For nearly six million years, the Colorado River flowed 1500 miles from the Rocky Mountains to the Gulf of California in northwestern Mexico. It once supported entire communities and was the source of rich biodiversity. Since about 1960, however, the river has not regularly reached the ocean, a combination of damming and diverting the water to serve some 40 million people. Add climate change to the mix and things start to look more bleak for the river. Its flow has decreased by about 11 percent since the last century - and it’s expected to keep dropping off as severe droughts become more common.
A problem for climate scientists to ponder, surely? Indeed. But it’s also a problem being tackled by investors who are motivated to solve some of the world’s biggest environmental challenges with large sums of money. Enter Encourage Capital, an impact investment firm with a difference. Its approach is to think about the problem you are trying to solve and the impact you want to have, then to ask yourself what capital flows are necessary to get there. At the end of that process, you decide what investment suits the outcomes best - private equity, venture capital or perhaps real estate.
Most impact investors are coming at this from a different position, argues Ricardo Bayon. He’s a partner at Encourage Capital and one of its founders. It’s his view that many impact investors are likely to manage a portfolio that excludes Exxon, for example, on the basis that it’s not good for the environment. Or they might avoid anything that invests in firearms. Meanwhile, there are firms that invest in private equity with a strong asset-class lens. They might then ask themselves, “How do we layer impact into private equity?”
What Encourage Capital does is deploy capital for solutions, always with the view that an investment can make an attractive financial return in addition to having impact. The firm calls it “solutions investing”. “That’s what we’re trying to do,” confirms Ricardo, “find the middle ground between the need to solve these problems and the money that’s likely to be made from solving these problems.”
Research and collaboration
It’s an approach that’s heavy on research, due diligence and partnering with experts. Take the Colorado River as an example. Encourage Capital spent a number of years working on how investment can be used to solve some persistent water scarcity issues in the Western United States which the government alone won’t address. This led to a lengthy report called Liquid Assets. In the Executive Summary, the firm said: “This reflects a movement at a global scale towards the use of market-based mechanisms to manage a variety of natural resource issues, and to ensure that the value of ecosystem services to economies and societies are adequately captured in the marketplace.”
Eleven financing solutions were eventually proposed to address water problems in the West. Among them were irrigation infrastructure upgrades and pay-for-performance structures. Speaking to Invest for Good from his office in San Francisco, Ricardo explains that some of the solutions had potentially commercial-rate returns while others might not. “As an investor you can say, ‘Well, this has this impact but it gives you this return. Whereas, this has that impact and it gives you a different return.’ You can then begin to make those trade-offs.”
Ideas that catch on
Since the report was written in 2015, some of the ideas contained within it have been adopted and adapted by others. Blue Forest, a mission-driven organisation in California, developed their flagship financial product as a result of some of the report’s findings. The Forest Resilience Bond (FRB) deploys private capital to finance forest restoration projects on private and public lands at risk of catastrophic wildfire. It’s currently being piloted in the Tahoe National Forest.
The way in which Blue Forest took the seed of an idea and ran with it is a promising development, Ricardo judges: “I’m proud of Encourage Capital for some of our investments, but I’m just as proud - maybe even more proud - about how our ideas have filtered into the investment world in a different way. Some of our ideas have actually moved the needle.”
In another piece of work, the firm partnered with the Bloomberg Foundation, the Rockefeller Foundation and NGOs to come up with investment ideas that could tackle issues related to our oceans, such as overfishing. One of the various solutions proposed was to create a holding company in Chile that would invest in processing facilities. Various High-Net worth individuals have since taken over the holding company, with investments that have led to improvements in this space.
I think there’s a misconception that, automatically, if you’re going to have an impact you’re going to give up on return. I don’t think that’s true.
One of the advantages of looking at investments in this way is that you can potentially come up with some big solutions to very big problems. It’s unlikely that you’d have the same level of impact by simply managing a portfolio that excluded certain companies on the basis that they’re bad for the environment or society.
Whether you are actively investing in solutions or managing an impact investment portfolio, you can still make a good return, maintains Ricardo, sometimes a very competitive one. “I think there’s a misconception that, automatically, if you’re going to have an impact you’re going to give up on return. I don’t think that’s true. It can sometimes be the case, yes, there can be trade-offs, but not necessarily.”
A case for carbon and solar
California’s emerging carbon market proves the case. In 2013, the state started a cap-and-trade programme aimed at using a market-based system to reduce greenhouse gas pollution in the state. Encourage Capital created a carbon fund to invest in carbon credits for California’s private market. The credits allow private landowners and timber companies, as well as Native American tribes, to sell credits to climate polluters as long as they take steps to reduce their emissions, such as planting trees or changing management practices on existing forests. It was a risky investment, admits Ricardo, but the aim was to prove that carbon markets could work in the United States. The risk of investing in such ideas is calculated on a case-by-case basis depending on whether it’s a private equity investment or something else.
“We basically returned money to investors last year on that fund and that fund returned close 40% IRR [internal rate of return] for its investors. That is highly competitive,” says the partner at Encourage. He tells Invest for Good that some of the investors had come for the impact but stayed for the return, while other “strategic” investors came for the return and stayed for the impact. In addition, some of the money benefitted the White Mountain Apache tribe in Arizona, millions of dollars that were used to support community developments and help manage their forests. “We need more than philanthropy and more than government money if we’re going to solve the world’s problems,” Ricardo continues. “If we’re going to bring in private capital, then you’re not going to bring in a whole lot unless you have some level of return.”
Rooftop solar in India is one of Encourage Capital’s latest investments that has the potential to achieve a good financial return and have significant impact. It’s an opportunity estimated to be worth up to $9bn. The private equity fund invests in financial institutions that lend to smaller businesses and enterprises looking to develop and scale commercial rooftop solar. In India, one of the biggest barriers to developing solar is financing, with a credit gap that Encourage estimates to be about $230bn. Ricardo believes the fund can be summed up as “financial inclusion meets solar as a solution to climate change”.
Barriers to progress
Yet the biggest barrier to achieving true progress to major environmental issues is not necessarily money, apathy or corruption, argues Ricardo, but that the big polluters and emitters are not seeing the cost of damaging the planet come up on their balance sheet. “The cost is being borne by us, by governments, by poor people with bad health who are affected by this. You’re privatising the benefits and socialising the costs.” A challenge is to figure out how we could transform our financial system so that things which currently don’t have value, such as our natural systems, end up having a monetary value. The carbon market is one example of doing this but Ricardo believes we could go much further, pointing to a future in which water markets might become necessary.
In this vein, Encourage is hoping to launch a new project that does go further by supporting regenerative agriculture techniques. This would focus on rebuilding soil organic matter to reverse climate change, using less water and eliminating chemical fertilisers. The aim would be to change the way in which we grow food that could result in carbon drawdown and improving the water cycle. It’s Ricardo’s prediction that this space will see more investment opportunities soon. It’s important to be cautious, however, of investments that require the government to change a current regime because it can be slow and politically challenging.
Repercussions of Covid
In some cases, the government is part of the problem; by the same token, it has to be part of the solution - whether that’s climate change, inequality or world hunger. In facing the current health pandemic, for instance, the role of an effective, bipartisan government has become apparent. Unfortunately, the burden of the crisis has tended to fall hardest on the poor, on people of colour and on low-paid sectors of the economy, such as the service and hospitality industry. The polarisation wrought by COVID-19 and further sowed by political division is not just being felt in the United States.
If we can overcome that polarisation, one possible repercussion of the current pandemic is that we will recognise the role we all must play in solving some of the world’s biggest problems, including this crisis. After all, Covid has shown that a fragmented approach is unlikely to work; we must come together. “I think that attitude will then have an impact on how we address climate change,” says Ricardo, “or how we address other environmental problems. It will change the way we view government as well.”
While that optimistic outcome is not yet certain, there are things we can all do today to challenge and change the status quo. “Think about how you’re investing your money,” Ricardo advises. “Is it traditional investments that are going into traditional stocks and into fossil fuel companies? Or is it innovative solutions to the problems? That applies not just to investments, it applies to where you bank and how you buy insurance.”
However you spend, use or invest your money, it’s important to think about how it’s contributing to the future you want to see. Is that a future in which the Colorado River once again flows into the ocean? We don’t know but we have hope.
Ricardo Bayon is a partner and co-founder of Encourage Capital. He is also a member of the Board of Directors, leads the water team and new business innovation. He co-founded the EKO Green Carbon fund in 2007 and has written extensively on the voluntary carbon market.