Real Assets and Sustainability: Investing in a Changing Policy Environment

Hello, everyone. This is George Suttles, executive director of Common Fund Institute. And I'm Amanda Novello, senior policy and research analyst at Common Fund Institute. And this is Espresso Chats, a podcast by Common Fund Institute where we deliver short, strong shots of governance and leadership insight. Today we have on the show friend and colleague Dan Connell, Managing Director and Co Head of Real Assets and Sustainability. Dan, welcome to the show. Hey, great to be on. Thanks for having me. Amazing. Good talking with you both. Absolutely. Thank you. Dan, let's jump right in. Can you tell us about what your team at Common Fund does, where it sits in the firm, the market segments and opportunities that you're focused on? Absolutely. So our team, we have a team of, eight people now, a combination of folks with really interesting backgrounds. We have folks that are former military that have worked in chemicals businesses that have worked in upstream oil and gas companies, worked with agriculture, in internal farming firms, indoor farming firms, really interesting set of backgrounds. That team is within the CF private equity arm of the broader common fund, which is the private investment arm of the firm. And our real assets and sustainability team really oversees our efforts investing in areas like natural resources and environmental sustainability. Awesome. Thanks, Dan. About a year ago, you wrote an article on commonfund dot org about what might happen under a new administration in terms of real assets and sustainability investing, notably with the Inflation Reduction Act, a major piece of legislation that served in a variety of ways to address climate change and boost a clean energy transition. Obviously, we're in, for lack of a better term, fraught, a fraught public policy environment on many fronts. But can you give an update on what's happened over the past year or so and how the environment for real assets and sustainability investing has shifted? And no pun intended on shifting environment given we're talking about sustainable investment. Wait. Has the has the policy environment changed in the last twenty four months? I wasn't aware of that. So, yeah, look, it's it's certainly been a significant change in the real assets and sustainability space. When you look at not just the public policy and even sort of the posturing that you get from folks in in political life, but also the implementation of policy that existed previously. So you see that in changes around stances on permitting, even permitting for existing renewables projects. You see it certainly in terms of full throated support for the traditional upstream energy ecosystem. And so those changes have been pretty significant in terms of the perception. I think that that's more nuanced in terms of the reality of the implementation of some of that. Now, the changes around the Inflation Reduction Act have been meaningful. You saw a meaningful shift and rollback of some key elements of the Inflation Reduction Act, and that combined with some of the efforts around additional regulatory and executive branch intervention in renewables markets in particular, have combined to really sort of shift the market environment. And what does that end up meaning? For some areas of the market, it's been a near standstill, so think offshore wind. This is something that was, I think for most market participants, fairly predictable. It was clear that there was likely to be some level of opposition for that segment of the renewables market. For other areas of the market, impact is there, but maybe less significant. So think about utility scale solar as an example. One of the topics of conversation right now that you can't escape is the demand for power, especially in the context of AI driven, artificial intelligence driven installation of data centers. You see the data center boom going full. That is creating a really interesting growth trajectory in power markets. So one of the things we're seeing is a lot of attention paid to where do we get that incremental next electron? So inevitably, becomes a question of what is most practical in terms of speed of deployment and cost. And policy environment changes a lot. Inflation Reduction Act policy has certainly shifted, but fundamentally, utility scale solar remains low cost and relatively easy to deploy at scale. So consequently, it continues to be deployed. The inverse is things like nuclear, which have gained a lot of attention and certainly are a focus of conversation. Those are harder to bring to market. For a utility scale, a traditional conventional nuclear asset, you're talking about a decade plus before you bring a new asset online. For things like small modular nuclear reactors, which are very popular and have gained a lot of popular attention, There certainly is a more permissive regulatory environment today, but it's still fundamentally hard to bring those projects to market. There remains a need to field those projects at the pilot phase, which has been a moving target and continues to slide to this point, kind of the latter part of this decade and the early part of the next. It's a long way of saying there has been change in the market, but it's maybe not as pronounced and not necessarily a straight line in the way that folks might intuitively expect. Thanks, Dan. Just really quickly, a follow-up question. You know, we've had broader conversations about the energy transition and the fact that we're going to have to pull multiple levers to satisfy the need for power, as you mentioned. You speak a little bit about sort of how you all are thinking about the energy transition in these terms, especially since the regulatory landscape has implications for implementation and maybe how we understand the transition? Yeah. I mean, look, I I think I think I would encourage listeners to go back to sort of first principles when they evaluate what the energy transition is likely to look like. And what I mean by the first principles is first and foremost cost. And what wins in most circumstances is the most cost effective solution. In a market like the US, that really for a lot of it is going come down to a combination of gas fired generation. So natural gas is going to continue to remain a big part of the energy mix, and utility scale renewables. Increasingly in conjunction with distributed renewables. So think solar on rooftops, along with batteries and battery storage, and that could be battery storage at utility scale. That could also be distributed battery storage. Those types of solutions blend the features that the market really needs, which is a combination of cost effectiveness, speed of deployment, and dispatchability or control. What I mean by dispatchability is at the end of the day, the grid wants power that can be ramped up and down to match demand. So you can't ramp up, let's say, an individual solar project or wind farm because fundamentally they run when the wind blows or the sun shines. Pair them with batteries, now you have a dispatchable asset. Natural gas fired power generation, same concept. And so that matters a lot at a time where there's a lot of scrutiny around how stable is the grid. You think about some of the recent events that we've had with wildfires in California knocking out power, with winter storm Uri in Texas several years ago. You go back almost a decade ago, you had the major polar vortex that froze significant portions of areas like Pennsylvania and Ohio. These are real challenges for grid operators, and the grid is only going to be under increasing strain as you start to see demand growth after two decades where demand growth was basically zero. So now you've moved to this period where you have significant demand growth. That energy transition is going to have to be focused on delivering cost effective, dispatchable, flexible solutions, and it's going to be some combination of those assets that's going to really end up help carrying the day. Thanks, Anne. Where can you speak to where real assets and sustainability sit within a nonprofit institutional investors portfolio? So maybe listeners are intrigued by some of the focus areas you are describing and just want to tease out how and why someone would take this to their IC or their board and say, this is important, and we should be talking more about this. Why now? Yeah, absolutely. So there's a few different ways that investors tend to use these types of investments in their portfolios. The first tends to be an allocation to areas like traditional natural resources to provide a combination of diversification, inflation hedging, and alpha generation or return. But it's a blend of those three factors, and it's not necessarily one. So sometimes they'll have a dedicated allocation to that in their portfolio. That could be the case for traditional natural resources. It could also be the case for environmental sustainability, environmental solutions type of mandate. They look at those types of assets as providing that blend of return, inflation hedge, and diversification to really help round out their portfolio. And you've seen that, by the way, play out in the last several years, where if you go and look at some of the studies that have been done on performance by different asset classes, Private natural resources was a leader in twenty twenty two and twenty twenty four for delivering return, and importantly, delivering liquidity at a time where the broader private markets were generally pretty frozen with interest rates rising, inflationary pressure, really sort of slowing down deal flow. So that diversification piece ended up being really important, that inflation hedging piece got tested and proved to be really important, and those are some of the factors that drive investment decision. Now that said, some investors may not have that dedicated allocation. They may have it as a broader allocation to privates or a broader allocation to diversifying private exposures. Sometimes you'll see these types of allocations put in an infrastructure or even a private equity bucket. There's a lot of different approaches to that. And it really sort of depends on the investor, how they think about and classify the investment approach. But those are some of the attributes that they're often looking for when thinking about these types of investments from a big picture allocation perspective. Dan, really interesting. Just a follow-up question. So Amanda posed sort of an opportunistic question, right? Like what's the profile? Why is this a compelling investment opportunity? But when you're speaking with folks in the industry, asset owners who are contemplating this, where's the hesitancy lie? Where are you getting pushback and what are some of the investment challenges, both perceived and maybe real? Yeah. So it's funny how often the challenge is also the opportunity, right, George? And so you look at a place like traditional natural resources, if you go back and look at some of the fundraising data for let's just focus on oil and gas private equity firms. From twenty thirteen to twenty fifteen, those firms raised in excess of one hundred billion dollars Those same firms or that same segment of the market over the period from twenty twenty two to twenty twenty four raised less than twenty billion dollars. That's a huge swing in capital availability in that market. And it's not as though and most of by the way, many of those groups focus on North America in particular US and to a lesser extent Canada. Even the casual observer will recognize it's not as though upstream oil and gas activity was slowed or curtailed in North America during that time period, quite the opposite. What's going on there? Well, a lot of what happened was capital flight from the space, which was driven by significant amounts of capital having been formed and then underperforming for a handful of different reasons in the first part of the twenty tens. And that drove this really protracted hangover and resulted in a huge capital flight, which was accelerated by both focus on the energy transition and also concerns about climate change, which factor in our are significant for many investors. Those created a sticky situation where capital remained absent from the space and continues largely to remain absent from the space. So that's the that's the challenge. The opportunity that stems from that is it's a really interestingly dislocated part of the market where you've seen recovery in cash flows. You've seen balance sheets get cleaned up for a lot of these businesses. So really attractive profile, but still really stayed multiples on a historic basis. So you have these businesses that are clean, functioning, driving significant cash flow, but really sort of dislocated in terms of how they're valued and priced. So it creates a really interesting dynamic for investors. And we see that as being particularly pronounced in traditional energy on the secondary side of the market, where you continue to see investors struggle with how they think about allocating capital there. Yeah, that's amazing and what I love about these opportunities to chat with really smart people such as yourself is that we always get the sound bite that I love to repeat. So I think, you know, from a governance standpoint and a strategic decision making standpoint, Amanda and Dan and Dan, you can correct me if I'm if I'm not, if I'm, misrepresenting this, but the challenge is also the opportunity. We might put that on a common fund institute t shirt or something, but I think that's right. Right. It's like the challenge is also the opportunity. And so it's a nice strategic decision making reframe, especially for institutional investors who are still contemplating whether this is an attractive opportunity or not in the real assets and sustainability space. We certainly think that's the case, George. We see that play out. And you think about it, there's a degree of intuition there that tracks, where you think about the whole concept of a crowded trade, which is a cliche in finance, and the idea that as capital gathers in a particular corner of the market, it inevitably drives up valuations, and it makes that opportunity set on the margin comparatively less interesting, even if it's just less interesting than maybe it had been a few years or a few quarters prior. That concept very much holds here where you're seeing it's a significant part of the real economy, the physical economy, but significantly starved for capital relative to levels that it saw a decade plus prior. Absolutely, absolutely. So Dan, I want to close us out here. We promised the people short and strong shots of governance, leadership and investment insight. But obviously we could speak, we could chat with you and be in conversation with you for hours about this. But I want to pose a final open question to you. What's exciting right now about your role or the field more broadly? And you can take any direction that you want on that question. Yeah. Tend to really like the idea of being able to move into parts of the market as other investors are leaving. And so selfishly, I'm really excited because I look at the traditional natural resources space as an area that a lot of investors have fled and remain reluctant to return to. And I look at the sustainability end of the market, which is certainly out of favor based on sort of knee jerk read of headlines in most major, you know, news articles. And I think that's a really interesting end of the market too. You're seeing capital flight from that part of the market also. And inevitably, that leads to more attractive multiples on entry for investments and potentially more interesting opportunities as a consequence. Absolutely. And it kind of feels like we've come full circle on the gem you dropped earlier. The challenge is the opportunity. The challenge is definitely the opportunity. I love it. I love it. Dan, thanks so much for coming on the show. Really appreciate it. Always enjoy speaking with you. Thank you. You. Thank you. To those of you listening, if you liked this conversation and you want to hear more from leaders in this field, w w w dot commonfund dot org slash espressochats to view the full playlist and subscribe on your preferred podcast platform. See you next episode. Bye now. Bye. Thanks, everybody. Alright, great job. Thank you. Thanks guys. Yeah, Dan, how do you feel? I thought it was great, but I'm biased of course. I mean, I tried to give as you all know, I think I'm I pretend to prefer shorter answers. So I tried to be a little less succinct. Hopefully, I was able to give you enough to work with. If you need anything else from me on the back end, just let me know. Yeah. No. I actually thought that was perfect. Right? Like you provided, it was a good balance of providing sort of robustness without it feeling like an overload. So I think somebody, you know, I actually think this is one of the better episodes where it's a very sort of complex, topic and you were sort of right on the money just in terms of your delivery, the type of information you shared. Yeah. And your excitement about the work and the opportunity I thought was felt as well. So, yeah, well done. Well done. Thank you, guys. Appreciate it. I appreciate you guys setting me up well. The questions really help. It's kind of easy when it's sort of up on a tee like that for you. So really appreciate it. And genuinely, if you guys need anything else from me, just let me know. Awesome. Yeah. Thanks, Dan. Thanks. Are we wait. Before we Amanda, Jewel, are we good? Is there anything that I missed that we need or? No. We're good. Thank Awesome. Thanks so much. Amanda, George, Jewel, thanks very much. Awesome. Thanks, everybody. Bye all. Bye.