Private Equity and Public Markets: an Investors’ Guide to Climate Impact Investing
Do you want to invest in line with your values while meeting your financial goals?
We believe investors play a crucial role in helping to fight climate change. To fund a transition able to keep the planet below a temperature rise of 1.5 degrees Celsius, the world must increase spending on solutions to at least $4.13 trillion every year by 2030*.
But how can an investor optimize their impact?
This guide will show you, as an investor, how to unlock your change potential and drive progress on climate change.
What is climate investing?
Climate investing is the mobilization of capital towards investments that mitigate climate change, in alliance with the goals of the Paris Agreement.
More broadly, climate investing fits under the umbrella term, sustainable (ESG) investing.
What is sustainable (ESG) investing?
In line with the Global Sustainable Investment Alliance (GSIA), we look at sustainable investing as an investment approach where environmental, social and governance (ESG) factors are considered in both portfolio selection and management.
There are seven commonly accepted types of ESG investing strategies:
- Exclusion screening: the exclusion of sectors, companies or practices based on specific ESG criteria
- Positive/best-in-class screening: investments selected for positive ESG performance relative to industry peers
- Norms-based screening: screening of investments for standards of business practice based issued by international entities like the OECD, ILO, UN and UNICEF
- ESG integration: the explicit inclusion of environmental, social and governance factors into financial analysis
- Sustainability themed investing: investment in specific themes or assets specifically related to sustainability (i.e. clean energy)
- Impact investing: targeted investments, where capital is specifically directed to achieve positive, social and environmental impact
- Corporate engagement and shareholder action: the use of shareholder power to influence corporate behavior
However, only two of the sustainable investing strategies above are suitable for impact-focused investors. In public markets, it’s corporate engagement and shareholder action. In private markets, it’s impact investing. Below, we will tell you why. But first…
What is impact investing?
For impact investing, we align with how Global Impact Investing Network (GIIN) defines it: investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return.
Impact investing is premised on three ideas:
- Intentionality: Being intentional about what you want to achieve and designing your investment strategy to meet this objective.
- Additionality: In investing, it’s the result of your investment that would not have happened without your participation.
- Measurement: Data transparency allows investors to understand the realized versus intended impact and identify further improvement areas.
To go into more depth on how Carbon Equity defines impact investing, read our blog here.
You can find GIIN’s core characteristics of impact investing here.
But what does this mean for you as an individual investor?
How do investors make impact?
According to the research done by The Center for Sustainable Finance and Private Wealth at the University of Zurich*, there are three ways an investor can have an impact: 1) enabling green companies to grow, 2) encouraging brown companies to improve and 3) public discourse on your investments.
To understand why these are an investors’ three mechanisms for impact, we need to understand one key distinction.
Your impact as an investor is not the sum of the companies you own (and their impact).
Your impact as an investor is the change you cause in a company’s impact.
If your goal as an investor is to make an impact, it’s crucial to understand the difference between investor impact and company impact.
Are you seeing the difference?
Now, let’s first discuss the two scientifically proven ways to have investor impact (aka creating change in a company’s impact if you still weren’t sure 🙂).
Allocate your capital to green companies that need the money. Look for companies whose growth is limited by external financing conditions, which tend to be small and young companies and companies in immature financial markets.
Encourage improvement by communicating with senior management and/or boards, filing or co-filing shareholder proposals, and voting toward better and more transparent ESG policies, targets and practices. Be aware that improvement is incremental so seek improvements within a reasonable cost.
The third way of investor impact is called signaling. It’s the least scientifically proven form of impact, but still an important one to consider.
Influence public discourse
By being vocal about your investment decisions and why you made them, you can signal to other investors and society at large.
Now, let’s place these three impact mechanisms into the context of public markets and private equity.
Note: If you need a recap on public and private market fundamentals, please skip to here.
Where is investor impact in public markets?
Money in the stock market (public market) does not reach the company.
When you buy stocks in the stock market, you generally buy them in the secondary market, meaning you buy the stock from someone else who has it.
Your capital then goes to the person you bought it from — the company doesn’t see your money.
Plus, the rise and fall of the stock’s price tend to only have a small effect on the company’s business.
“There is no empirical support for investors’ capital allocation influencing the growth of large, established companies. These companies usually have sufficient access to capital markets and are more constrained in their growth by product demand and competition than by access to capital.”
Source: Center for Sustainable Finance and Private Wealth at the University of Zurich
Similarly, Triodos and PYMWYMIC research concluded, “our impact is far less direct when investing in public equities than it would be when investing directly into private companies.”*
That said, if your goal is to earn as much return on your money as possible, at the lowest possible risk, buying ESG funds is not a bad idea.
However, if you want to have a real-world impact in the public markets, then you need to be an active owner and use your voice for positive change — it cannot be passive.
Shareholder engagement is necessary to have investor impact in public markets.
File or co-file shareholder proposals, vote toward better ESG targets and/or write open letters about your investment decisions and why you made them.
Or, you can join in on the growing amount of initiatives that bring together shareholders to conduct their engagement on their behalf, like Engine No.1 and Follow This.
Through active ownership and signaling, investors can encourage brown companies to improve and influence public discourse around certain investments.
To enable growth as an investor, we must shift our attention to private markets.
Where is investor impact in private markets?
The impact of capital allocation in private markets is much greater — private startups and scaleups 100% depend on private capital to fund their growth and product development.
By investing in private markets, investors can directly provide working capital to emerging leaders in climate tech — and new climate innovations not yet comercialized.
With governance or management expertise, a trusted reputation or an extensive network, investors can also enable company growth by expediting regulatory needs, finding additional investors or introducing new customers.
To maximize impact, investors must focus on companies whose business models contribute to solving the world’s problems, and whose growth is constrained by limited access to external financing.
How can I gain access to climate private equity investing?
You can invest in private markets in three main ways:
- Angel Investing: directly investing in a company you like
- Crowd Equity: using investment platforms to select companies raising capital based on your preferences
- Private Equity funds: invest via a team of experts searching for the best investment opportunities in a specific area or industry
Our next article will go in-depth about these different options, but let’s quickly set them apart.
Angel investing is a high-risk, high-reward kind of investment where you often need a large bag of capital available. An investor may also need a personal connection to the company to be able to invest directly.
Crowd Equity platforms make this easier for you. They set up the connection between you and the company that is raising capital, but the homework and challenge of company selection remains with you.
And it’s super hard to select the winning startups and scaleups — 9 out of 10 startups fail.*
It’s even more difficult to judge a company based on a few marketing pages.
That is why an investor can benefit from a team of experts with technical, investment and market knowledge to perform research (due diligence) on a company before you invest.
This is where private equity funds come in.
Simply put, a private equity fund is a team of experts trying to find companies with the highest possibility of success. This isn’t to say private equity funds solve the adverse selection of startups and scaleups* — the market is crowded with low-quality ventures and with low-quality funds selecting them.
Top performing funds are responsible for the overall above-market performance of the whole industry, which makes it critical that you invest via these well-positioned fund managers who know the game.
The problem with best-in-class private equity funds is that the majority of investors have been excluded due to regulatory constraints, high entry investment amounts (starting in the millions) and the lack of network.
We at Carbon Equity unlock investor access to top-tier private, climate impact investing opportunities.
By pooling small tickets together, Carbon Equity directly connects many more individuals to some of the world’s best climate funds. In doing so, next-gen investors finally have the chance to use their capital to have high-impact — plus, high-yield opportunities.
What is public market investing?
In public markets, you invest in public companies.
A public company is one that has held an initial public offering (first sale of stock to the public) and whose shares can be bought, sold or traded on a stock exchange.
Stocks and bonds are examples of traditional asset classes and are considered to be mainstream investments.
Stocks are small portions (shares) of the ownership of a public company. Bonds are a form of debt that the issuing entity promises to repay at some point in the future.
Individual and institutional shareholders constitute the owners of a publicly-traded company, in proportion to the amount of stock they own as a percentage of all outstanding stock.
What is private equity and how does it work?
Private equity is considered an alternative investment class and consists of investing in companies not listed on a public stock exchange.
97% of all companies are privately held.
Private equity investment comes primarily from institutional investors and accredited investors, who can dedicate substantial sums of money for extended time periods.
In most cases, considerably long holding periods are often required for private equity investments to turn around for struggling companies or to enable liquidity events of fast-growing companies to reach initial public offerings (IPO) or a sale to a public company.
Here are four common types of private equity to understand: