
Jay: First and foremost, we need to recognize that climate change is a humanitarian disaster, particularly for disadvantaged people and developing countries. In addition, climate change now impacts the real economy. The Wall Street Journal called PG&E the first climate change bankruptcy in January 2019, and BlackRock recently released a report identifying underpriced risk in coastal real estate, the $3.8 trillion U.S. municipal bond market, and 269 listed utilities.
In fact, every asset that you own—your home, your 401(k), your college savings account—is “naked long” climate risk unless you have screened it for climate change.
What we need now is investment in climate resilience.
Q: What do you mean by climate resilience?
Jay: Adaptation or climate resilience refers to adapting and preparing society and the economy to respond and recover from the effects of climate change.
Q: How does climate resilience present an investment opportunity?
Jay: When we started looking at the effects of climate change in the context of investment, we realized three things: First, climate change is already causing increased risk and impact to society and the real economy.
It is now clear that climate change will increasingly affect the global economy – everything from PG&E to the Panama Canal, which will be inoperable for part of this year because of drought increased by climate change. The UN estimates that up to $300 billion per year will be required to deal with the effects of climate change in developing countries alone by 2030.
Second, somewhat surprisingly, very little is being done right now about the effects of climate change, particularly from an investment perspective. Fewer than 5-6% of all investment tracked globally that has to do with climate change can be linked to adapting to or building resilience to climate change – and virtually none of that is in the private sector.
Third, there are ways to start investing against the effects of climate change now. Existing companies with technologies and solutions can help assess and address the growing risks and impacts increased by climate change.
These companies produce the “tools” to build resilience to climate change.
You don’t have to develop technology in a lab or wait for a comprehensive global strategy to address the effects of climate change – you can find the technologies and solutions that assess these risks and impacts now and invest in scaling them up.
These realizations lead to a simple investment strategy: Find the companies whose technologies and solutions can help build climate resilience tools and invest to help to scale their solutions to the problem as the problem gets bigger.
Investing in climate resilience companies can generate two outcomes – extranormal growth for those companies and returns for investors, as well as measurable impact on the climate change problem itself. These outcomes are complementary – the faster these technologies and solutions grow, the more capacity we will have to deal with climate change.
Q: That’s an interesting thesis, but how big is the market for climate resilience right now? Isn’t this a future challenge or opportunity, as opposed to one presenting itself now?
Jay: We have identified 20 sectors of the economy representing $130 billion of current market size related to resilience to climate change. Those market segments are already growing 20-30% per year. We believe they will grow even faster to address the need and demand generated by climate change.
Most of the companies in these sectors don’t call what they do “climate resilience,” but they have data and analytics, products and services that can help companies and individuals, and communities understand and have started to prepare for the risks and impacts being increased by climate change.
We have now mapped over 800 companies worldwide that have technologies and solutions that can help analyze and manage the risks increased by climate change. We think there are hundreds if not thousands more.
Q: Can you give some examples?
Jay: We think there are particularly interesting investment opportunities in an initial set of six sectors: agricultural analytics; supply chain analytics; catastrophe risk management and weather analytics; geospatial imagery and mapping; water harvesting and drip irrigation; and climate resilient food systems. Targeted companies in these sectors analyze and address the current risks in agriculture, water, and supply chains, for example, that are being increased by climate change and are very well positioned to help manage those risks as they get larger and more complex.
For example, there is a catastrophe risk modeling and digital mapping company that analyzes natural disasters and provides information about everything from agriculture to utility networks. Their hurricane and flood models become even more important as extreme weather events grow more frequent and severe. But they are also now extending their technology to help underwrite agricultural insurance and manage wildfire risk by identifying encroaching vegetation. And their technology can be applied globally, including in emerging markets.
We have also identified companies that use solar energy to generate pure drinking water and big data to increase water efficiency that can be critical parts of addressing the increased water scarcity that will result from climate change. There are many other examples of companies that have developed technologies and solutions that can address the effects of climate change.
Q. I understand the potential opportunity for investing in climate resilience, but why private equity? Why not public stock market investments or investments in infrastructure or real estate?
Jay: Building climate resilience will require investment across asset classes from infrastructure and real estate that are designed to withstand greater physical risks to companies and communities that respond and recover more quickly from climate impacts.
All investments will be impacted by climate risk, and investments in every asset class can help build resilience to climate change. Private equity is a particularly useful way to invest because it enables active investment and engagement in companies over a three- to five-year period that can help those companies expand their focus to address climate risk and apply their solutions globally. Growth equity investing enables you to find and invest in the best companies, work with them to scale up their solutions, and realize the value created by working together.
Q. How did Lightsmith become focused on investing in climate resilience?
Jay: At Lightsmith, my partner Sanjay Wagle and I each have over 20 years of experience in direct growth equity investing at The Carlyle Group and VantagePoint Capital, as well as at Siguler Guff, the Overseas Private Investment Corporation (OPIC), the International Finance Corporation (IFC), and the U.S. Department of Energy.
We have been investing in growth stage companies in the sectors related to climate resilience since we graduated together from Harvard. We also have developed a unique network of relationships among entrepreneurs, companies, and governments that can help identify and scale up companies with the tools for climate resilience.
We started to focus on the effects of climate change through our work with companies and investors in these sectors and through our engagement with the UN’s Green Climate Fund. Looking at the risks increased by climate change, we became convinced that private equity investment into companies with existing technologies and solutions could be an attractive and effective way of attacking the problem. It’s not often that you reach conviction that there is an overlooked opportunity to make very attractive investments that address a very important problem that seems to fit perfectly with your background and experience.
In addition, since the 2015 Paris COP21 global climate talks, we have been chairing the Global Adaptation and Resilience Investment Working Group (GARI), which for the past four years has been bringing together investors, governments, companies, climate experts, and other stakeholders to discuss the impact of climate change on investments and the opportunities to invest in climate resilience.
We think that we have the right experience and expertise to find, invest in, and help scale up climate resilience companies.
Q. I understand the importance of climate resilience from the point of view of society – what’s the pure investment case?
Jay: Well, beyond the importance to society of scaling up the tools to address the key challenge of climate change, climate resilience investment has a few interesting characteristics from an investor’s perspective.
First, from a pure investment perspective, investing in climate resilience is a highly differentiated way to invest and build value in fast-growing companies that will grow even faster due to an increasingly powerful macro trend. Second, climate resilience investments are a natural hedge against climate change risk. As climate risks increase over time and impact all kinds of investments, the demand for companies involved in climate resilience should grow. Third, climate resilience investments are likely to be less correlated with other investments. The growth of climate resilience companies will be more related to the increasing impact of climate change rather than the credit cycle or trade conflict. For example, the demand for multinational companies to understand the risk of floods or hurricanes to their manufacturing and shipping will have more to do with the pace of climate change than the interest rate strategy of the Federal Reserve or current trade talks with China. Finally, climate resilience investments can provide investors with additional insights into other investments. A company analyzing natural disasters can identify specific investments in specific places and sectors that have increasing risk, for example.
Q: What about the government? Shouldn’t climate resilience and adaptation be a responsibility of governments worldwide?
Jay: Government undoubtedly has a critical role in building resilience to climate change. And we are grateful for our partnership with the Nordic Development Fund and the Global Environment Facility, as well as the European Investment Bank, the Luxembourg Government, and the Rockefeller Foundation. These key partners have supported our focus on investing in climate resilience and adaptation companies. However, in addition to government action, private investment capital and private sector entrepreneurship and innovation are critical to addressing the effects of climate change. Private companies and private capital can produce and scale up the tools—the technologies and solutions—to assess and address the risks and impacts of climate change.
Q. You mentioned a “measurable effect” of these investments on the risk and impact of climate change – how would that work?
Jay: We believe in investing in growth stage companies with technologies and solutions that can help generate climate resilience, and then working with them to increase their focus on climate risks to help them grow even faster. We also developed a system for evaluating how investing in climate resilience companies can help prepare society for the effects of climate change. By tracking three to five key pieces of information in each company we invest in, we can better understand their effect on climate adaptation and on other objectives like the Sustainable Development Goals and gender.
Q: I’d like to return to your point about disadvantage populations and emerging markets. How does investing in climate resilience companies help them?
Jay: We believe that emerging markets present a large and growing demand for climate resilience technologies and solutions and therefore a substantial growth opportunity for climate resilience companies. We plan to work with all of the companies we invest in to apply their technologies and solutions to emerging markets. In addition, we think that scaling up, dropping the average cost, and increasing the capability of climate resilience solutions is critical to building the tools to address the effects of climate change. We also plan to work with governments and philanthropies to bring the best technologies and solutions for climate resilience to disadvantaged populations and developing countries.
Q: How did you personally decide to invest in climate resilience?
Jay: I returned to the private equity industry in 2012 after the first term of the Obama Administration and was appointed to the Private Sector Advisory Group to the UN’s Green Climate Fund in 2014. I was asked to provide advice to the board of the GCF on how to engage the private sector on mitigation (reducing greenhouse gas emissions) and adaptation (preparing for the effects of climate change). I had no idea what adaptation meant and began to look at how we could invest against the effects of climate change.
My daughter Athena (3) also inspired me to look differently at the effects of climate change. When thinking about how investing could address the risks of climate change, I suddenly had an epiphany. A typical private equity firm invests over ten years, and I was struck with the question of what the world will look like ten years from now.
I call it my “Marty McFly Moment.” If my 2029 self could come back in time in a silver DeLorean and talk to me right now about what had happened over the next ten years and what would happen for the ten years after 2029, would I make different decisions about what to do and what to invest in now? The answer is yes. In 2029, my daughter Athena will be 13 years old. I will be, well, let’s say somewhat older. A lot of things will have changed. But the one thing that I know with a reasonable amount of certainty is that the climate will have changed, with resulting increased risks and impacts. We will have experienced at least two more hurricane cycles—each likely to be worse and not better than the last—and at least a few more Cape Town “Zero Day” situations where major cities come close to or actually do run out of water. We will have the visceral experience of a decade’s worth of the increased risks and impacts of climate change. And that is the world my 13-year-old daughter will face, looking forward another 10 years until she is 23, and so on.
Knowing that with some degree of certainty, we have two choices: In ten years, we can have this same conversation, and the climate will have changed, and we can be in a far better position as a result of important—and attractive—investments in climate resilience. Or not. The choice should be clear.
I am a technology and investment optimist: I think we can harness entrepreneurship and investment and begin to assess and address the increasing effects of climate change. There is a very interesting and largely overlooked investment opportunity to do so right now. We have an urgent problem and an attractive investment solution. Private equity can help fight climate change.