“Creativity is not the finding of a thing,” as the 19th-century New England poet James Russell Lowell noted, “but the making something out of it after it is found.”
Dave Chen, CEO of Equilibrium Capital, has built a $1 billion asset management platform out of the finding that environmentally and socially beneficial practices can drive operational efficiencies, reduced risk and above-market, or ‘alpha,’ returns. The Portland, Ore., firm is not only an investor but an operator of blueberry and citrus farms, agricultural bio-digesters, energy efficiency generation and other “sustainable” real assets.
“Sustainability is becoming just the way business is done,” says Chen, a former venture capitalist and tech executive. Increasingly, companies are internalizing the true costs of their operations, and the pricing of risks is becoming well-understood. In earlier decades “quality” in manufacturing went from being an added cost to a competitive advantage, Chen notes. “Sustainability is on this very same path.”
Chen formed Equilibrium in 2007 around what he saw as powerful trends, from the rising consumption of the global middle class to a new focus on water use to the reshaping of major commodity sectors. For Equilibrium, natural resource constraints and increasing demand create a value-shift and market opportunities. To realize those opportunities and tap the sustainability value, Equilibrium has built investor-operator teams and asset-management strategies that combine on-the-ground experience with the financial discipline required by institutional investors.
Financial engineering, which got a bad rap in the global financial crisis, is a potentially huge force for social good, he says. A teacher at the Kellogg School of Management and Stanford’s Graduate School of Business, he tells his students: If you want to change the world, you better know your way around a spreadsheet. He is a co-founder of what is now the Morgan Stanley Sustainable Investment Challenge, in which teams of MBA students compete to develop workable structures for financing solutions to social and environmental challenges.
But finance isn’t enough. Unlike most fund and asset managers, Equilibrium is the actual grower of its blueberries and operator of its wastewater biogas generators. Equilibrium recently closed its $250 million ACM Permanent Crops Fund, which is already a large organic blueberry producer and is buying and developing hazelnut, table grape and citrus farms in California, Oregon and Washington. Equilibrium’s team manages not only the financing, but the growing, processing, packaging and marketing of the crops, many of them organic. By applying modern water, soil and pest management, the team aims to lower input costs while fetching premium prices.
Equilibrium’s wastewater and biogas strategy, Wastewater Capital Management, provides project capital to design, build and operate agricultural and municipal biodigesters. The projects generate multiple revenue streams: from farmers and cities for waste disposal, from utilities for renewable natural gas and from carbon credits bought by other companies to offset their emissions. In agriculture alone, the Obama Adminstration’s “biogas opportunity roadmap” last year found a market for more than 11,000 additional systems in the U.S., up from 2,000 currently. Together, the digesters could power more than 3 million homes and reduce methane emissions by up to 54 million metric tons by 2030, the equivalent of taking 11 million passenger vehicles off the road.
Equilibrium also is developing investment vehicles to scale-up energy efficiency financing. It is the backer of EnergyRM, a Portland company that has developed a “DeltaMeter” to measure the energy generated by energy efficiency. Seattle City and Light last year became the first utility to approve an agreement to buy and sell such energy just like any other source.
In its early years, Equilibrium started by buying into the companies of leading fund managers who were executing on sustainability strategies. Australian Pastoral Fund Management has assembled large ranches across Australia to cost-effectively produce sustainably grassfed beef and sheep for the growing Asian market. Gerding Edlen’s Green Cities funds manages more than 60 office, apartment and mixed-use projects worth more than $5 billion. In 2011, Equilibrium shifted to a proprietary fund model, developing its own strategies and teams.
In pitching investors, Equilibrium doesn’t generally lead with its sustainability thesis. Many institutional investors already are increasing their allocation to real assets, such as real estate, farmland and timber, as a hedge against inflation and market volatility and can combine immediate yields with long-term appreciation. To this appeal, Equilibrium adds practices that further boost returns and reduce risk. The fact that they are environmentally sustainable is an added plus.
There’s some big thinking behind Equilibrium’s offerings. Externalities — the economic term for costs and benefits that are attributable to a company but not directly valued on its books — are increasingly becoming internalized in business operations. Just as mortgage-backed securities and collateralized debt obligations let financial engineers offer investors different levels of risk, the quantification of social and environmental benefits — a still-rough but improving science — is starting to let financial engineers create different “tranches” of benefits, including social and environmental ones.
Chen sees an emerging shift in the understanding of “fiduciary duty,” away from a narrow focus on short-term financial gain to consideration of a long-term values and comprehensive risk factors. For long-term holders, such as public pension funds, he says, sustainability drivers are becoming “material macro-trends that must be considered in their duty of care and loyalty.”
Indeed, several of the firm’s investment strategies already have attracted public pension funds, university endowments and other major institutional investors, as well as high-net-worth individual investors. The institutional focus makes Chen something of a pioneer of impact investing’s next stage: large-scale, repeatable investment strategies that can attract eight- or even nine-figure checks in the mainstream capital market.
Chen considers this a “break out” strategy for impact investing. ”We’ve charted and executed a very different impact approach,” he says. “Real assets. Solid fundamentals. Scale economics. Institutional investors. That’s our contribution to the impact conversation.”
Disclosure
One of a series of impact profiles produced in conjunction with the Case Foundation’s publication, “A Short Guide to Impact Investing.”
Equilibrium Capital is a sponsor of ImpactAlpha.
This post was originally published on ImpactAlpha.com
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