Generating Impact Alpha: A Global Projects Center Conference - Stanford University, 2015

Global Projects Center

GENERATING IMPACT ALPHACatalyzing Solutions to Global Problems through

Investment Innovation

PRESENTS

CONFERENCE RECAP

28-29 April 2015Paul Brest Hall, Munger Building 4

Stanford University

Contents

PRESENTATIONS

Conference Introduction Dr. Ashby Monk, Global Projects Center, Stanford University Catalyzing Development with Sovereign Development Funds Dr. Ashby Monk, Global Projects Center, Stanford University

Corporate Foundations as Vehicles for Community Solutions Prof. Gordon Clark & Dr. Caitlin McElroy, Smith School for Enterprise and the Environment, Oxford University

Re-Intermediation and the ‘Collaborative’ Model of Institutional Infrastructure Investment Dr. Rajiv Sharma, Global Projects Center, Stanford University

Sustainability & Investments: Taking the Long View Austin Kiessig & Noel Kullavanijaya, Equilibrium Capital

Dr. Strange Returns Rob Day, Black Coral Capital

The “Impact Investment Bank” Dr. Alicia Seiger, Steyer-Taylor Center for Energy Policy & Finance, Stanford University

READINGS

‘The Valley of Opportunity’: Rethinking Venture Capital for Long-Term Institutional Investors Jagdeep Bachher, Prof. Gordon Clark, Dr. Ashby Monk and Kiran Sridhar

What Institutional Investors Desperately Need: Two Letters Dr. Ashby Monk

Sectors, Not Just Firms Matt Bannick & Paula Goldman

The Financial Value of Extra-Financial Motives Dr. Ashby Monk

Transcending Home Bias: Institutional Innovation through Cooperation and Collaboration in the Context of Financial InstabilityProf. Gordon Clark & Dr. Ashby Monk

Climate Exposure Impact on Equity Valuation: Case Study of Vail Resorts, Inc.Donna Debb

Impact Investing in the Energy Sector: How Federal Action Can Galvanize Private Support for Energy Innovation and Deployment Sarah Kearney, Alicia Seiger and Peter Berliner

A New Vision for Funding Science Sarah Kearney, Fiona Murray and Matthew Nordan

Impact Investing: Six Principles for Effecting Change and Returns Dr. Ashby Monk

Letter from the Global Projects Center

APPENDIX

About the Global Projects Center

Letter from the Global Projects Center

Dear Friend, Affiliates, and Colleagues,

On behalf on the Global Projects Center, thank you for joining us at Generating Impact Alpha: Catalyzing Solutions to Global Problems through Investment Innovation. We hope that you enjoyed the conference, and that you found it both educational and interesting. We really appreciated your participation and discussion at the conference, and hope to see you at future events.

Within this document we have provided many of the presentations given over the two days, as well as additional, unseen content and related research. We present this information for those of you who are curious and desire further information, and encourage those who found the conference interesting to read the research that has influenced our unique perspective and work.

If, in reading this document, you seek further information regarding specific topics or direction as to areas of research relevant to your work, please don’t hesitate to contact us.

For more information on our research regarding impact, long-term investment, sustainability and frontier finance, please contact Peter Clark ([email protected]) for more information.

Best wishes,

Ashby MonkExecutive DirectorStanford Global Projects Center

PRESENTATIONS

GPC$–$Stanford$University$

Welcome$to$Impact'Alpha$$$ $

Execu;ve$Director$Global$Projects$Center$$Stanford$University$

$

1$

! !! !Dr.!Ashby!H.!B.!Monk!$


In!theory,!there’s!plenty!of!long9term!capital!

(Note: That’s actually a conservative estimate. Seriously)


Lack!of!investments!dollars!for!criAcal!“projects”!!!

3$


Financial!services!may!be!capturing!too!much!value…!!

4$

…!and!distorAng!incenAves.!!


Short!termism!is!endemic!

5$


Not!just!USA…!There!is!endemic!short9termism!

Average Holding Period - Selected Exchanges

Source:'OECD%(report%DAF/CA/CG(2010)12)$


“We$seek$to$facilitate$understanding$of$the$financing,$development,$and$

governance$of$cri;cal$infrastructure$worldwide.”$

What!are!we!doing!at!GPC?!!

7$

GPC$–$Stanford$University$ 8$


But!the!real!quesAon!is!how!we!get!from!short9termism…$$$$$$$$$$

$ $$$

$

9$

…!to!long9termism.!


Sovereign$Development$

Funds$

Long$Term$$

Investment$

Climate$Finance$

Impact$Investment$

Collabora;ve$Investment$$PlaSorms$

Crowd$Sourcing$

Due$Diligence$

Sustainable$Inves;ng$

Infrastructure$$Investment$

Corporate$Founda;ons$

Innova;ve$Investment$$Structures$

Leveraging$Financial$$Networks$

Philanthropic$$Finance$

Investment$Innova;on$

Why!“Impact!Alpha”!Conference?!!


We$focus$on$helping$the$$100$trillion$find$beXer$and$more$aligned$access$to$the$“real$economy”.$This$has$led$to$an$overYarching$research$focus$on$the$following:$$

1)  Professionaliza;on$of$Asset$Owners$

2)  ReYIntermedia;on$of$External$Service$Providers$

3)  Technological$Adop;on$

4)  New$Conceptual$Tools$

Why!the!GPC!exists…!!


Ground$Rules$$for$$

Impact%Alpha%

12$


Session$1$Sovereign$Development$Funds$

$Execu;ve$Director$

Global$Projects$Center$$Stanford$University$

$

13$

! !! !Dr.!Ashby!H.!B.!Monk!$


Before!Impact!invesAng!was!a!“thing”,!there!were!SDFs…!

14$

18%$IRR$over$40$years$$ 13%$IRR$since$2004$reform$$

16%$IRR$since$2004$

“Inves;ng$For$Development”$


1)  Situating SDFs in the community of institutional investors.

2)  Description of Stanford / Oxford SDF Project

3)  Some of the findings & lessons

4)  UC Ventures

5)  Final Thoughts

$

Table!of!Contents!

GPC$–$Stanford$University$16$

2010s$2000s$1990s$1980s$1970s$1950s/1960s$

30$$$$$$$$$$$$$20$$$$$$$$$$$$$10$$$$$$$$$0$

$

#$of$New$SWFs$

3$ 4$ 5$8

29$

Source:$Ashby$Monk,$Oxford$SWF$Project$

?$Precau;onary$savings$has$become$a$standardized$macro$and$fiscal$policy$tool.$$Countries$use$commodity$revenues,$foreign$exchange$reserves$and$budget$surpluses$to$set$up$SWFs$for$global$investments.$$$

Examples: Azerbaijan$Botswana$

China$(SAFE)$Hong$Kong$

Iran$Malaysia$Norway$

Venezuela$$$$

Australia$Brazil$China$$

(CIC,$NSSF)$France$S.$Korea$Russia$Qatar$

and$others$$$$

Angola$Colombia$Ghana$India$Israel$

Mongolia$Nigeria$

South$Africa$and$others$

Kiriba;$Kuwait$

New$Mexico$

Abu$Dhabi$$(ADIA)$Alaska$Alberta$Wyoming$

$$

Abu$Dhabi$$(IPIC)$Brunei$Chile$$Oman$

Singapore$$

Sovereign!Wealth!Funds!


Sovereign!Wealth!Fund!Basics!

Accepted!DefiniAon:$�Sovereign$wealth$funds$(SWFs)$are$special$purpose$investment$funds$or$arrangements$that$are$owned$by$the$general$government.�$

$Generic!FuncAon:$Created$by$na;onal$or$subYna;onal$

governments$for$macroeconomic$purposes,$SWFs$hold,$manage,$or$administer$assets$to$achieve$financial$objec;ves,$and$employ$a$set$of$investment$strategies$that$include$inves;ng$in$foreign$financial$assets.$

$Sources!of!Capital:$SWFs$are$generally$established$out$of$

balance$of$payments$surpluses,$official$foreign$currency$opera;ons,$the$proceeds$of$priva;za;ons,$fiscal$surpluses,$and/or$receipts$resul;ng$from$commodity$exports.$

$Investment!Strategy:$The$investment$approaches$adopted$by$

sovereign$wealth$funds$are$as$varied$as$the$types$of$public$funds$that$qualify$as$a$SWF.$Some$are$highly$conserva;ve$and$shortYterm$oriented,$while$others$will$consider$inves;ng$in$interYgenera;onal$assets.$$

The$IMF$sees$five$types$of$funds$that$qualify$as$being$a$�sovereign$wealth$fund�:$$$1. 'Stabiliza6on'funds:$The$objec;ve$is$to$insulate$the$budget$and$the$economy$against$commodity$price$vola;lity$(e.g.,$Chile,$$Russia).$$

2. 'Savings'funds:$The$objec;ve$is$to$convert$nonrenewable$assets$into$a$diversified$porSolio$of$assets$that$can$be$held$offshore$to$mi;gate$the$effects$of$Dutch$disease$(Abu$Dhabi,$Alberta).$$

3. 'Reserve'investment'corpora6ons:$The$objec;ve$is$to$invest$excess$foreign$exchange$reserves$in$riskier$assets$to$bolster$the$return$on$reserves$(e.g.,$China,$Korea).$$$

4. 'Development'funds:$The$objec;ve$is$to$help$fund$socioYeconomic$projects$or$promote$industrial$policies$that$might$raise$a$country�s$poten;al$output$growth$(e.g.,$Kazakhstan,$Malaysia).$$$

5. 'Pension'reserve'funds:$The$objec;ve$is$to$provide$(from$sources$other$than$individual$pension$contribu;ons)$for$con;ngent,$unspecified$pension$liabili;es$on$a$government�s$balance$sheet$(e.g.,$Ireland,$New$Zealand).$$

SWF 101 Sub-Types


Sovereign!Wealth!Fund!Basics!

Accepted!DefiniAon:$�Sovereign$wealth$funds$(SWFs)$are$special$purpose$investment$funds$or$arrangements$that$are$owned$by$the$general$government.�$

$Generic!FuncAon:$Created$by$na;onal$or$subYna;onal$

governments$for$macroeconomic$purposes,$SWFs$hold,$manage,$or$administer$assets$to$achieve$financial$objec;ves,$and$employ$a$set$of$investment$strategies$that$include$inves;ng$in$foreign$financial$assets.$

$Sources!of!Capital:$SWFs$are$generally$established$out$of$

balance$of$payments$surpluses,$official$foreign$currency$opera;ons,$the$proceeds$of$priva;za;ons,$fiscal$surpluses,$and/or$receipts$resul;ng$from$commodity$exports.$

$Investment!Strategy:$The$investment$approaches$adopted$by$

sovereign$wealth$funds$are$as$varied$as$the$types$of$public$funds$that$qualify$as$a$SWF.$Some$are$highly$conserva;ve$and$shortYterm$oriented,$while$others$will$consider$inves;ng$in$interYgenera;onal$assets.$$

The$IMF$sees$five$types$of$funds$that$qualify$as$being$a$�sovereign$wealth$fund�:$$$1. 'Stabiliza6on'funds:$The$objec;ve$is$to$insulate$the$budget$and$the$economy$against$commodity$price$vola;lity$(e.g.,$Chile,$$Russia).$$

2. 'Savings'funds:$The$objec;ve$is$to$convert$nonrenewable$assets$into$a$diversified$porSolio$of$assets$that$can$be$held$offshore$to$mi;gate$the$effects$of$Dutch$disease$(Abu$Dhabi,$Alberta).$$

3. 'Reserve'investment'corpora6ons:$The$objec;ve$is$to$invest$excess$foreign$exchange$reserves$in$riskier$assets$to$bolster$the$return$on$reserves$(e.g.,$China,$Korea).$$$

4. 'Development'funds:$The$objec;ve$is$to$help$fund$socioYeconomic$projects$or$promote$industrial$policies$that$might$raise$a$country�s$poten;al$output$growth$(e.g.,$Kazakhstan,$Malaysia).$$$

5. 'Pension'reserve'funds:$The$objec;ve$is$to$provide$(from$sources$other$than$individual$pension$contribu;ons)$for$con;ngent,$unspecified$pension$liabili;es$on$a$government�s$balance$sheet$(e.g.,$Ireland,$New$Zealand).$$

SWF 101 Sub-Types


SDFs have come to be seen as useful tools to catalyze local economies and markets.

$

Why!Governments!Want!SDFs!


SDFs have come to be seen as useful tools to catalyze local economies and markets.

While generating HIGH financial returns!

(If they are set up correctly.)

$



Oman!Investment!Fund!

Temasek,!Singapore!

Mubadala,!UAE!Mumtalakat,!Bahrain!

Russia!Direct!Investment!Fund!

Brazilian!Development!Bank!!

Khazanah,!Malaysia!

PalesAne!Investment!Fund!China!ASEAN!Fund,!Hong!Kong!

AP6,!Sweden!

Public!Investment!CorporaAon,!South!Africa!

State!Capital!Investment!!CorporaAon,!Vietnam!!

NaAonal!Development!Fund,!Iran!

NaAonal!Development!Fund,!Taiwan!

NaAonal!Development!!Fund,!Venezuela!

Strategic!Investment!!Fund,!Ireland!

Strategic!Investment!!Fund,!France!

Strategic!Investment!Fund,!Italy!

Infrastructure!Fund,!NSIA,!Nigeria!

The!(ParAal)!Map!of!SDFs!



The$SDF$Project$$


•  In May 2013, we launched a multi-year research project to analyze sovereign development funds (SDFs).

•  Specifically, we are looking to create principles and policies for how governments can best use SDFs to catalyze local industries and spur local economic development.

•  We were particularly interested in better understanding the high financial returns that some of these vehicles are generating.

•  The crux of this research rests in understanding the design, governance and management of successful sovereign development funds as well as to unpack the factors driving such high investment returns.

Research!ObjecAves!


This project began with the following key questions: •  Why do these funds exist? Why is it that the private sector is incapable of taking the

lead in developing the target markets?

•  Should the government do the job of developing the target markets via the budget instead of setting up a SDF? Why is a quasi-private vehicle necessary?

•  What are the key success factors? (i.e., development, financial returns, both)

•  How should these vehicles be structured and governed to maximize their likelihood of success?

•  Can we develop a series of principles and policies for effective SDF management?

•  What implications can we draw for those governments looking to improve the operations of their own SDFs? $

Key!Research!QuesAons!


Here’s a list of the reasons sponsors told us they launched SDFs:

•  To unlock capital in what would otherwise be capital-starved industries or regions.

•  To create efficiency and discipline where oftentimes none exists.

•  To develop industries and create jobs.

•  To bring in foreign investors.

•  To help build local competencies.

•  To serve as a credible; local co-investor.

•  To provide financial discipline.

•  To generate dividend or tax income for the government.

$



Reinforcing$Professionalizing$and$

reorganizing$the$exis;ng$SOEs$and$na;onal$

champions$for$success$

Cataly;c$Diversifying$old$industries$by$seeding$new$ones$

Financializa;on$Through$credible$

commercial$focus,$bring$discipline$and$

commerciality$to$domes;c$industries$$$

CrowdingYIn$Through$credible$

commercial$focus,$aXract$foreign$investors$into$domes;c$industries.$$

Link$To$Na;onal$Endowments$&$$Advantages$

Tight$

Loose$

Sovereign$Development$Fund$

Objec;ves$$

Commercial$Strategic$

Clark$and$Monk$2014,$based$on$Chesbrough’s$(2002)$$analysis$of$corporate$venture$capital.$$$

There$is$a$focus$on$commerciality$and$financial$returns,$which$in$turn$creates$addi;onality$

SDF!Categories!


Lessons$from$Case$Studies$


We’ve found the following criteria are important in SDF success domestically: 1) Commercial Orientation: The new vehicle should have a clear, commercial mandate that will guide the management team’s decision-making and help other investors understand and relate to its mission. 2) Governance: The SDF must have a robust governance framework that can stand up to external due diligence. Indeed, if this fund is going to originate deals locally and bring co-investors alongside, it will have to! 3) Local Access: The SDF must be able to source, assess, structure, and de-risk (as appropriate) the investment opportunities in a credible way. 4) Top Talent: It’s crucial that the individuals running SDFs be of the highest standing and, ideally, that they have a investment track record to back up their reputation. 5) Local Voice: SDF should provide a point of contact for outside investors to make their voices heard among the local agents and actors. 6) De-Risking: In certain circumstances, it may be necessary for the SDF to be in a ‘first loss’ position with certain guarantees around local risks. 7) Clarity of Mission: The “financial” component of the SDF can generally handle developmental constraints so long as they are very well defined.

SDF!Success!Factors!


Avoid!Deadweight!Loss:$SDFs$should$avoid$doing$things$that$either$the$government$or$the$free$market$would$do$on$their$own.$$!Avoid!Unintended!Consequences:!SDFs$should$learn$from$the$failures$of$government$and$capitalism$and$try$not$to$make$shortYterm$decisions$that$lead$to$longYterm$problems.$$!Avoid!‘Bridges!to!Nowhere’:$DevelopmentYorienta;on$is$not$an$excuse$for$a$lack$of$rigor$in$investments.$$$If$you’re$going$to$try$to$use$financial$markets$to$drive$extraYfinancial$benefits…$you$need$to$be$more$rigorous$and$savvy$than$the$average$investor.$Or,$at$the$very$least,$you$beXer$understand$your$strengths$and$weaknesses$very$well.$

Some!Things!SDFs!Should!Avoid…!

GPC$–$Stanford$University$February$3,$2015$

UC$Ventures$


Background!

•  Funded with up to $250M from the Investment Office •  Entity to operate at arm’s length from the University •  Primary objective to generate an attractive return on investment •  Secondary objective to foster innovation, research and technology

commercialization across the UC system

At the September Regents Committee on Investments Meeting, CIO Office was given approval to create an entity (“UC Ventures”) for the purpose of investing in startup companies and technologies that are spun out of the University.

Key Parameters:

Approval Process:

•  Staff to develop business plan in consultation with General Counsel’s office •  Business plan to be approved by Chief Investment Officer and presented to

Committee on Investments before moving ahead

32$


Proposed!strategy!

Untapped!systemic!opportunity.!1!

Using$pension$and$endowment$funds,$UC$Ventures$must$always$seek$return$on$its$investment.$Drive$high$financial$performance$by$untangling$the$complexity$of$inves;ng$within$the$UC$ecosystem.$

Focused!on!UC!InnovaAon.!2!

Investment$opportuni;es$must$emerge$from$the$UC$innova;on$economy.$Our$core$constraint$is$poten;ally$our$biggest$compe;;ve$advantage.$

InnovaAon!is!local.!3!

Source$through$local$partners$by$being$a$thoughSul$partner.$Allocate$small$investments$to$local$funds$focused$on$campus,$medical$center$or$lab$technology$to$secure$followYon$rights$and$deal$flow$for$UC$Ventures.$

Use!best9in9class!partners.!4!

Must$syndicate$deal$with$preYapproved$VC,$angel,$or$superYangel$investors$to$reduce$risk.$We$will$bring$a$name$brand$investor$alongside$in$any$deal$we$do$to$validate$our$beliefs$about$a$certain$company$and$help$grow$companies.$


Final$Thoughts$



“What investment strategies do you believe can deliver high risk-adjusted returns, while simultaneously delivering on local development objectives?”

Table!Discussion!–!10!minutes!

Auer$Table$Discussion$–>$40$minute$Panel$with$Eugene,$Shauna$and$Hugo$


Corporate(Founda-ons

Dr.(Caitlin(McElroy(([email protected](

April(28th,(2015(Stanford(University((Global(Projects(Centre(Genera-ng(Impact(Alpha(Conference((

Corporate(Foundations?(Why?((M Independence((of(decision(making(and(longevity)(in(the(governance(and(investment(of(funds(for(environmental(and(social(development(projects(

How?((M Annual(percentage(of(profit(M Ini-al(lump(sum(alloca-on(M Ongoing(giving(of(dona-ons(

What?(!"""Funds/Trusts/and(Founda-ons((M (((Distribu-ng(funds/governing(investments/(implemen-ng(projects.((

(

Examples:((Who?/(Where?(

– Mul-Mna-onal(corporate(wide(or((–  Site(specific/opera-on(focused(

(BHP(Billiton((international(and(site(speci?ic)(WalAMart(Foundation(The(Body(Shop(

(

Form(and(Function:(Old(mindsets(of(CF’s((Philanthropy(

– Charitable(giving((– Minimal(focus(on(return(on(investment(– Very(strong(brand/reputa-on(associa-ons(– Limited(cri-que/oversight/independence(of(investment(and(dona-on(decisionMmaking((

(

Form(and(Function:(New(mindsets(of(CF’s((Investment(M  Development(of(SME’s(M  Capacity(building(M  Independence(of(investment(decision(making((M  Formal(strategy(for(and(focus(on(evalua-ng(impact(and(

return(on(investment(

((

Measuring(Impacts((A](Projects(and(investments(M  Accessible,(auditable(metrics(M  Sustainability(postMinvestment(M  Growth/service(gap/market(development(

B](Sponsoring(corporation(M  Sustainability(and(security(of(opera-ons(M  Benefits(to(brand(and(reputa-on((M  Improved(market(or(capital(access?(

Key(“How(to”(components:(Partnerships(for:(M  investment(management(M  project(implementa-on(M  collec-ve(impacts(

(Governance(M  Need(for(new/coordinated(standards(M  Board(and(management(teams(require(new(mixes(of(exper-se(

(Exit(M  Timeframe/(success(as….?(M  ROI?((

(

Re-Intermediation and the ‘Collaborative’ model of Institutional Infrastructure Investment

RAJIV SHARMA RESEARCH ASSOCIATE, GLOBAL PROJECTS CENTER,

STANFORD UNIVERSITY

1 Please do not reproduce or distribute any part of this presentation

Agenda

1.  Background Information/Context for Re-intermediation and Collaboration for Institutional Investors

2.  Theoretical Approach - sociology

- Social Network Analysis - Relational Contract Theory

3. Case Studies on Infrastructure Co-investment platforms

2

1. Background/Context 2. Theoretical Approach 3. Case Study Examples

Background/Context

Since the financial crisis – there has been a renewed focus on long-term investing by institutional investors.

Central to this is the need for institutional investors to invest in long-term illiquid asset classes such as infrastructure.

Our research looks at how institutional investors can access infrastructure assets in a more efficient way than what was previously happening.

In particular we have been tracking the ‘collaborative’ model of investing that seems to have been adopted by a number of institutional investors.

3


Background/Context

The Three models of Institutional Investment:

1.   Norwegian Model – in-source, traditional public markets

2.   Endowment Model – out-source, alternative assets

3.   Canadian Model – in-source, alternative assets

4


Background/Context

What we seem to be observing in the market place is a 4th model of institutional investment – The ‘Collaborative’ Model

The ‘Collaborative’ Model = co-operative investment partnerships/platforms for long-term assets

(co-investment platforms, seeding managers, platform companies, collaboration initiatives with peers)

Our research at Stanford looks at theoretically validating the collaborative model of investing that is taking place.

We essentially explain the collaborative model through the Re-intermediation thesis.

5


The Re-intermediation Thesis

1. Those investors that are able to invest directly….should!!

2. Investors should develop an efficient, effective network to form collaborations and co-investment partnerships

3. Investors need to re-engage with financial intermediaries in a more ‘relational’ way

6




Empirical Evidence:

Fang, L., Ivashina, V. and Lerner, J. (2014) The Disintermediation of Financial Markets: Direct Investing in Private Equity.

Seven sophisticated institutions with long standing direct investment programs University, corporate, and government affiliated organizations based in North America, Europe,

and Asia. Several hundred investments over the last 20 years (1991-2011)

Key Finding: Direct investments outperform fund investments

CEM Benchmarking Database (Sample of global pension funds invested in infrastructure in 2009):

7




Empirical Evidence:

Cost Comparison (simplified) Example: Institutional Investor with a $10 bn infrastructure allocation

WEF report: “Direct Investing by Institutional Investors: Implications for Investors and Policy-Makers”

8

External Manager In-source

1-2% management fee Similarly large internally run

portfolio of infrastructure

assets by CPPIB – 0.3%

$100m - $200m /annum $30m /annum



2. Investors should develop an efficient, effective network to form collaborations and co-investment partnerships

Case Studies: Pension Infrastructure Platform Global Strategic Investment Alliance

CPPIB 407 toll road syndication

Macquarie PINAI fund

9

Build a Network (Social Network Theory)

Collaborations

Co-Investments



3. Investors need to re-engage with financial intermediaries in a more aligned way

Investor Universe is differentiated – not all can be direct investors

MORE ALIGNED = relationships with intermediaries based on trust, long-term, mutual dependency and cooperation

The LP-GP relationship has historically been weighted too heavily towards managers. Relational contract theory informs us how the new investor-manager partnership can be defined.

10

Investors Intermediaries

Relational Contract Theory


Theoretical Approach

SOCIOLOGY

SOCIAL NETWORK THEORY - HOW CAN INVESTORS BUILD AN EFFICIENT

AND EFFECTIVE NETWORK? (GRANOVETTER, BURT, WHITE)

RELATIONAL THEORY - HOW SHOULD THE INVESTMENT RELATIONSHIP

WITH PARTNERS BE APPROACHED? (MACNEIL, WILLIAMSON, MACAULEY)

11

INVESTMENT MANAGEMENT

ASSET MANAGEMENT


Social Network Theory

12


ASSET MANAGEMENT

- A strategy for helping to overcome the challenges of accessing long-term private assets is to develop an efficient and effective network.

- There are many benefits that can be accrued to an organisation as a result of building its social capital

- One of these benefits is to form co-investment partnerships with peer investors to achieve more alignment for investing in private market assets.

- Social Network Theory informs us how an efficient and effective network can be developed.



13


ASSET MANAGEMENT

-  What is social network theory? -  Study of how people or organisations interact with each other in a network. Looks at how these groups can invest in their social capital.

-  Provides an alternative approach to understanding finance (Contrast Neo-classical finance based on efficient/perfect markets)

-  Other applications of network theory applied to finance: -  syndication effects amongst VC firms -  the risk of contagion in the banking system -  role of investment and merchant banks as network creators -  impact of social ties between CEO’s and directors on board monitoring



14


ASSET MANAGEMENT

Two seminal papers: 1.  “The Strength of Weak Ties” – Granovetter, M. 2.  “Structural Holes and Brokerage” – Burt, R.

-  All else constant, the information benefits of a large diverse network are more than the information benefits of a small, homogenous network.

-  Diversity is important. A large network without diversity can be crippling.

-  The number of non-redundant contacts is what matters. Contacts are redundant to the extent that they lead to the same people, and so provide the same information benefits.

1. Background and Context 2. Re-intermediation 3. Theoretical Approach


15


ASSET MANAGEMENT

-  Balancing network size and diversity is a question of optimizing structural holes

-  Primary contacts are not just actors at the other end of the relations, they are points of access to clusters of people beyond.

-  Distinguish between primary and secondary contacts – focus resources on preserving primary contacts.

Structural Hole or Weak Tie

Non-Redundant Primary Contacts

Secondary Contact



16


ASSET MANAGEMENT

-  Structural hole creates information benefits. Brokers stand to profit from connecting the two contacts together over a structural hole.

-  In the investment management industry, investors have expressed a preference for investing in private market opportunities but have been forced to rely on financial intermediaries as the brokers bringing the opportunities to them.

-  Thus actors with networks rich in structural holes are more likely to know about, have a hand in and exercise control over, more rewarding opportunities.

Structural Hole

Broker



17

IFSWF WEF Long Term Investment Council Institutional Investor Roundtable Pacific Pensions Institute Sovereign Investor Institute Long Term Investors Club OECD Long Term Investment Club Co-investment Roundtable of Sovereign and Pension Funds Rotman International Center for Pension Management

KIC and CPPIB ADIC, GIC and Tothschild CIC, GIC and Future Fund ADIA and QIC NZ Super and Harvard NZ Super, ADIA, AIMCO CDC and RDIF, Qatar Holding, Mubadala OMERS and GPIF, DBJ, DBI



AGGLOMERATION ECONOMIES

REPLACED WITH

NETWORK ECONOMIES

18

Replaced with ‘Network Economies’ among Institutional Investors Reducing dependence on ‘Agglomeration Economies’



19


ASSET MANAGEMENT

The financial services industry has created a certain amount of value over an extended period of time and many investors will still need to rely on them.

Theory from Economics and Law informs us how the re-intermediation with financial services can be redefined.

The question of make or buy (Internal vs Outsource) becomes a question of utilising employment or service contracts.

Within contract theory, a spectrum of contracts exists, which can be used to analyse investment service contracts.



20


ASSET MANAGEMENT

Classical Contracts Neo-Classical Contracts Relational Contracts

‘one-off’, short term, discrete transactions

Alternative to classical Longer-term

Identity of parties irrelevant ‘Non-ideal’, transaction costs Process of transacting as opposed to discrete transaction

Terms and limits carefully outlined More emphasis on third party assistance, not litigation

Planning is tentative not binding

‘Ideal’ market transaction For more complex situations where parties gain confidence from settlement machinery

Repeated exchanges, based on trust, co-operation and mutual dependency

Large emphasis on price Personal involvement of parties important

Fund Model, LP/GP structure Example: Construction Projects (series of stage payments flowing from single contract)

New Model, Managed Accounts, Funds-of-one Other examples: Heathrow Terminal 5, pricing regulation,



21

ASSET MANAGEMENT

1980/1990’s 2008

Historically, investment management agreements or segregated portfolios were adopted by investors for traditional asset classes (listed equities, fixed income). These were like relational contracts for the larger investors. Smaller investors invested in mutual funds.

Recent (last few decades) move into ‘alternatives’ such as private equity, etc. The only way to get access was through funds using the LP-GP model.

As a result, investors started to get a poorer service moving away from relational contracts (segregated IMAs) towards classical contracts (purchase of an interest in a fund).

Any investor who protested about the terms of the classical contracts

was told that ‘this is market’.

Investors need to re-engage with their managers with the principles of relational contracts in mind!!



22


ASSET MANAGEMENT

Practical Considerations

Using infrastructure, which has been proposed as a long-term asset class suited to long-term institutional investors such as pension funds, SWFs etc.

-  Core economic infrastructure

-  Open ended funds or funds greater than 15 years

-  Ongoing Investment Period

-  Investors have more control

-  Liquidity available from cash yield/ exits or redemption if appropriate

-  Management Fees (closer to 0.5%)


Co-Investment Platforms

Platforms and Vehicles for Institutional Co-Investing – (Bachher and Monk 2013)

Three Types:

1.  The Alliance: - Loose affiliation of like-minded investors around an investment theme to share deals and resources.

2. The Syndicate: - Characterized by a formal affiliation of like-minded investors around an investment theme to share deals and resources.

3. The Seed: - Characterized by a formal legal structure (e.g., GP, LLC) that brings together like-minded investors

around a de-novo asset manager staffed by a seasoned investment team.

- --

23


Co-Investment Platforms

Platforms and Vehicles for Institutional Co-Investing Benefits:

24

Benefits of Co-Investment Platforms

Higher Returns

Cost Savings

Deal Flow

Diversification

Governance Rights

Headline Risk


New Initiatives for Infrastructure Investment

Platforms and Vehicles for Institutional Co-Investing Challenges:

25

Challenges of Co-Investment Platforms

Governance

Structure

True Alignment?

People

Regulation


26

INSTITUTIONAL INVESTORS (Large and Small)

CO-INVESTMENT PLATFORMS -Pension Infrastructure Platform -Global Strategic Investment Alliance -CPPIB Syndicate Model -PINAI fund

INVESTMENT OPPORTUNITIES Unlisted, Private Market

-National Infrastructure Plan (UK) -Natural Gas Plant, Michigan, USA -407 Toll Road -Wind Power, Northern Philippines

Using Infrastructure as an Example


Case Study 1: Pension Infrastructure Platform (PIP) (UK)

Structure:

•  Infrastructure fund set up by pension funds for pension funds

•  MOU signed between NAPF and PPF in 2011 – scheme to allow pension funds to access infrastructure investments on more favourable terms than traditional fund managers

•  10 founding pension members of the PIP came together through NAPF association and previous fund investments

•  Objective is to let small funds access infrastructure on top of the larger founding members

•  Invest in UK focused low risk infrastructure assets in equity and debt (no construction risk, preference for availability payments, not usage-based)

27


•  Initially tried to hire individuals to set up a management company – too difficult – reverted to an external manager

•  Target Size: £2 billion •  Target returns: RPI +2-5% •  Fees – 0.5%

28



Key Challenges:

•  Example of a ‘formal’ seed arrangement

•  Government regulation has stifled the process

•  Finding personnel with the appropriate knowledge, expertise but at the same time without conflicts of interest to carry out the administrator role has been very challenging.

•  The large number of people involved has made co-ordination challenging

29



Background/Structure:

•  Launched in 2012 by Ontario Municipal Employment Retirement System (OMERS)

•  Designed to gather like-minded sophisticated investors to invest directly in infrastructure assets

•  Assets – Transport, Power generation/distribution, EV $US 2bn, North America and Europe.

•  All GSIA investments are originated and managed by OMERS

•  Total raised $US 12.5 bn primarily with Japanese pension funds and one US pension plan manager. $5 bn committed by OMERS.

30

Case Study 2: Global Strategic Investment Alliance (Canada)


STRUCTURE:

31


•  0.5% fee on invested capital earned by OMERS (OMERS managing the assets)

OMERS GPIF DBJ Pension Fund Association

Mizuho Bank

Japan Bank for International Cooperation

Mitsubishi Corporation

Nissay Asset Management

Double Bridge Infrastructure

Global Strategic Investment Alliance ($12.5 bn)

Infrastructure Assets – North America/Europe – Transport, Power, Gas Pipelines

McMorgan & Company


Lessons:

•  GSIA enables critical mass to be achieved so that GSIA is able to access assets previously restricted to large fund managers

•  No issues of lack of expertise when lead party (administrator) is a sophisticated investor

•  Quicker set up and deployment of capital compared with PIP (less complicated)

•  Higher alignment of interests, fees don’t drive the model – it is the scale and investment power that is most attractive for OMERS

32



Background/Structure

•  CPPIB acquire 40% of the 407 Toll Road in Toronto for $US 3.5bn

•  CPPIB syndicate up to 30% of their stake to other institutional investors via a Confidential Investment Memorandum

33

Case Study 3: Canada Pension Plan Investment Board (CPPIB) Syndicate Model



•  CIM sent to other interested investors following acquisition

•  $US 100m minimum investment

•  No ongoing management fees, no performance fee (carry)

•  Share of acquisition costs

•  No fiduciary obligation among members of the investor group

•  Investors can select directors – 15% interest per board seat

34



Lessons

•  Members aligned in terms of investment horizon, views on governance, views on infrastructure - physical assets with long-term cash flows, low risk profile, and inflation protection

•  Syndication closed in March 2011, 6 months after CPPIB’s acquisition of the toll road – quick timing (due to good governance)

•  No issues of lack of expertise, clear transparency on governance,

•  Availability of lead investor like CPPIB and asset like 407 may be limited.

35




•  Unlisted fund dedicated to investing into Philippines Infrastructure launched in July 2012

•  Cornerstone investors came together first – Government Service Insurance System, Asian Development Bank, APG who then selected a manager (Reverse order).

•  Macquarie Infrastructure and Real Assets (MIRA) selected as manager who also provide equity to the fund – total size of fund: $625 million. 36

Case Study 4: Philippine Investment Alliance for Infrastructure (PINAI) Fund


37


PINAI%FUND%Total%Fund%Size%is%$625%million%ADB%conceptualised,%designed,%mobilised%investment%capital%and%structured%the%fund%

•  Closed end fund with time horizon of 10 years

•  Management fee and performance fee negotiated and agreed upon by both parties (not disclosed but likely similar to other Macquarie funds)

•  Invested in wind power project in northern Philippines July 2013

Equity Investment Fund

Management


Benefits/Lessons

•  Mandate and conditions set by investors

•  Close relationship between manager and investors (small number of parties involved) worked well

•  Partnering with a development bank and government investor seemed to provide confidence to the pension fund investor to invest in the higher risk area (many have been reluctant to do so)

•  Strong commitment and support from the government (creating a PPP market in Philippines)

38



Summary

39


ASSET MANAGEMENT

Institutional Investors as long-term investors are theoretically ideally suited to invest into infrastructure assets.

Previous investment methods however have not provided the most efficient means of accessing these types of assets.

New innovative models of investment need to be developed.

Co-Investment and other platforms under the collaborative model of investing can provide more efficient means of accessing infrastructure investments.

Infrastructure Investing is complex however – there are many other issues that need to be discussed!


Sustainability-Driven Investment In Real Assets

Sustainability & Investments: Taking the Long View

Stanford Global Projects Center Conference 29 April 2015

Private & Confidential For Qualified or Sophisticated Investors Only

Portland, OR | San Francisco, CA | London, UK

Confidential 2

Sustainability & Investments: Taking the Long-Term View

A Working Definition of Impact Investing Framing the Challenge – The Need for Long-Term View in Investment

Sustainable Strategies in Agriculture and Food

A Working Definition of Impact Investing

Confidential 3

Confidential 4

Defining Impact Investing�

•  Using market and investment tools to drive positive impact on environment and community, and deliver a return to the investor

•  Three components to Impact:

1. Additionality 2. Intentionality 3. Long-term returns

•  Across all asset classes •  Across spectrum of returns and impact

Stocks Private

Equity / VC Bond / Credit

Capital�

Advisors & Intermediaries�

Fund Managers

Assets

Financial-first� Sustainable ALPHA�

Impact-first�Returns

Impact

Low�

Below Market�

Market Rate�

High�

Real Assets

We’ve Come a Long Way

•  We have come along way since its inception in the 70s

•  Impact-related investments currently

around US$25B-75B under management

•  It has the potential to become US$500B over the next ten years

•  We see more opportunities in the sustainability-driven real asset space

Confidential 5

Source: Monitor Group’s “Investing for Social and Environmental Impact, Giving USA, Social Investment Forum, 2010

Framing the Challenge:

The Need for Long-term View in Investment

Confidential 6

Source: PWC’s Sustainability and Climate Change

Confidential 7

4 Billion More People Eating Meat and Driving Cars�

Confidential 8

Significant global macro trends: •  Rapid population growth (to 9.6B by

2050)

•  Emerging middle class in developing world

•  Compounded by climate change and pollution

•  Driving natural resource consumption and dislocation

Resource access, availability, and productivity creates new risks and opportunities, drives innovation and opens the door to disruptive market shifts, and new opportunities for value creation

Sustainability: rooted in economics, process efficiency, asset productivity and resiliency for the long-term

4 Billion More People Eating Meat and Driving Cars�

Source: National Geographic’s “The Future of Food”

Changes Across the Impact Investment Eco-System

Institutions with economic interests: 1. Corporations 2. Customers

3. Investors

Experienced fund managers:

•  Across asset classes and strategies

•  Maturing of structures

Advisors applying rigor & research: •  Cambridge •  NEPC •  Cliffwater

•  Mercer

Fiduciary duty: •  Risk, Value & Duration

Corporations shift from PR to strategy

Confidential 9

Changing the Investments Conversation�

The investments conversation is changing: •  Community and environmental problems are opportunities

for financial innovation •  Engaging institutions – scale and returns •  Managing towards targeted outcome •  Connecting constituencies -investors, businesses,

customers, employees, communities •  More direct link between capital and assets Essentials of Successful Impact Investing – to Achieve Sustainable Alpha: •  Taking the (very) long view – recognizing that all the little

things matter •  Returning to investment basics: risks, value, and duration •  Identifying and monetizing a market (capital) and operating

inefficiencies •  Arbitraging different views of risk •  Re-aligning benefit and currency for each part of value

chain to produce returns

Confidential 10

Come for the returns Stay for the impact

Sustainable Strategies in Agriculture & Foods

Confidential 11

Sustainable Strategies in Agriculture and Food: Our Experience

To transform food production in a way that

encourages the preservation and enhancement of resources to support human,

environmental and economic development.

Confidential 12

Confidential 13

Upstream: Farmland •  Generates income by

producing a crop, typically annually

•  Significant downside protection provided by the security of the underlying farmland

Midstream: Packing, processing, and storage facilities

•  Generates income based on the number of units that are processed or stored in the facility

•  Some downside protection provided by the security of the facility

Downstream: Value-added processing

•  Consumer branded products

•  Retail / Customer relationships

The Agriculture Supply Chain: From Farm to Fork

Supply Chain Values: Quality and Margins Linkage

Source: Equilibrium Estimates, Company Reports, Factset

FOOD SUPPLY CHAIN (Industry Average) EXAMPLE

Confidential 14

Risks in Agriculture

•  Weather risk mitigation: diversification, crop insurance, weather prediction and prevention technology

•  Integrated pest management systems •  Ensuring access to quality labor •  Water: micro and drip irrigation

•  Large volume contracts with major retailers and grocers •  Vertical integration •  Multiple sales avenues—fresh and processed •  Crop forecasting •  Branded shelf space

•  Stringent certification compliance •  Global Food Safety Initiative benchmarks •  Product traceability

Food Safety

Po

ten

tial

Ris

ks

Mitigation Strategies

Environment

Market

Confidential 15

Managing for Long-term Returns

Seek to generate Financial & Non-financial outperformance •  Owner-operator model drives returns – vertical

integration •  Sustainable farming practices •  Current returns from active operations – farming, sale of

products •  Capital returns from value built on the operating assets •  Standard real assets characteristics: non-correlated

returns and inflation hedge •  Non-financial “Foundations” – Social &

Environmental - for long-term returns

The right team: investment AND operating experience & expertise Operating and Investment structures: •  Farm-to-fork – supply chain management •  Instruments with term flexibility – matching productive

asset lives and investors needs •  Strategy and operations oversight – Investment

Management and Operations Management – to remain true to strategy and mission

Confidential 16

$0.00$

$2.00$

$4.00$

$6.00$

$8.00$

$10.00$

$12.00$

$14.00$

$16.00$

$18.00$

4/2/07$ 4/2/08$ 4/2/09$ 4/2/10$ 4/2/11$ 4/2/12$ 4/2/13$ 4/2/14$

Conv$($)$ Org$($)$

Corn%Pricing%

Price%

Source: USDA

Source: NCREIF and Standard & Poor’s

0.00%$

2.00%$

4.00%$

6.00%$

8.00%$

10.00%$

12.00%$

14.00%$

16.00%$

18.00%$

20.00%$

5+Year$ 10+Year$ 15+Year$$ 20+Year$

Annu

alized

%return%(as$o

f$12/31/13)$

NCREIF$Farmland$ S&P$500$

Farmland Returns

Sustainable Farming Practices

Managing and reducing inputs to optimize yield

•  Water: Micro and drip irrigation

•  Pesticides: Environmentally friendly pest control

•  Fertilizer: Micro application

Innovative farming techniques

•  Technologies to optimize sustainability

•  Practical and strategic uses of information / data

Converting from traditional to organic

•  Increasing demand for organic

•  15% higher expenses

•  25% higher revenues

Confidential 17

Social Foundation for Long-Term Returns

Create products that enhance human health •  Sell nutritious foods that support a healthy lifestyle •  Expand access to healthy foods for all Americans •  Enable transparency

On-Farm health and wellness for the community and our employees

•  Provide superior living and working conditions •  Build a community of shared wellness values •  Support community garden for employee use

Professional development for the community and our employees

•  English language training for all workers. •  Cross training with other farmers •  Training across the platform •  Developing leaders in sustainable and organic

agriculture

Confidential 18

Environmental Foundation of Returns

Improve health of the assets by focusing on key environmental indicators

1.  Soil: Soil carbon and topsoil depth 2.  Water: Water quality and water use 3.  Species: Encourage biodiversity throughout the

farm from microbial to larger species 4.  Habitat: Insure preservation and development

of habitat to support native species

Industry leading management practices to drive long term value

•  Connecting consumers to the farm

•  Aligning with customers / consumers needs

Confidential 19

Case Study: ACM Permanent Crops Fund

Confidential 20

Case Study: Sustainable Agriculture ACM Permanent Crops Fund

Superior value-creation from vertically integrated, sustainable farming Strategy Summary Agriculture Capital Management (ACM) is pursuing a strategy that produces and delivers high-quality produce to fetch premium market prices and returns, achieved through vertical integration by investing in and operating farms as well as produce-handling operations. By allowing for produce to be grown, picked, stored and delivered to consumers, the process allows quality control and tracking of nutrients reliably and at scale.

Manage for optimized risk-adjusted financial returns •  Farms and midstream assets •  Geographic and crops diversification •  Information and data •  Consumer-driven solutions Market Opportunity •  Accelerating demands: for dependably high quality food, driven by population

growth and movement, and heighten quality awareness •  Sustainable farming practices: water management, topsoil protection /

enhancements, long-term farming systems design •  Drivers of returns: organic products offer premium pricing, midstream assets

captures margins, sustainable farming practices accumulates value of the croplands

Fund Features

!  Basic Terms: 10-year fund with extension, structured to allow for conversion to longer-term vehicle / instrument

!  Targeted Fund returns: !  Current income from crop operations

!  Capital return from sustainable land use practices

!  Attractive total returns

Impact Achieved

!  Sustainable food sourcing – nutrients delivered, at scale…as long as trees last

!  Sustainable land and resources uses

!  Jobs and workforce practices – on-farm staff, seasonal staff, families

Confidential 21

Superior Characteristics of Permanent Crops

•  Long-lived, high yielding assets   Permanent crops include trees, bushes and vines with

productive lives of 25-50+ years

•  High revenue per acre

  Revenue per acre can be US$15,000 (permanent crops) vs. US$1,500 (row crops)

  Enhanced revenue from Organic produce

•  Multiple channels for end use products

  Ability to create value-added products including packaged, dried, and frozen

Confidential 22

Managing for Environmental Performance

•  Insure the long term health of the property •  Water –Track and optimize usage through installation of state-

of-the- art delivery systems.

•  Consumption and quality •  Soil – Track soil quality to assess impact of practices

•  Carbon •  Depth

•  Organic matter •  Nutrients / inputs

•  Landscape degradation, habitat preservation

•  Biodiversity •  Wildlife survey, species count, native pollinators, plant

diversity, eventually soil microbes •  Energy – Track and reduce carbon impact of farming.

•  Input source tracking •  Fuel use

•  Insure long term health of the surrounding environment.

•  Community gardens / green space / community support •  Organic and sustainable permanent crop leader

•  Transparency, tracking •  Implementation

•  Team development, supplemented by consultants

Confidential 23

Managing for Social Performance

•  Professional development for managers and employees   ESL training for all workers.   Cross training with other ACM farmers.   Training across the platform.

  Developing leaders in sustainable and organic agriculture. •  On-Farm health and wellness for ACM managers and

employees

  Provide superior living and working conditions.   Build a community of shared wellness values.   Support community garden for employee use.

•  Create products that enhance human health   Sell nutritious foods that support a healthy lifestyle.   Expand access to healthy foods for all Americans.   Enable transparency.

Confidential 24

Equilibrium Capital Group

Leadership in Sustainability-Driven Real Assets

Confidential 25

Confidential 26

Disclaimer and Forward-Looking Statements

Information contained herein and any other forms of communication related thereto are for information purposes only, and should not be regarded as an offer to sell or a solicitation of an offer to invest in any security. Past performance is not indicative or a guarantee of future performance. Equilibrium Capital is not a registered investment advisor and does not provide tax, accounting, or legal advice. Investors are advised to consult with their tax, accounting, or legal advisers regarding any potential investment. This information and all the material shared in conjunction with it whether verbal or oral are confidential.

11/05/15%

1%

Dr. Strange Returns

Generating Impact Alpha, April 29th, 2015

Or: How I learned to stop worrying and love the VC model

“How do you make [boatloads] of

money investing in early stage climate change solutions?”

11/05/15%

2%

Cleantech “has been a noble way to lose money”

VC/PE New Investment In Clean Energy

11/05/15%

3%

11/05/15%

4%

Late-Stage Momentum Investing

11/05/15%

5%

Late-Stage Momentum Investing

11/05/15%

6%

Capital required to get to first significant commercial revenue (est.)

$0%$50%$100%$150%$200%$250%$300%$350%$400%$450%$500%

Source: S-1s, company histories, CB Insights, BCC estimates

Getting Ahead of Commodity Prices is Hard

Sources: BNEF, LEDinside

11/05/15%

7%

11/05/15%

8%

Launching Tech Innovation into Momentum

Some guidelines: 1.  Go for very big breakthroughs --

otherwise the upside doesn’t justify the risks or timeframes.

2.  Run very lean until post-revenue. Get non-dilutive $$ instead of VC.

3.  Build scalable hardware: Off-the-shelf components wherever possible; contract manufacturable; modular, intelligent, automated.

4.  Eventually, build a company and a full service offering, not a commodity producer.

11/05/15%

9%

Venture Capital IRRs (2000-2012 investments)

.6%%

.4%%

.2%%

0%%

2%%

4%%

6%%

8%%

Renewable(Power(Manufacturing(

Renewable(Power(Development(

Energy(Op:miza:on(

Resource(Solu:ons(

Source: Cambridge Associates, 2014

11/05/15%

10%

Let’s Bring The Cheap Capital In After Us

Hybrid (ProjFin+VC) and other non-traditional investment

approaches

Market reinvention

11/05/15%

11%

1.  Right-size the cap table = right-size the valuation

2.  Reduce the need for the most expensive capital

3.  Bring in the cheaper implementation capital

Team Risk Structure Risk Implementation

Risk

Market Risk Financing Risk Tech Risk

To Bring In Follow-On Capital, Eliminate Risks

11/05/15%

12%

New channels/

implementers

New financing platforms

Downstream systems + controls

IMPLEMENTATION IS IMPACTFUL!

11/05/15%

13%

By 2025, the global greentech market is

projected to be $5.7 TRILLION in

annual revenues...

Source: Roland Berger Strategy Consultants

…And potentially quite profitable

11/05/15%

14%

Thank you

Impact Alpha Conference Hosted by Stanford Global Projects Center

Paul Brest Hall April 29, 2015

The “Impact Investment Bank” an early concept in response to the “Clean Energy Investment Initiative”

Coauthors:

Ashby Monk Executive Director

Stanford Global Projects Center

Alicia Seiger Deputy Director

Stanford Steyer-Taylor Center

Elliott Donnelley General Partner

White Sands Investment Group

Sarah Kearney Executive Director PRIME Coalition

Foundation Grantmakers

•  Private•  Corporate•  Community

Families

•  Single Family Offices•  HNWI/Accredited investors

Investor-side Partners•  Membership Groups•  Multi Family Offices •  Trade Groups

Innovator-side Partners•  Incubators•  Accelerators•  Business plan competitions•  Government grantmakers•  Universities

Pensions

Endowments

•  Foundations•  Universities

Sovereign

Innovation Valley of Death

•  New Companies•  New Products

Commercialization Valley of Death

•  Growth Companies•  New Projects

PH

ILA

NT

HR

OP

IC L

TIs

CO

MM

ER

CIA

L L

TIs

IIB

•  Highlight best-in-class, additive investment opportunities

•  Provide legal and financial expertise•  Serve as an information clearinghouse•  Facilitate direct investments



Foundation grants/PRIs Family offices DAFs HNWIs Endowments Pensions Sovereign Funds

SEED/VENTURE CAPITAL

INNOVATION VALLEY OF DEATH

COMMERCIALIZATION VALLEY OF DEATH

GROWTH CAPITAL

PROJECT FINANCE

LTIs along the resource innovation & deployment pipeline

3



IIB would collect and coordinate commitments from LTIs

IIB (501c3)

Philanthropic Investment Opportunities

Seed-Stage Investment Opportunities

Growth-Stage/Project Finance Investment Opportunities

PRIVATE FOUNDATION

UNIVERSITY ENDOWMENT

FAMILY OFFICE/

HNWI

PENSION

SOVEREIGN

4

IIB (501c3)

Philanthropic Investment Opportunities

Seed-Stage Investment Opportunities

Growth-Stage/Project Finance Investment Opportunities

PRIVATE FOUNDATION

UNIVERSITY ENDOWMENT

FAMILY OFFICE/

HNWI

PENSION

SOVEREIGN

$200K (annual grant –

operating capital) $3M

(annual PRIs)

$5M (annual equity)

$8M (annual debt)

$1M (recoverable grant –

IIB endowment)

Example Letter of Intent to IIB from a Private Foundation

5

READINGS

Electronic copy available at: http://ssrn.com/abstract=2391005

!

!‘The!Valley!of!Opportunity’!!Rethinking!Venture!Capital!for!Long9Term!Institutional!Investors!

!†Jagdeep(S(Bachher,(+Gordon(L(Clark,(*Ashby(H(B(Monk(and(¥Kiran(S(Sridhar.!

!†Alberta! Investment! Management! Corporation! (AIMCo)! and! Global! Projects! Center,! Faculty! of! Civil! and!Environmental!Engineering,!Stanford!University,!Palo!Alto!CA!9430594121,!USA;!!+Smith!School!of!Enterprise!and! the! Environment,! Oxford! University,! Oxford! OX1! 3QY,! UK! and! Department! of! Finance,! Monash!University,! Caulfield! VIC! 3145,! Australia;! *Global! Projects! Center,! Faculty! of! Civil! and! Environmental!Engineering,! Stanford! University,! Palo! Alto! CA! 9430594121,! USA,! and! Smith! School! of! Enterprise! and! the!Environment,! Oxford! University,! Oxford! OX1! 3QY,! UK;! and! ¥! Global! Projects! Center,! Faculty! of! Civil! and!Environmental!Engineering,!Stanford!University,!Palo!Alto!CA!9430594121,!USA!!Contact:[email protected]!!Abstract:!Investing!in!venture!capital!has!been!an!unsatisfactory!experience!for!many!long9term!institutional!investors,! as! it! has! not! performed! in9line! with! their! expectations! for! more! than! a! decade.! Consequently,!many! investors! have! been! scaling! back! their! venture! commitments! and,! instead,! have! been! focusing! on!alternative!asset!classes!that!offer!the!benefits!associated!with!economies!of!scale.! In!this!paper,!however,!we!argue!that!venture!capital!still!offers!attractive!opportunities!for! intrepid!institutional! investors.! Indeed,!we! outline! a! mechanism! by! which! institutional! investors! can! bring! venture9backed,! capital9intensive!companies!to!commercial!scale!and,!in!turn,!assist!in!their!success!over!the!long!term.!Specifically,!we!identify!an! opportunity! whereby! institutional! investors! can! leverage! their! experience! in! direct! private! equity! and!direct!infrastructure!so!as!to!realize!direct!venture!investing!in!creative!ways.!Rather!than!being!held!hostage!to!the!‘valley!of!death’!when!investing!in!capital9intensive!VC9backed!companies,!we!explain!why!there!may!be!a!‘valley!of!opportunity’.!!!Keywords:!Infrastructure,!Innovation,!Institutional!Investment,!Venture!Capital!!Acknowledgements:! The! authors! acknowledge! the! support! of! The! Planet! Heritage! Foundation! (PHF),!Stanford! University’s! Global! Projects! Center! (GPC),! and! the!members! of! the! GPC! research! consortium! on!institutional! investment.! Members! of! the! research! consortium! also! provided! insight,! field! assistance,! and!partial!support!for!staff!salaries.!Consortium!members!were,!however,!not! involved!in!the!formation!of!the!paper’s! content! and! argument.! The! first! and! third! authors! have! been! involved! in! the! formation! and!management!of!a!venture!capital! investment!portfolio!for!AIMCo;!neither!the!sponsor!nor!the!participating!ventures!have!an!interest!in!this!paper.!The!authors!also!acknowledge!the!research!assistance!of!Peter!Clark.!Any!errors!or!opinions!herein!are!our!own.!


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Introduction!Venture! capital! (VC)! investing! has! been! an! unsatisfactory! experience! for! many! long9term! institutional!investors!(LTIs),!such!as!pension!funds!and!sovereign!wealth!funds.!First,!the!asset!class!has!not!performed!in!line! with! expectations! for! more! than! a! decade.! For! example,! LTIs! have! invested! more! money! in! venture!capitalists!(VCs)!since!1997,!in!aggregate,!than!VCs!have!returned!to!LTIs!over!that!same!period!(Mulcahy!et!al.! 2012).! Second,! there! have! been! few! opportunities! for! newer! or! slower!moving! LTIs! to! access! the! top!(decile)!managers!that!have!demonstrated!a!consistent!ability!to!outperform!VC!benchmarks.!As!such,!VC!as!an! asset! class! appears! to! work! only! for! those! LTIs! that! were! first! movers! into! the! asset! class,! such! as!endowments!and!family!offices.! In! large!part,! the!challenges!associated!with!this!asset!class!stem!from!the!fact! that! VC! investing! is! not! easy! to! bring! to! a! scale! consistent! with! the! investment! objectives! of! large!institutions.!!!VC! is! an! investment! industry! characterized! by! high! labor! intensity.! This! stems! from! the! fact! that! venture!investing! is! largely! a! services! business! founded! on! ‘high9touch’! interaction! with! entrepreneurs! through!trusted!(and!hard!earned)!networks!of!interaction!and!reciprocity.!Further,!the!best!performing!VC!firms!tend!to!view!their!roles!in!terms!of!business!development!rather!than!just!investment.!Herein!lies!the!irony!of!the!VC! industry:! the! best! performing! venture! capitalists! are! capable! of! helping! entrepreneurs! scale9up! their!businesses,!but!they!have!not!been!able!to!bring!scale!to!their!own!investment!management!sector!without!eroding!financial!performance!(see!Mulcahy!et!al.!2012).1!In!fact,!many!VCs!have!stopped!trying!to!grow!their!businesses,!purposely!keeping!the!size!of!their!funds!relatively!small! in!order!to!focus!on!their!core!area!of!expertise:!helping!entrepreneurs!launch!and!build!companies.!!This! ‘keep9it9small’!mentality,!however,!means!that!venture!capital!has!not!been!able!to!accommodate!the!demands!of!LTIs!for!opportunities!in!terms!of!scale.!After!all,!an!allocation!of!$10!or!$20!million!to!a!top!VC!fund! would! not! affect! the! overall! return! for! a! large! pension! or! sovereign! fund! even! if! the! underlying! VC!investment!were!highly!successful.!Moreover,!spreading!a!large!VC!allocation!across!a!large!number!of!asset!managers!would!likely!result!in!an!institutional!investor!paying!high!fees!for!beta!exposure!to!what!is!already!an!underperforming!asset!class.!This!is!not!desirable.!As!a!result,!a!growing!number!of!LTIs!are!disenchanted!with!the!VC!industry.!Indeed,!public!pension!funds!and!sovereign!funds!have!been!scaling!back!their!venture!capital!commitments!to!external!managers!and,!instead,!have!been!focusing!on!alternative!asset!classes!that!can!offer!economies!of!scale,!such!as!real!estate,!private!equity!and!infrastructure.!!!While! we! understand! the! reasons! LTIs! have! become! disaffected,! we! nonetheless! believe! there! is! an!opportunity!for!them!to!re9engage!with!venture!investing!in!a!meaningful!way.!Consider!that!over!the!period!that! venture! capital! returns! have! been! relatively! poor,! innovation! and! technological! development! has! not!stopped.! If! anything,! the! rate! of! innovation! has! continued! to! accelerate,! changing! the! lives! of! everyday!people! in!meaningful!ways.2!Ultimately,!value! is!still!being!created!through!technological! innovation,!which!suggests!that!VC!investing!has!enormous!potential!value!to!the!broad!community!of!LTIs.!!However,!if!LTIs!are!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!1/.!Size!of!fund!has!been!shown!to!influence!performance!over!the!long!term!(see!Kaplan!and!Schoar!2005;!Phalippou!2010).!!2/.!Consider!the!examples!of!the!iPhone,!iPad,!Facebook,!Android,!Kindle,!Electric!Car,!Twitter,!apps!of!all!kinds,!etc.!


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to!participate!in!VC!in!successful!ways,!we!believe!they!should!participate!only!in!niches!where!they!can!add!value.!!!There!are!two!broad!VC!domains! in!which!we!think!LTIs!can!add!value.!First,! there! is!a!compelling!case!for!LTIs! to! participate! in! the! VC! of! financial! services! (e.g.,! ’fintech’)! and! asset! management! (e.g.,! seeding).!Pensions!and!sovereigns!not!only!have!considerable!expertise!in!these!two!domains,!but!they!also!have!the!capacity! to! deliver! cornerstone! clients! to! the! portfolio! companies! VC! firms! are! investing! in.! Second,! LTIs!should! participate! in! venture! investments! for! which! they! can! serve! as! an! important! bridge! to!commercialization!for!growth!stage!companies.!Said!differently,!making!venture!capital!work!for!LTIs,!such!as!pensions! and! sovereign! funds,! means! finding! opportunities! where! the! target! companies! cannot! rely! on!venture! managers! alone! to! reach! commercial! scale.! Clearly! this! has! been! the! case! in! capital9intensive!industries,!such!as!energy!innovation.!!!In!the!last!decade,!VCs!added!‘green’!to!their!traditional!staples!of!‘IT’!and!‘biotech’!investments.!What!VCs!found! in!doing!green! investments,!however,!was! that! the! time!horizon! to!profitability!was! far! longer! than!they! had! been! anticipated.! It! has! been! observed! that! VCs! often! reached! a! point! where! their! investee!companies’!futures!were!dependent!on!finding!another!set!of!investors!that!could!‘take!the!baton’!forward!and!develop!the!‘green!infrastructure’!that!is!often!required!for!commercial!scale.!This!has!been!a!problem!for!VCs,!and,!ironically,!it!left!many!feeling!like!the!entrepreneurs!that!approach!them:!They!have!been!forced!to! look! to! other! investors! to! fund! their! big! ideas! through! to! commercial! scale.! In! this! sense,! the! green!strategies! of! VCs! have! offered! LTIs! a! chance! to! re9engage! with! the! venture! asset! class! on! terms! more!conducive! to! their! particular! interests.! In! any! event,! it! offers! a! way! to! bring! scale! to! the! VC! industry,!particularly! in! the! capital9intensive! industries! such! as! energy,! materials,! food! and! water;! where! the! time!horizon! and! scale! of! LTIs! affords! the! possibility! of! funding! capital9intensive! companies! from! initiation! to!commercial!scale.3!!!In!this!paper,!we!suggest!that!venture!capital!is!a!compelling!option!for!those!LTIs!that!have!the!governance!procedures! and! skills! to! realize! intended! goals.! The! juxtaposition! of! large! past! losses! coming! from! green!investments!with!the!potential!for!enormous!future!gains!presents,!however,!a!challenge!to!LTIs’!capabilities!and!resources.!Nonetheless,!we!contend!that!LTIs!can!serve!as!important!bridges!for!venture9backed,!capital9intensive!companies!seeking!commercial!scale.!In!turn,!LTIs!can!participate!in!the!success!of!these!companies!over! the! long! term.! Rather! than! retreating! from! the! ‘valley! of! death’! for! capital9intensive! companies,! this!presents!a!’valley!of!opportunity’.!4!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!3/.! In! 2008,! the! traditional! partners! of! VC! GPs,! such! as! endowments,! demonstrated! an! inability! to! participate! in! co9investments! due! to! liquidity! constraints.! This! has!opened!up! the!opportunity! to!other,! longer9term! investors! such! as!pension!and!sovereign!funds.!!!4/.!This!is!based!upon!case!studies!with!predetermined!interview!questions,!as!described!by!Richards!and!Morse!(2006).!As!suggested!by!Clark!(1998),!we!have!granted!anonymity!to!the!people!and!the!firms!that!have!agreed!to!participate.!We!have!also!used!a!method! called! triangulation! in!which!we!back9up! the! ideas! addressed!by! the! interviewees!with!previous!literature,!news!articles!and!case!studies;!see!Jick!(1979)!and!Morse!(1991).!!

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The!‘Valley!of!Death’!At!the!earliest!stages!of!launching!a!company,!investors!are!asked!to!provide!capital!to!a!venture!that!has!no!products!and!sometimes!no!obvious!market!for!future!products.!In!effect,!investors!are!asked!to!believe!in!an!entrepreneur’s! vision! for! what! the! company! can! become! and! how! the! company! can,! in! turn,! generate!acceptable! returns.! Assuming! the! entrepreneur! secures! funding! to! launch!his! or! her! company,! it! can! take!years! before! products! come! to! market! and! cash! flows! turn! from! negative! to! positive.! Before! reaching!commercial!scale,!these!companies!are!entirely!reliant!on!external!financing!to!fund!operations.!This!period,!long! or! short,! is! sometimes! referred! to! as! the! ‘valley! of! death’! (VoD).! It! is! that! period! in! which! the! vast!majority!of!companies!fail!(see!Gompers!and!Lerner!2001).!!!While!the!VoD!is!relevant!to!all!companies,!those!operating!in!industries!with!high!capital!inputs!are!believed!to!be!particularly!vulnerable!(see!Nanda!et!al.!2013).! In!economic!terms,!the!standard!J9curve!applicable!to!venture! investments! in! sectors! such!as!energy,! food!and!water,! tend! to! run!deeper!and! longer! than! is! the!case!for!generic!venture!investments!in!industries!such!as!software!and!IT!(Mathonet!and!Mayer!2008).!It!is!perhaps! not! surprising! then! that! ‘green! companies’! that! rely! on! private! financing! find! it! difficult! to! get!beyond!the!VoD!(see!Murphy!and!Edwards!2003),!as!the!average!green!energy!venture!requires!roughly!$500!million! from! investors! before! successful! commercialization! (Hargadon! and! Kenney! 2011).! Given! that!companies! only! begin! to! exit! the! VoD!when! commercialization! starts! to! take! hold! and! entrepreneurs! can!demonstrate!a!clear!path!to!profitability!(and!steady!cash!flows),!companies!in!capital9intensive!industries!are!more!prone!to!failure!in!the!VoD!than!those!in!less!capital9intensive!industries.!!!It! is! little!wonder!then!that!the!promise!of!a!‘green!revolution’,!which!was!embraced!by!the!VC!community!over!the!last!decade,!has!thus!far!generated!so!few!success!stories.!In!our!view,!the!traditional!model!of!VC!does! not! lend! itself! as! easily! to! capital9intensive! industries,! such! as! energy,! as! it! does! to! capital9light!industries,!such!as!software.!A!traditional!VC!firm!raises!money!from!individuals!and!institutions!in!order!to!invest! in! early9stage! ventures! that! are! high9risk! and! have! high9expected! returns! (see! Sahlman! 1990).!Typically,!the!general!partner!(GP)!raises!between!$300!and!$600!million!from!limited!partners!(LPs)!for!an!investment! fund! (see! Kenney! and! Florida,! 2000;! and! Lerner! et! al.! 2007).!With! this! capital,! a! VC! fund!will!invest!in!15!to!30!fledging!companies,!with!initial!investments!ranging!between!$5!and!$15!million.!This!then!allows!for!as!much!as!$20!to!$30!million!in!follow9up!funding!for!the!most!promising!three!to!five!ventures.!!!By! necessity,! the! large!majority! of! successful! venture! capital! exits! have! been! ‘capital9light’! (Wiltbank! and!Boeker!2007).!In!fact,!the!most!successful!venture!investments!tend!to!be!those!where!less!than!$30!million!was! invested! before! commercial! scale!was! achieved! and! cash! flows! turned! positive.! In! fact,! 79! of! the! 98!venture9capital! backed! exits! in! the! 2nd! quarter! of! 2013! were! in! the! capital9light! information! technology!sector!(Cruz!and!Herman!2013).!Google! is!the!classic!example!of!a!successful!capital9light!venture;! it! raised!only!about!$25!million!before!its!IPO!(Vise!and!Malseed!2006).!If!we!compare!Google’s!path!to!success!to!that!of! Tesla,! the! automobile! company! that! is! the! darling! of! the! green! movement,! it! is! easy! to! see! the!diametrically!different!cash!flow!profiles!of!these!two!companies.!In!year!seven!of!operations,!Tesla!lost!$396!million! dollars.!Overall,! it! has! lost! almost! $1! billion! in! total.! As! for!Google,! it!was! profitable! in! year! 3! and!generated!$1.4!billion!in!net!income!in!year!seven!(See!Figure!1).!!!

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While! the! VC! community! is! renowned! for! taking! fledgling! innovations! and! developing! businesses! around!them!(see!Gompers!and!Lerner!1998;!Kortum!and!Lerner!2000;!Florida!and!Kenney!1988;!Lerner!2002),!this!has! not! held! true! for! capital9intensive! green! investments.! To! be! sure,! this! can! be! partially! attributed! to! a!mediocre!IPO!market,!which!has!a!strong!influence!on!VC!returns!(Hall!2005).!But!poor!performance!is!also!the! result!of! fundamental! incongruence!between! the!characteristics!of! capital9intensive!green! investments!and! the!monetary! resources!of!VC! funds.! In! short,! the! time!horizon!and! capital! intensity!of! green!venture!investments!has!rendered!the!traditional!VC!community!much!less!effective!at!‘picking!winners’!compared!to!their!past!performance!with!other!industries!(see!Marcus!et!al.!2013;!Kenney!2011;!Petkova!et!al.!2011).!To!a!large! extent,! this! stems! from! the! fact! that! VCs! have! sought! to! ‘disrupt’! the! built! infrastructure! of! our!economy!without!recognizing!that!enormous!pools!of!capital!are!required!to!do!so.!As!such,!they!have!had!to!rely! on! other! parties! and! investors! to! help! them! bring! their! capital9intensive! portfolio! companies! to!commercial!scale.!Once!again,!this!left!VCs,!like!their!portfolio!companies,!vulnerable!to!the!VoD.!!!Given! the!disappointing! returns!VCs!have! reaped! from!green! investments!over! the!past!decade! (especially!compared!to!the!remarkable!returns!in!decades!prior),!many!VCs!have!sought!to!cultivate!additional!pools!of!external! capital! to! help! them! bring! their! companies! to! scale.! In! general,! they! have! turned! to! three!main!sources!of!capital!for!green!companies:!!

!• Government:! The! US! government! has! traditionally! been! a! key! backer! of! technological! innovation,!

especially!at!the!riskiest!levels!of!IP!development.!As!such,!many!VCs!actively!cultivate!relationships!with!government!in!order!to!secure!funding!for!their!companies,!even!launching!lobbying!efforts!and!participating!in!government!as!key!advisors.!However,!in!the!current!political!and!economic!climate,!there!is!little!appetite!among!taxpayers!to!support!governments!that!seek!to!pick!winners!(and!more!so!losers)!by!providing!loan!guarantees!to!private!companies.5!

!• Syndicates!of!VCs:!Many!VCs!have!looked!to!one!another!to!help!pool!together!capital!commitments!

for!portfolio!companies.!However,!even!when!syndicating!across!venture!capital!funds!is!successful,!as! suggested!by!Lerner! (1994)!and!Lockett!and!Wright! (2001),! there!can! remain!significant! funding!gaps!for!capital9intensive!companies!seeking!to!scale9up.!Indeed,!the!most!successful!cleantech!and!green!energy!companies!have!required!a!billion!dollars!or!more,!which!is!beyond!the!reach!of!even!syndicates!of!VCs.!!

!• Syndicates!of!Other! Investors:! Syndicates!of! other! types!of! investors! can!be!effective!when!banks,!

growth9stage! private! equity! (PE)! investors! and! project! financiers! are! brought! together! in! a!transaction.!However,! the! coordination! and!management! of! these! disparate! investors! can! be! very!challenging! (see! Pease! and! Westney! 2010).! Most! of! these! investors! bring! with! them! different!objective! functions! and! incentives! that! can! derail! the! long9term! plans! of! an! investee! company.!

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!5/.! The! Obama! Administration! was! embroiled! in! controversy! over! its! $535!million! loan! guarantee! given! to! the! now!bankrupt!solar!company!Solyndra.!The!House!Oversight!Committee!accused!the!US!Department!of!Energy!of!negligence!and!mismanagement! in! a! Staff!Report! (2012).! This!has! resulted! in!declining!government! support! for! capital9intensive!green!company!initiatives;!see!Cahoy!(2012).!!

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Moreover,! in!an!increasingly!short9term!market!(see!Aghion!et!al.!2012;!Dallas!2011;!Brochet!et.!al.!2013;! Bernstein! et! al.! 2009;!World! Economic! Forum!2012;! Kay! 2011),!most! investors! view! capital9intensive! investments! as! unattractive.! In! any! event,! some! investors! are! constrained! by! their!mandates!from!investing!in!specific!segments,!products!or!strategies!that!are!not!obviously!relevant!to! the! green! sector;! consider! that! these! types! of! investments! often! combine! aspects! of! venture!capital,!private!equity,!and!infrastructure!into!a!single!transaction.!!!

!Within! the! broad! arena! of! financial! investors,! it! is! quite! difficult! to! identity! groups! that! can! credibly!work!alongside! VCs! to! finance! these! capital9intense! ventures! through! to! commercial! scale.! In! the! section! that!follows,!we!provide!a!case!for!working!more!intensely!with!LTIs.!!!The!‘Valley!of!Opportunity’!Notwithstanding! the! past! failures,! it! is! reasonable! to! suggest! that! a! select! number! of! capital9intensive!ventures!will,! in! the!years!ahead,! revolutionize!antiquated! industries!by!becoming!commercially!viable!and!indeed!scalable!companies.!Due!to!the!combined!impacts!of!climate!change!and!resource!scarcity,!the!green!economy!is!almost!certainly!not!just!a!passing!fad.!Quite!the!contrary,!we!believe!that!a!subset!of!the!green!energy! and! technology! companies! of! this! generation! will! go! on! to! be! the! most! profitable! companies! for!generations! to!come.6!And! it! is! this! juxtaposition!of! large!past! losses!next! to! the!potential! for! future!gains!that!we!believe!creates!a!rather!interesting!opening!for!LTIs.!We!call!this!opening!the!‘valley!of!opportunity’.7!!!!The!problems!that!capital9intensive!industries!create!for!the!VC!industry!actually!serve!the!interests!of!LTIs.!In!fact,! we! see! tangible! examples! of! the! LTI! community,! and! in! particular! pension! and! sovereign! funds,!participating!as!key! financiers!of! innovative! companies!and!projects! (with!provision!of!equity!and/or!debt)!that! sit! between! venture! capital,! private! equity! and! infrastructure! (see! the! Innovation!Alliance! case! study!below).!And!yet,!in!order!for!LTIs!to!take!advantage!of!this!situation,!they!need!to!re9conceptualize!the!way!they!access!VC!opportunities.!Too!many!pensions!or!sovereign!funds!want!VC!to!be!easy,!but,!as!we!see!it,!making!VC!work!for!LTIs!requires!far!more!than!writing!a!check!to!Sand!Hill!Road!and!then!crossing!fingers.!It!requires!meaningful!engagement!with!the!asset!class!and!the!companies!therein.!!

Through!interviews!and!case!studies,!three!innovative!mechanisms!have!been!identified!through!which!LTIs!have!sought!VC!opportunities!in!a!more!aligned!and!scalable!manner.!8!!

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!6/.!A!recent!German!government9sponsored!study!projected!that!the!cleantech!industry!would!be!valued!at!as!much!as!$5.8!trillion!by!2025!(Dembicki!2012).!!7/.!Institutional!investors!(LTIs)!are,!in!theory,!well!suited!to!the!characteristics!of!capital9intensive!venture!investments!(see!Graves!and!Waddock!1990;!Bushee!1998;!Hartzell!and!Starks!2003;!Dahlquist!and!Robertsson!2001).!For!example,!the!time!to!commercialization!of!a!typical!green!energy! investment!aligns!quite!well!with!the!time!horizon!of!pension!funds! and! sovereign! funds.! In! addition,! the! scale! of! investment! required! for! a! green! company! to! commercialize! fits!reasonably! into! an! institutional! investors’! set! of! resources.! In! fact,! most! LTIs! don’t! even! want! to! spend! time! and!resources!on!investments!below!$50!million!due!to!their!own!resourcing!and!needs.!!8/.! Doing! direct! investments! in! venture! stage! companies! within! a! public! fund! requires! high! levels! of! buy9in! and!understanding!by!the!Board.!Some!of!the!investments!will,!inevitably,!go!to!zero.!In!our!view,!that!is!simply!the!nature!of!

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!• Direct:!A!few!institutional!investors!have!brought!VC!investing!in9house,!utilizing!their!experience!in!

direct! private! equity! and! direct! infrastructure! in! order! to! give! effect! to! direct! venture! investing! in!creative! ways.! ! The! one! fund! that! stands! out! in! this! regard! is! the! Ontario! Municipal! Employees!Retirement! System! (OMERS).! OMERS! has! a! 149person! investment! team! responsible! for! direct! VC!deals!in!the!USA!and!Canada.!They!have!made!approximately!15!direct!investments!since!launching!a!couple! of! years! ago,! and! they! have! a! reputation! as! one! of! the! “go! to! VCs”! for! Canadian!entrepreneurs.! This! is! an! attractive!model.! If! funds! can! recruit! the! necessary! talent! to! run! such! a!program,! it! can! solve! the! time9horizon! problem;! OMERS! can! continue! to! invest! in! the! portfolio!companies!as! the!program!expands.! It!also!solves! the!scale!problem,!as! the!winners!coming!out!of!the!VC!portfolio!will!require!ever9larger!amounts!of!capital.!Conceivably,!the!biggest!winners!coming!out!of!the!venture!portfolio!can!be!passed!into!the!fund’s!public!equity!portfolios!and!even!handed9off!to!fixed!income!teams.!!

!• Seeding:! Some! funds! have! taken! to! seeding! new! managers! in! order! to! achieve! the! alignment! of!

interests!and!scale!wanted!from!the!asset!class.!An!example!that! is!relevant! is!the!Wellcome!Trust,!which!recently!seeded!a!$325!million!venture!capital!business!that!will!back!biotechnology!startups.!The! new! entity! is! called! Syncona! Partners.! It! has! been! designed! as! an! “evergreen! investment!company.”!This!approach!offers!many!of!the!benefits!of!an! in9house!VC!practice,!while!offering!the!flexibility! required! to! attract! top! talent.! In! addition,! this! particular! vehicle! is! interesting! because! it!takes!advantage!of!the!unique!skill!set!of!the!Wellcome!Trust—a!charity!entirely!focused!on!health!care!research.!As!such,!building!a!venture!practice!around!healthcare!research!enables!the!Trust!to!manage!asymmetric!information!and!deal!flow.!!

!• Creative!Collaboration:!!Some!VCs!and!LTIs!have!actively!sought!to!form!on9going!relationships!with!

one! another.! The! VCs! look! to! the! pension! funds! and! sovereign! funds! to! help! bring! their! most!promising! companies! to!market,!while! the! funds! look! to! the!VCs! to!provide!a!more!aligned!access!point!to!the!asset!class!than!they!have!had!in!the!past.!In!addition,!these!pension!and!sovereign!funds!often! work! with! each! other! in! creative! ways,! recognizing! that! the! success! of! these! collaborative!arrangements!with!GPs!will!only!work!if!the!former!can!credibly!assess!the!companies!presented!by!the!latter.!!

!In!all!cases,!whether! it’s! investing!via!an! in9house!portfolio,!seeding!a!new!manager,!or!working!with!peers!and!managers! in! creative!ways! to! support! growth9stage! companies,! LTIs! that! can! find! the! talent! to! run! a!direct!or!hybrid!program!can!claim!access!to!a!remarkable!range!of!opportunities.!Among!these!options,!our!research! has! focused! upon! understanding! “creative! collaboration.”! As! such,! we! offer! a! case! study! of! this!approach,!demonstrating!how!VC!can!work!for!LTIs!through!a!real9world!example.!!!

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!the!asset!class.!Boards!need!to!understand!this!and!be!prepared!for!the!possible!negative!and!positive!consequences!of!VC!investment.!!!

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Case!Study:!The!Innovation!Alliance!In!late!2012,!three!sovereign!funds!signed!a!memorandum!of!understanding!to!jointly!invest!in!growth!capital!opportunities! globally.! This! group! was! called! the! Innovation! Alliance! (“Alliance”)! and! included! the! New!Zealand! Super! Fund! (NZSF),! the!Alberta! Investment!Management!Corporation! (AIMCo)! and! the!Abu!Dhabi!Investment! Authority! (ADIA).! The! Alliance! was! established! to! take! advantage! of! the! members’! long9term!investment!horizons,!global!networks,!and! large!pools!of! capital! to!help!build!companies! in! capital9starved!industries.! This! was! one! of! the! first! formal! co9investment! vehicles! created! to! offer! sovereign! funds! the!chance! to! cherry9pick! the!best!opportunities! in! top!VC!portfolios.!By! committing! to! the!Alliance,!members!sought! to! increase! their! investment! options! by! aligning! interests! and! reducing! costs.! The! Alliance! thus!represents!an!investment!option!(rather!than!an!obligation)!for!the!three!SWFs.!!!

• Foundational!Beliefs:! In! launching! the!Alliance,! the!members! agreed! to! a! set!of! investment!beliefs!relevant!to!a!co9investment!platform.!These!were!as!follows:!9 LTIs!can!use!the!VoD!to!their!advantage,!extracting!investor9friendly!terms!from!companies!that!

could!one!day!disrupt!energy!markets.!!9 LTIs!have!a!unique!ability!to!make!a! long9term!commitment!to! illiquid! investments,! resulting! in!

higher!returns.!!9 LTIs!can!pool!resources!to!vet!opportunities,!an!especially! important! issue!since!venture!capital!

tends!to!be!a!highly!technical!and!non9standard!asset!class.!!9 LTIs! agreed! that!making!direct!VC! investments! are! risky! and! expensive;! the!Alliance,!with! like9

minded! and! deeply! resourced! peers,! is! an! attractive! option! in! terms! of! facilitating! asset!diversification.!!

9 LTIs! believed! that! forging! strategic! relationships! with! best9in9class! VC!managers! could! lead! to!compelling!investment!opportunities!with!sustainable,!long9term!returns.!!!

!• Strategy:! The! Alliance! seeks! direct! investments! in! high9quality,! late9stage,! private,! venture9backed!

companies! that!are!emerging!as! ‘the!next!big! thing’! in! the!energy,! food,!and!water! industries.! The!Alliance!will!make!sizeable!commitments!($509500M!per!company!of!initial!and!follow9on!capital)!in!a!concentrated!portfolio!of!companies!(5!to!10).!The!Alliance!pays!no!fees.!!

!• Implementation:!One!Alliance!member!has!had!a!close! relationship!with! two!top9decile!VCs.!These!

VCs!were!approached!to!see!if!a!formal!collaboration!with!the!Alliance!would!be!agreed.!The!Alliance!was!offered!unique!and!privileged!access!to!opportunities.!The!Alliance!solidified!these!relationships!through! letters!of! intent!to!build!companies! in! industries!with!high!capital!requirements,! long9term!advantages,!and!market9validated!growth.!These!agreements!came!with!no!(explicit!or!implicit)!fees!or! costs;! the! VCs! and! LTIs! viewed! the! arrangement! as! a! division! of! labor.! That! is,! the! VCs! de9risk!portfolio! companies’! business! models,! and! the! Alliance! actively! helps! the! companies! achieve!commercial!scale.!

!• Administration:!On! a! semi9annual! basis,! the! Alliance!meets! in! Silicon! Valley!with! its! peers! and! VC!

partners.! There! are! routine! calls! among! the! staff! of! the! Alliance! and! the! VCs! to! keep! abreast! of!

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developments! in! portfolio! companies.! The! Alliance! members! share! costs! and! expenses! for! due!diligence!as!well!as!administration.!The!Alliance!has!been!kept!small!(three!funds)!to!ensure!effective!and!efficient!execution.! The!Alliance!may!add!a! small!number!of!new!partners! in! the!years!ahead,!based!on!unanimous!agreement!among!the!founders.!Investment!decisions!are!made!on!a!case9by9case!basis,!and!Alliance!members!share!the!responsibility!of!the!analysis!and!due!diligence.!

!• Commitment:!The!three!funds!have!made!in!total!a!notional!commitment!of!$1!billion!to!the!Alliance.!

The!commitment,!even!if!only!notional,!was!a!mechanism!to!trigger!internal!resourcing!and!planning!by!each!fund.!To!date,!the!Alliance!has!deployed!over!$450!million!directly!into!‘green’!companies.!!

!• Key! Success! Factors:! What! makes! this! model! work! is! that! the! LTIs! are! not! naïve! about! the! GPs’!

motives,!even!if,!in!the!end,!the!motives!end!up!being!pure.!The!partnership!with!the!GPs!only!works!if!the!Alliance!has!the!in9house!talent!to!properly!vet!the!opportunities!that!the!VCs!bring.!!There!are!serious!principal9agent!problems!in!helping!VCs!salvage!their!underperforming!companies.!!With!this!in!mind,!the!three!funds!decided!to!team9up,!pooling!their!venture!resources!into!a!single!cohesive!team.!Opportunities!are!run!through!this!team!with!a!focus!on!executing!a!rigorous!and!meticulous!evaluation!of!opportunities.9!In!addition,!by!focusing!on!industries!that!touch!upon!infrastructure,!the!three!SWFs!can!utilize! their!deep!expertise! in!direct! infrastructure! investments.!This!has!also!been!critical! in! vetting! some! of! the! opportunities! presented! to! the! Alliance.! To! date,! this! creative!collaboration! amongst! peers! and!GPs!has! been! rewarding.!Nonetheless,! given! the! time! frame,! the!investment!program!has!many!years!to!run.!!

!!Lessons!Learned!In!this!section,!we!distill!the!lessons!learned!from!our!case!studies!and!experience!working!with!LTIs!looking!to!take!advantage!of!the!valley!of!opportunity.!Here,!we!set!out!the!principles!and!policies!that!LTIs!should!consider!when! reviewing! (or!managing! the!process! of)! investing! in! capital9intensive! ventures.! Readers!will!notice!that!the!principles!below!highlight!the!cultural!and!theoretical!challenges!facing!LTIs,!while!the!policies!focus!on!resolving!operational!and!implementation!challenges.!!!A)#Principles:!Making!direct!venture! investments!means!asking!LTIs! to!step!outside!of! their!comfort!zones.!The! nature! of! the! risks! embedded! in! small! capital9intensive! companies! places! them! beyond! the! reach! of!traditional! investors.! As! such,! various! cultural! and! organizational! adjustments! may! be! required! for!institutional! investors! to!be! successful! in! financing!green! innovations.! The! following!principles!are!deemed!fundamental!for!LTIs!investing!in!green!VC!opportunities:10!

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!9/.!The!Alliance!has!also!routinely!tapped!Dr.!Monk’s!colleagues!at!Stanford!and!Oxford!universities!to!serve!as!expert!consultants!during!due!diligence.!!10/.! Embedded! in! these! principles! is! the! economic! theory! of! differentiation! (see! Krugman! 1998;! Buckley! and! Ghauri!2004).! Economic! differentiation! states! that! in! different! industries,! finance! is! required! to! serve! dramatically! different!roles.! Institutional! investors! have! wide9ranging! investments! in! many! different! industries! (Schneeweiss! and! Georgiev!

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!• Responsibility:! The!most! challenging! cultural! issue! facing! LTIs! is,! ironically,! the! need! to! take!more!

responsibility! for,! and! ownership! of,! the! investments! in! their! portfolio.! Typically,! institutional!investors!work! through!a! long!chain!of! intermediaries!before! their! capital! is! actually!deployed! into!companies! (see! Colombo! and! Grilli! 2010;! Gillan! and! Starks! 2003;! Levich! et! al.! 1999).! While!intermediation!may!make!an!allocator’s! job!relatively!easy,! it!also!serves!to!neuter!the!competitive!advantages!of! LTIs! in! this!domain.! Investing!via!external! asset!managers! serves! to! shrink! the! time9horizon!of!the!investment!decision9making!and!distort!the!incentives!and!objectives!of!the!ultimate!asset!owners! (Clark!and!Monk!2013a;!Clark!and!Monk!2013b).! In!short,!LTIs!need!to!be!willing!and!able!to!make!direct!investments!in!green!companies,!which!means!they!have!to!build!in9house!teams!and!capability.!In!this!regard,!governance!is!critical!(see!Clark!and!Urwin!2008;!Marathon!Club!2007).!

!• Theory:!For!investors!relying!on!conventional!portfolio!and!investment!theories,! it!can!be!very!hard!

to!justify!growth!stage!investing!in!green!companies.!As!such,!LTIs!may!have!to!go!beyond!the!tenets!of!modern!portfolio!theory,!as!modern!portfolio!theory!will!not!be!able!to!capture!and!articulate!the!value! of! these! long9horizon! innovations.! In! large! part,! this! stems! from! the! fact! that! truly! game9changing! technologies! create! new! industries,! not! just! new! firms.! Entrepreneur(s)! have! to! build! a!whole!set!of!vendors!and!suppliers!to!help!the!company!scale9up.!Thus,!the!rigid!metrics!of!modern!portfolio!theory!are!not!easily!applied!to!these!ventures,!as!modern!portfolio!theory!does!not!take!into!account!future!increased!earnings!stemming!from!the!opportunities!to!capture!value!along!the!path!of!building!an!entire!industry!(see!Müller!1988;!Elton!et!al.!2009).!Therefore,!LTIs!have!begun!to!use! a! hybrid! model! that! combines! venture! capital! style! assessment! with!more! traditional! PE! and!infrastructure!metrics!(see!Baum!and!Silverman!2004).!

!• Risk:!When!it!comes!to!green!ventures,!LTIs!have!to!adopt!a!different!belief!system!about!risk.!In!all!

likelihood,! cash! flows! do! not! yet! exist! on! a! level! that! justifies! existing! valuations! (see! Bürer! and!Wüstenhagen! 2009;! Horwitch! and! Mulloth! 2010),! especially! when! compared! to! comparable!companies!in!other!industries!(see!Gompers!and!Metrick!2001;!McConnell!and!Servaes!1990).!What!is!required! is!an!ability!to! look!beyond!risk!and!focus!on! ‘what’s!possible’;!LTIs!must!view!risks! in!a!similar! manner! to! venture! capitalists! (see! Moore! and! Wüstenhagen! 2004).! This! qualitative! and!subjective! framing! leaves! many! LTIs! uncomfortable.! Nonetheless,! it! is! required! when! investing! in!companies! like! Amazon,! which! required! enormous! financial! backing! before! finally! turning! a! profit!(due!to!the!infrastructure!that!had!to!be!built!by!the!firm!before!profitability.)!Note!that!qualitative!judgment! need! not! imply! a! lack! of! rigor.! Rather,! it! implies! bottom9up! analysis! and! in9depth! due!diligence.!This! is!an!approach! that! requires!more!discipline! than!some!of! the!more! traditional! top9down!models!of!investment!decision9making.11!!

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!2002),!making!it!challenging!for!the!achievement!of!differentiation!among!strategies.!However,!this! is!what’s!required!when!focusing!on!“green”!venture!capital.!!!11/.!In!order!to!make!such!risky!investments,!LTIs!should!develop!risk!budgets!such!that!these!high9risk!investments!do!not!put!a!strain!on!the!entire!portfolio.!Since!disruptive!companies!have!considerable!idiosyncratic!risk,!these!risks!can!be!managed!through!diversification!(see!Campbell!et!al.!2001;!Goyal!and!Santa9Clara!2003).!

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!• Engagement:! It! is! crucial! that! LTIs! recognize! the! importance! and! value! of! their! engagement! in!

portfolio! companies.!Many! target! companies! view! the!manner! in!which! institutional! investors! add!value!to!be!more!critical!than!the!cost!of!capital!(Bygrave!and!Timmons!1992).!While!LTIs!believe!that!they!have! little!of!value!to!add,! there!are!various!ways!of!assisting! in!commercialization.!Since!LTIs!have! a! large! network! of! peers,! LTIs! can! provide! introductions! to! peers! that! can! provide! cash!injections,! reducing! the! need! to! be! in! a! continuous! fund9raising! mode.! The! LTIs! can! also! provide!introductions!to!potential!customers!and!vendors.!And,!critically,!LTIs!can!provide!support!and!capital!to! help!with! transformations! similar! to! those! articulated! by! Christensen! (1987)! in! The( Innovator’s(Dilemma.! Often! initial! business!models! need! to! be! changed! for! businesses! to! remain! competitive.!Both!VCs!and!LTIs!can!add!value!at!different!stages!of!a!venture’s!lifespan.!!

!B)#Policies:!The!following!operational!and!strategic!factors!are!deemed!to!be!important!for!all!LTIs!looking!at!this!type!of!investing:!!!

• Direct! Investing:! In! order! for! LTIs! to! be! active! and! engaged! in! their! investments,! and! have! the!capability! to! assess! which! green! ventures! have! the! most! promise,! LTIs! need! organizational! and!human! resources! that! match9up! against! even! the!most! sophisticated! growth9stage! investors.! This!implies! the! presence! of! strong! in9house! management! and! deliberate! efforts! to! recruit! and! retain!qualified!staff!and!advisors! (see!Bachher!and!Monk!2013).!The!creative!collaboration!model,!which!brings!LTIs!together!with!VCs,!only!works!when!the!LTIs!are!proactive!and!not!naïve!about!the!GPs’!motives.!This!means!LTIs!need!the!requisite!in9house!talent.!

!• External!Partnerships:!VCs!often!fail!to!maintain! interest!alignment!and!deliver!adequate!returns!to!

LPs! (see!Mulcahy! et! al.! 2012;! Sensoy! et! al.! 2013;! Cumming! and! Johan! 2009).! Still,! the! specialized!knowledge!of!VCs!is!difficult!to!replicate!in9house,!which!means!that!VCs!have!an!important!role!to!play!in!the!investment!process.!As!such,!LTIs!tend!to!develop!a!handful!of!relationships!with!VCs!so!as!to! source!direct! deals! in! green! companies.! In! some! cases,! LTIs! become! “partners”!with!VCs! rather!than!competitors.!!

!• Trusted!Peers:!Since!it!is!difficult!to!build!investment!capabilities!in9house,!collaborative!vehicles!that!

bring! direct! investors! together! are! also! required.! As! noted! above,! collaborative! vehicles! can! help!long9term! investors! mobilize! the! resources! and! capabilities! necessary! to! judge! which! green!opportunities! are,! in! fact,! commercially! viable! over! the! long! term.! Syndicating! deals! among! LTIs!allows!these!organizations!access!to!a!broad!array!of!talent,! insight!and!expertise.!Because!some!of!these!investments!will!fail,!pension!and!sovereign!funds!are!best!served!by!pooling!capital!with!other!like9minded! investors! to! capture! the! benefits! of! diversification.! The! LTIs! we! have! studied! have!screened! green! opportunities! through! the! collaborative! team! and! have! focused! on! executing! a!rigorous!and!meticulous!evaluation!of!opportunities.!

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!

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!Conclusions!!Venture! capital! has! been!out! of! favor! for! the! past! decade! among! the! largest! institutional! investors! in! the!world.!Much!of!this!stems!from!the!poor!returns!generated!by!external!managers,!as!the!large!majority!of!VC!funds!have!not!out9performed!public!markets.!A!majority!of!VC!funds!have!failed!to!even!return! investees’!capital.! As! a! result,!many! LTIs! have! scaled!back! their!VC! commitments! to! external!managers! and,! instead,!have! focused! on! alternative! asset! classes! that! can! offer! economies! of! scale! such! as! private! equity,!infrastructure! or! real! estate.! In! this! paper,! however,! we! have! argued! that! VC! still! offers! remarkable!opportunities!for!well9positioned!institutional!investors.!!!Indeed,! there! is! a! unique! opportunity! for! LTIs! to! carry! venture9backed,! capital9intensive! companies! to!commercial!scale!and,!in!turn,!participate!in!their!success!over!the!long!term.!Rather!than!a!valley!of!death!(VoD)!for!these!companies,!we!see!a!valley!of!opportunity:!the!juxtaposition!of!large!past!losses!from!green!investments!with!the!potential!for!future!gains!presents!an!important!investment!opportunity!for!long9term!investors.!!But!in!order!for!LTIs!to!take!advantage!of!this!opportunity,!they!need!to!re9conceptualize!the!way!they!access!VC!opportunities.!!!While!LTIs!have!a!variety!of!paths!to!access!VC!opportunities!(e.g.,!in9house!teams!and!seeded!managers),!in!this! paper! we! focused! on! creative! collaborations! that! bring! LPs! together! with! GPs! in! new! and! mutually!aligned! structures.! As! such,!we! argued! that! LTIs! could! launch! a! new! type! of! VC! investment! platform! that!provides!direct,!diversified,!cost9effective,!and!aligned!access!to!quality!VC!opportunities.!With!this!in!mind,!we!presented!the! logic!behind!the! Innovation!Alliance.!The!Alliance! is!a!group!of! three!SWFs!that!took!the!opportunity! presented! by! the! VoD! to! extract! investor9friendly! terms! from! companies! that! could! one! day!disrupt! energy!markets.! The! three! SWFs!pooled! resources! to! vet! these!opportunities,! as!VC! tends! to!be! a!highly! technical! and! non9standard! asset! class.! To! date,! the! Alliance! partners! have! made! a! notional!commitment! of! more! than! $1! billion! to! the! Alliance! and! have! deployed! over! $450! million! to! green!companies.!!In! the! course!of!our! research,! it!was! found! that! there!were! several! key! success! factors! for! LTIs! seeking! to!participate! in! these!capital9intensive!ventures.!LTIs!need! to! take!more!responsibility! for! the!deployment!of!capital,! changing! the!way! they!view! risk.!At! the!core!of! these!vehicles,!moreover,!were!LTIs! that!were!not!naïve! about! the! relationships! they! needed! to! develop! to! source! deals.! These! ‘partnerships’! for! capital9intensive!investment!in!VC!companies!will!only!work!if!LTIs!have!the!in9house!talent!to!vet!the!opportunities!that!the!VCs!bring!to!the!table.!Thus!far,!the!creative!collaborations!have!functioned!effectively.!But!it!is!still!early!days,!and!the!true!value!of!these!relationships!may!not!be!known!for!years!to!come.!!!

!!!!!

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References!Aghion,!P.,!Askenazy,!P.,!Berman,!N.,!Cette,!G.,!and!Eymard,!L.!(2012).!Credit!constraints!and!the!cyclicality!of!R&D!investment:!evidence!from!France.!Journal(of(the(European(Economic(Association,(10(5),!pp.!100191024.(!Bachher,! J.S.,! and! Monk,! A.H.! (2013).! Platforms! and! vehicles! for! institutional! co9investing.! Rotman(International(Journal(of(Pension(Management,!6(1),!pp.!64971.!!Baum,! J.A.,! and!Silverman,!B.S.! (2004).!Picking!winners!or!building! them?!Alliance,! intellectual,! and!human!capital! as! selection! criteria! in! venture! financing! and! performance! of! biotechnology! startups.! Journal( of(Business(Venturing,!19(3),!pp.!4119436.!!Bernstein,!S.,!Lerner,!J.,!and!Schoar,!A.!(2009).!The!investment!strategies!of!sovereign!wealth!funds.!National!Bureau!of!Economic!Research!Working!Paper!(No.!w14861).!!Brochet,!F.,!Loumioti,!M.,!and!Serafeim,!G.!(2013).!Short9termism,!investor!clientele,!and!firm!performance.!!Buckley,!P.J.,!and!Ghauri,!P.N.! (2004).!Globalisation,!economic!geography!and! the!strategy!of!multinational!enterprises.!Journal(of(International(Business(Studies,!35(2),!pp.!81998.!!Bürer,!M.J.,!and!Wüstenhagen,!R.!(2009).!Which!renewable!energy!policy!is!a!venture!capitalist's!best!friend?!Empirical!evidence!from!a!survey!of!international!cleantech!investors.!Energy(Policy,!37(12),!pp!499795006.!!Bushee,! B.! (1998).! The! influence! of! institutional! investors! on! myopic! R&D! investment! behavior.! The(Accounting(Review,!73(3),!pp.!3059333.!!Bygrave,!W.D.,!and!Timmons,!J.A.!(1992).!Venture(Capital(at(the(Crossroads.!Boston,!Massachusetts:!Harvard!Business!Press.!!Cahoy,! D.! (2012).! Inverse! enclosure:! abdicating! the! green! technology! landscape.! American( Business( Law(Journal,(49(4),!pp.!8059887.!!!Campbell,!J.Y.,!Lettau,!M.,!Malkiel,!B.G.,!and!Xu,!Y.!(2001).!Have!individual!stocks!become!more!volatile?!An!empirical!exploration!of!idiosyncratic!risk.!The(Journal(of(Finance,!56(1),!pp.!1943.!!Christensen,!C.!(1997).!The(Innovator's(Dilemma:(When(New(Technologies(Cause(Great(Firms(to(Fail.!Boston,!Massachusetts:!Harvard!Business!Press.!!Clark,! G.L.! (1998).! Stylized! facts! and! close! dialogue:! methodology! in! economic! geography.! Annals( of( the(Association(of(American(Geographers,(88(1),!pp.!73987.!!!!Clark,!G.L.,!and!Monk,!A.!H.!B.! (2013a).!The!scope!of!financial! institutions:! in9sourcing,!outsourcing!and!off9shoring.!Journal(of(Economic(Geography,!13(2),!pp.!2799298.!!Clark,!G.L.,!and!Monk,!A.H.B.!(2013b).!Principles!and!Policies!for!In9House!Asset!Management.!The(Journal(of(Financial(Perspectives!1(3),!pp!1914.!!!Clark,!G.L.,!and!Urwin,!R.!(2008),!Best9practice!pension!fund!governance.!Journal(of(Asset(Management,(9(1),!

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Wiltbank,! R.,! and! Boeker! W.! (2007).! Angel! investor! performance! project:! data! overview.!http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1024714.!!World!Economic!Forum.!(2012).!Measurement,!governance!and!long9term!investing.!!Wright,!M.,!and!Lockett,!A.!(2003).!The!Structure!and!Management!of!Alliances:!Syndication!in!the!Venture!Capital!Industry*.!Journal(of(Management(Studies,40(8),!207392102.!!!!

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Figure!1!

Tesla!and!Google!Net!Income/Net!Loss!(First!Seven!Years!of!Operation)!

!

Series!1:!Google!!

Series!2:!Tesla!

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1,000,000,000!

1,500,000,000!

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14 JAN 2015 - ASHBY MONK

What Institutional Investors DesperatelyNeed: Two Letters

I can’t recall ever seeing an institutional investor with a group focused exclusively on

the research and development of innovative investment tools, methodologies or

even technologies. There are, to be sure, “special opportunities” groups and

“special situations” teams, and most investment organizations will usually have a

strategy team that can do some applied research and development work. But none

of these groups can be accurately characterized as “R&D,” as they don’t really

foster and exploit learning about innovation from a holistic perspective.

I find this odd. In fact, I’d like to suggest here that we need public pensions and

sovereign funds to add R&D to their organizational toolkits. It seems like a good

idea to me that an industry, which is utterly reliant on informational advantages and

knowledge, would institutionalize and formalize processes for creativity. Today,

however, most institutional investors are allergic to innovation. In fact I’d argue that

most prioritize efficiency (and expediency) at the expense of innovation, which is

bad. Being a successful investor requires creativity and innovation.

The job of an institutional investor is to take money and turn it into more money. To

achieve this, investors apply human resources and decision-making procedures to

information with the hope of generating knowledge that can drive returns. That’s all

institutional investors really do. Seriously, that’s it. Now, great investors combine

talented people with effective procedures and unique information in order to create

proprietary knowledge and, thus, persistent outperformance. Indeed, research

shows quite clearly that knowledge is a resource as valuable as any other form of

What Institutional Investors Desperately Need: Two Letters | M... http://www.institutionalinvestor.com/Popups/PrintArticle.aspx?A...

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capital. And Eduard van Gelderen, one of my co-authors and friends, recently

reminded me that we often judge investors according to their “information ratio,” as

the secret sauce to successful institutional investment is in the development of

knowledge and its management.

But “knowledge” doesn’t just happen. It’s not something that can be outsourced (to,

for example, pension consultants) because the best R&D and knowledge will be

inevitably tailored to the specific circumstances of the investment organization. If I’m

a Giant looking for alpha, I’ll have to think hard about the kind of knowledge that I

have the capacity to develop that others do not. I’d need to think about opportunities

that don’t fit in silos or boxes and look for markets that are complex, inefficient, and

opaque.

I’d also focus on a subset of those markets in which I have an understanding

advantage that I could use to identify endemic inefficiencies (perhaps thanks to my

network or unique access). If I were a university endowment, I’d be thinking about

my own campus and alumni. If I were a sovereign fund, I’d be looking for

opportunities emerging locally. If I were a family office, I’d look for family assets and

networks.

But to all of this unique knowledge, which I believe can be a source of persistent

and structural alpha to institutional investors, one must apply innovation and

creativity. And that, in turn, requires investors to develop mechanisms to “think

different.” While this mechanism has not been formalized organizationally in R&D

groups, some investors are moving in the right direction by focusing on the potential

for collaboration and cooperation to facilitate knowledge creation and transfer.

Indeed, research importantly shows that cross-department or asset class

collaboration and interaction is critically important to organizational success.

As an example of how institutional investors might start thinking about

institutionalizing R&D, take the example of Jagdeep Singh Bachher and the

University of California’s Office of the CIO. The UC just published its annual report

(which, caveat lector, I assisted in writing, so discount and disapprove what follows

accordingly). What I think is unique about this report and the CIO’s office is the way


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in which it positions collaboration as a key component in its long-term strategy for

developing new investment opportunities. Specifically, the UC talks in the report

about harnessing collaboration in four distinct networks:

- Internal: The UC is trying to work as a single team, aiming for a coherent portfolio

that achieves all its objectives. It is trying to cut across silos and simple asset-class

designations in order to avoid missing investment opportunities that might fall

through the cracks.

- Sponsors: The UC is aiming to leverage the unique resources it has within the

University of California by collaborating with the wider academic community. For

example, the University has three national labs, five massive medical centers, ten

campuses, and something on the order of $5 billion in research funds deployed

every year. The amount of knowledge created in this one university ecosystem

rivals entire countries. Heretofore, the CIO will attempt to take advantage of this

wealth of knowledge through discussions and engagement, as well as find

investment opportunities within the UC ecosystem.

- Peers: The UC is looking to collaborate and, where possible, invest with

like-minded peers. Peer networks can be invaluable for investment innovation, as

peers can pool capital, scale costs, and share risks across a range of opportunities.

Peer-to-peer platforms can also help connect investors around particular

opportunities or themes.

- Professionals: The UC is prioritizing knowledge sharing between its external

managers. It is seeking relationships that are truly collaborative, where the UC can

actually add value to the managers.

The UC is focused on these four layers of collaboration because it recognizes the

need to be more rigorous about the ways in which it develops, manages and

deploys knowledge. And the UC isn’t the only fund to encourage collaboration and

cooperation as deliberate R&D mechanisms; Adrian Orr and the New Zealand

Super Fund — their “Three Cs” — is another example that readily jumps to mind.


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Unfortunately, this isn’t the norm within institutional investment. The majority of

Giants should be trying to develop formal organizational structures for managing

innovation, but they’re not. As I’ve said before, I think the best investors are those

that accept financial markets as constantly changing ecosystems and, as a result,

are trying to evolve dynamically through innovation to be able to reap returns. Good

investment ideas don’t last forever, which means there are significant rewards for

spotting new opportunities early and acting in an entrepreneurial manner quickly.

Why don’t the biggest investors in the world recognize this?

I would advocate for R&D groups in all pension funds. This is not an excuse to

create yet another silo within an already bureaucratic organization. Rather, an R&D

group situated in a pension fund would have the mission to work cross functionally

and spread innovative ideas and practices around the organization in a coherent

and structured manner. Knowledge does not transfer or flow without

encouragement. Moreover, there is too much knowledge today for any single person

to be able to adequately deploy it all. So, we have to foster discipline around how

we use it.

Analogous to the way that we need pension funds to build risk-taking cultures, we

also need pension funds to develop cultures that can stomach and manage

innovation. Long-term out-performance relies on this.


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Sectors, Not Just Firms | 7

Embracing the Full InvestmentContinuum

Gaps in the Impact InvestingCapital Curve | 1

Do No Harm: Subsidies andImpact Investing | 1

Government Matters

Achieving Takeoff

Priming the Pump for ImpactInvesting

Omidyar Network makes the case for a

sector-based approach to impact

investing.

I

IMPACT INVESTING

Sectors, Not Just Firms

Part I in Omidyar Network’s case for a sector-based approach to impact investing.

By Matt Bannick & Paula Goldman | 7 | Sep. 25, 2012

t was roughly five years ago, in a late summer gatheringof investors and thought leaders, that the term “impact

investing” was coined. The practice, of course, is more thanfive years old. Omidyar Network, for example, had beeninvesting for both social and financial returns since 2004.

In the past five years we’ve seen an exponential growth ofinterest in our industry, much of it focused on individualfirms. Most impact investors see their primary goal asfinding and investing in enterprises that yield strongfinancial and social returns—a goal we share and support.But we worry this singular focus may miss the forest for thetrees.

In this online series, we argue for a shift in focus—towardthe goal of scaling entire industry sectors, in addition to individual firms. Our experience fromthe past eight years is that impact investors can massively increase the number of lives they touchby concentrating investments in specific industry sectors in specific geographies, and by investing

Sectors, Not Just Firms | Stanford Social Innovation Review http://www.ssireview.org/blog/entry/sectors_not_just_firms

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in a range of organizations to accelerate the development of these industry segments. The needfor investment is particularly acute at the earliest stages of innovation, which provide thefoundation in which entire new sectors can emerge and scale rapidly by tapping commercialcapital markets.

Creating and scaling entire sectors can make the difference, for example, between supporting onesolar lantern company that can provide safe lights to thousands of children who otherwise can’tstudy for school at night—and accelerating an entire solar lighting industry that could providethese lanterns to millions, if not hundreds of millions of students.

Tools for the Journey

Easier said than done, you may rightly be thinking. After all, many industry sectors, especiallythose serving disadvantaged populations and with weak infrastructures, can take decades todevelop. Microfinance, one of the most heralded innovations for the poor, first emerged in the1970s and, despite strong growth, is still available to only a minority of the world’s poor.

But consider this. Accelerating the development of the microfinance sector by just three or fouryears means extending critical financial services to tens of millions of people—well above thescale than any single firm can reach.

The nascent medical technology sector serving the base of the pyramid in India offers anotherexample of the potential of market acceleration. According to a 2011 study by McKinsey &Company, accelerating the growth trajectory of the affordable medical technology sector in Indiaby just three to four years could mean that poorer consumers have access to an additional twobillion medical treatments per year by 2015. For some of those customers, having access to suchtreatments could mean the difference between life and death.

In this series we offer several ideas on how to spark, nurture, and scale new sectors for socialchange. In our next article, for example, we lay out three specific types of organizations thattogether help build an industry sector—innovators, scalers, and infrastructure players. Each ofthese organizational types has very different risk and return profiles, but they all need to beadequately capitalized in order to speed up the development of any given sector.

The paucity of financial and human capital available for high-risk, early-stage ventures (what wecall “innovators”) and for sector-specific industry infrastructure poses a massive impediment tothe healthy growth of the impact investing sector. Everyone loves to invest in the occasional


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impact investing “homerun” that promises strong financial and social returns—and thesehomeruns have an important demonstration effect for the viability of the industry as a whole.Unfortunately, relatively few appear willing to step up to the hard and uncertain work of sparkingand nurturing the innovations that ultimately generate a robust flow of investable, high-returnimpact investments. It is as if impact investors are lined up around the proverbial water pumpwaiting for the flood of deals, while no one is actually priming the pump!

An excessive focus on the individual firm, we believe, also has caused many impact investors tounderestimate the importance of policy and political sensitivity, particularly when serving thedisadvantaged. In article four, we detail how three policy levers—promoting competition,ensuring consumer protection, and promoting entrepreneurship—can speed up or delay thedevelopment of industry sectors, often by decades. We also note how a lack of appreciation ofpolitical dynamics can cause firms, and entire sectors, to suffer serious setbacks. Oddly, despitethe dramatic fallout of microfinance in the Indian state of Andhra Pradesh, there seems to berelatively little discussion of the extent to which profit-making firms serving the disadvantagedare particularly vulnerable to backlash from a wide array of players, including concernedpoliticians, a skeptical press and citizenry and entrenched economic interests.

Our Own Evolution

Pierre and Pam Omidyar established Omidyar Network with a uniquely flexible structure—enabling us to deploy whatever type of capital, whether grants or for-profit investments, wethought could best help solve a problem. Pierre believes that for-profit firms might haveadvantages in achieving rapid scale that are unavailable to many non-profits—such as access tocommercial financing and the ability to reinvest profit to sustain growth. To date, OmidyarNetwork has invested more than a half a billion dollars in typically early-stage social impactorganizations, almost equally split between for profit and not-for-profit investments. Many ofthe observations and insights in this series come from our own explorations about how best totake advantage of our flexible structure.

In the past few years, we’ve noticed lots of new investors piling into the impact investing arena,many with the expectation of finding a steady stream of relatively mature businesses offeringboth social impact and risk-adjusted returns. We have found a real shortage of such deals.

Concern over inadequate deal flow was one of several factors that led us to reevaluate our ownapproach to what we referred to as the “gray space” between grants and risk-adjusted return


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investment. Historically, we were always comfortable with traditional grantmaking, where weexpected one hundred percent loss of principal. But when we did for-profit investments, weinsisted on deals that would yield risk-adjusted commercial rates of return. This was driven byconcerns about distorting markets and the desire to be as rigorous as possible in our investments.With time, we realized that this insistence on risk-adjusted returns would cause us—and theimpact investing industry as a whole—to systematically under-invest in creating the conditionsunder which innovations, and entire new sectors, could be sparked and scaled.

Since 2007, we have also invested in businesses that we did not expect to earn risk adjust returns,but which we DID expect would help advance entire sectors. For example, in 2008, we investedin MFX , a company that helps microfinance institutions decrease the foreign exchange risks ofborrowing money in western currencies and lending out in local currencies. MFX is a for-profitcompany, but we knew we might not achieve risk-adjusted returns on our investment, anddiscussed this question in great detail. We decided to move forward, because we were clear thatMFX would make a large contribution to accelerating the microfinance sector as a whole.

We realized that if we truly cared most about sector creation, then we needed to develop a way toaccount for the total value creation of the firm, including sector value creation as well as thefirm’s direct social impact and financial returns. This led us to refine the process by which weconsider investments across the entire returns continuum, from grants to risk-adjustedreturns—and particularly those that fall in the middle of the spectrum. While this has requiredmuch greater discipline around identifying sector-level value creation, we also think it has givenus new tools for priming the pump for sector-level change.

The observations, insights, and changes that we will highlight in this series were, for us, neitherimmediately obvious nor easy to adapt. The appropriate role of below market returns, forexample, continues to be the source of considerable debate within ON and across the sector.More broadly, the impact investing sector remains in its infancy and we are just beginning toexamine critical questions, such as how to create entire new markets for social change. Ourinsights will grow and deepen in the years to come.

Though we are eight years into our journey, we are still on a steep learning curve. Our intentwith this series is NOT to try to present the definitive blueprint on how to spark, nurture, andscale entire new sectors for social change. We are committed, rather, to contributing ourexperiences and thoughts to the ongoing dialogue that is shaping the incredibly promisingimpact investing sector. We invite you to participate in this dialogue with us, to push back, to


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If you like this article enough to print it, be sure to subscribe to SSIR!

help us refine our own thinking. Even more importantly, we invite you to collaborate with us onthis challenging but critically and inspiring journey. To truly scale sectors in impact investing, wewill need all hands on deck.

Matt Bannick is managing partner at Omidyar Network, where he leads all aspects of operations and strategy. He

is the former president of eBay International and of PayPal.

Paula Goldman is director at Omidyar Network, where she leads efforts to accelerate the development of the

impact investing industry.

We thank Jayant Sinha and Amy Klement for their input and assistance on this article.

Tags

Cross-sector Collaboration, Grantmaking, Microfinance, Omidyar Network, Partnerships

Copyright © 2015


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20 NOV 2014 - ASHBY MONK

The Financial Value of Extra-FinancialMotives

I recently found myself the lucky moderator of a candid discussion among a group

of asset owners — mostly sovereign wealth funds and public pensions — on

innovative investment models and creative approaches to deal sourcing. One of the

Giants in the room, whom I‘ll anonymize to protect the innocent, was opining on his

fund’s approach to accessing emerging market economies. This individual was thirty

seconds into a description when another individual in the room caught his eye. He

stopped. “You know what,” he said, “The fund that we learned this from is in the

room...” And he gestured to another Giant.

Turning to the latter, I asked what it was that had inspired his fund to take such an

innovative approach. The individual thanked me for the question as well as thanking

the gentleman from the first Giant for being so gracious and then he paused... for

what felt to the moderator like a long while. His eventual response was worth the

wait: “National survival,” he said. “We had to be creative and do something like this.

The future of our country was, if we’re honest about it, depending on us finding a

new way to drive development. And we did.”

Confused? Yeah, that’s understandable. Here’s basically what went down: An iconic

public pension fund known above all else for its purity of financial motives and

professionalization credited a sovereign development fund — one that

acknowledges publicly that it has a strategic overlay — for inspiring its approach.

Say, what?

The Financial Value of Extra-Financial Motives | My Blog http://www.institutionalinvestor.com/Popups/PrintArticle.aspx?A...

1 of 3 4/21/15, 9:14 AM

It’s largely for this reason that I became interested in sovereign development funds,

as I believe these organizations could serve as important catalysts for change in

financial markets generally. Admittedly, my views on this matter have been clouded

by the 18 percent dollar returns generated by Temasek since it launched 40 years

ago and the 14 percent dollar returns Malaysia’s Khazanah has generated since its

reorganization in 2004 and the double digit decennial returns generated by many

other SDFs, such as the Palestine Investment Fund or the Public Investment

Corporation of South Africa. More to the point, some of these funds (though clearly

not all) have posted remarkable returns while doing things in their local economies

that could be described as “off the beaten financial path.”

As I see it, most institutional investors are so far removed from the real economy

that they fail to see the connection between their future prosperity and that of the

economic system they are financing. They buy products not assets and invest in

managers not companies. And this disconnect between long-term investors and

long-term value creation leads to fundamental problems in our capitalist system.

But with SDFs, there’s a remarkable opportunity — in fact, it’s a requirement — to

re-root investment organizations in the “real,” and to take a limited pool of capital

and create wealth in general terms. SDFs aren’t burdened by the constraints or

complications that can come with traditional portfolio theories. In fact, they are

empowered by their additional necessities. Their extra-financial mandates are, in a

way, a license to think outside the box and to take on big problems. It’s also often

permission to develop internal capabilities. Why? If there were financial products for

sale in a region or market offering “development,” the government wouldn’t need an

SDF in the first place. Being the first investors in to a new industry or geography

demands such professionalism.

Is it crazy that a strategic investment vehicle would outperform pure financial

investors? Not really. Research suggests that corporate venture capital creates

more value when it is strategic in nature than when it is purely financial. How can

that be, you ask? As it turns out, the strategic focus of corporate VC is what attracts

the time and attention of the key players at the sponsoring company. This, in turn,

drives increased coordination and knowledge sharing, which leads to two-way value


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creation... and better overall outcomes.

I continually scratch my head when I hear people say, without thinking, that impact

or developmental investing erodes financial returns. Return erosion is, obviously, a

possible outcome from strategic investing done poorly, but I don’t see the two as

necessarily linked. Rather I see a strategic overlay as a license for investment

organizations to be highly creative. And I think creativity is the single most important

building block of long-term investment success.

In sum, you can either view the strategic objective of SDFs as a distraction from

running traditional financial models, or you can view it as a unique opportunity to

cultivate structural alpha. Perhaps I’m a naïve optimist, but I often sit in the latter

camp. I genuinely believe that a strategic overlay can help bolster a well-governed

fund’s returns by giving the investment organization a longer duration mindset, a

closer link to the real economy (from which all economic value will ultimately

emerge), a mandate to build internal capabilities and a license to innovate. And so, I

think it natural that highly professional “financial investors” are now looking to

strategic investors for inspiration and advice.


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Cooperation and collaboration Version 7a Page 1

Transcending Home Bias: Institutional Innovation through Cooperation and Collaboration in the Context of Financial Instability +Gordon L Clark and *Ashby H B Monk. +Smith School of Enterprise and the Environment, Oxford University, Oxford OX1 3QY, UK and Department of Finance, Monash University, Caulfield VIC 3145, Australia; and *Global Projects Center, Faculty of Civil and Environmental Engineering, Stanford University, Palo Alto CA 94305-4121, USA, and Smith School of Enterprise and the Environment, Oxford University, Oxford OX1 3QY, UK. Contact. [email protected] Abstract. This paper sets out an analytical framework for understanding the nature and significance of cooperation and collaboration in beneficial financial institutions like pension funds and sovereign wealth funds. Recognising that these types of institutions rarely face competition for the flow of funds, it is also noted that these institutions and other types of financial institutions compete with one another to realise target rates of return in global financial markets. At one level, these institutions can be quite parochial, even if there is a premium on institutional innovation. It is argued that in-sourcing and/or outsourcing the production of target rates of return may not provide senior managers sufficient flexibility to respond to changing market conditions. In this respect, cooperation and collaboration between financial institutions can be seen as a way of opening-up an ‘action space’ for innovation otherwise denied by the norms and conventions of the sector. In the penultimate section of the paper, examples of cooperation and collaboration are described noting the ways in which they enable senior managers to transcend home bias (the hegemony of local practice). Implications are drawn as to the limits of cooperation and collaboration, especially as regards the authority of senior managers. Keywords. Collaboration, cooperation, financial institutions, investment management JEL Codes. G23, J33, L24, R51 Acknowledgements. The authors acknowledge the support of Stanford University and members of the research consortium on institutional investment coordinated by the Center for Global Projects in the Faculty of Civil and Environmental Engineering. Members of the research consortium provided access, field assistance, and partial support of staff salaries. Consortium members were not involved in the formation of the paper’s content and argument. The authors are pleased to acknowledge the insights and ideas of Heather Hachigian, Ray Levitt, Caitlin McElroy, Dane Rook, and John Whiteman, conversations with Eduard van Gelderen, Deborah Ralston, Woody Powell, and Roger Urwin, and the assistance of George Boulton, Amanda Diener, and Zoe Whitton. As well, we benefited by presenting versions of this paper at seminars hosted by the Australian Institute of Superannuation Trustees and Ernst and Young, and Monash University. Research on the governance and management of financial institutions has also been supported by the Leverhulme Trust, the Rotman International Centre for Pension Management, and Towers Watson.

mailto:[email protected]



Introduction There is a voluminous academic literature on the structure and performance of financial markets (see Holmström and Tirole 2013). In the aftermath of the global financial crisis (GFC), there have been many reports and publications on the management of banking and shadow-banking institutions, especially as regards their risk-taking and internal control systems (Friedman 2011). Financial institutions like endowments, family offices, foundations, insurance companies, pension funds, and sovereign wealth funds have rather different forms and functions from banks, being beneficial in either intent or effect (Clark et al. 2013).1 These institutions have had to cope with the consequences of financial instability where, in some cases, their beneficial mandates have been fundamentally compromised. Financial instability in the core markets of the global financial system and systematic shortfalls in expected risk-adjusted rates of return have prompted reconsideration of the received theory of finance as well as conventional modes of asset investment (compare Merton and Bodie 2005 with Lo 2012). This paper is part of a larger project aimed at understanding the management and organisation of these types of beneficial institutions especially as regards their investment practices and performance in space and time (see Clark and Monk 2013a, 2013b). Previous papers have focused upon institutional form and function, the ways in which these institutions organise themselves and their service providers, and how they have sought to take advantage of opportunities in emerging markets. Motivating this research has been an interest in rewriting theories of the firm in economic geography and cognate disciplines that focus upon commodity-producing companies, favouring instead financial institutions that depend upon intangible assets to produce returns in global markets that are subject to risk and uncertainty. Related academic research includes Baker et al. (2001, 2002), Coase (1937), Hart and Holmström (2010), and Grossman and Helpman (2005), and the literature in economic geography on the modern firm including Amin and Thrift (1992), Dicken (2011), Dicken and Malmberg (2001), Maskell (2001) and Wrigley et al. (2005). Here, we analyse innovation in the organisation of beneficial financial institutions, highlighting the ‘capabilities and resources’ of these organisations (see Teece et al. 1997; Amin and Cohendet 2004; and Helfat et al. 2007). The problem facing financial institutions is more than that of responding to financial instability, the aftermath of the GFC, and the on-going Euro crisis. Recurrent financial crises have masked a significant shift in the underlying properties of financial markets, signalled as early as the Asian financial crisis of the late 1990s. There is little likelihood of returning to ‘normal’. Responding to these circumstances requires flexibility in institutional form and function, going beyond that which is inherited from the past. Explaining how and why this is the case is one contribution of the paper. A second contribution is to be found in the importance we attribute to new modes of cooperation and collaboration between rather than within institutions (compare Pitelis and Teece 2009); we argue that these options offer senior managers an intermediate action space between their organisations and financial markets so as to transcend home bias. These issues are illustrated by reference to modes of cooperation and collaboration evident in the industry. In the next section, we focus upon the ecology of the sector where large and small beneficial financial institutions are sheltered from competition for control over assets-under-management. It is noted that there are significant economies of scale in money management, providing a rationale for the in-house provision of financial services. In benign financial conditions, the issue of make-or-

1/. Some commentators describe these institutions as “shadow banks”. More precisely, Gennaioli et al. (2013, 1331) suggest that shadow banks function so as to “originate or acquire both safe and risky loans, and can finance these loans from (their) own resources as well as by issuing debt.” By contrast, the legal form and responsibilities of pension funds and the like are often quite different than shadow banks which owe their existence to either off-shore jurisdictions or on-shore jurisdictions operating quite literally in the shadow of their corporate sponsors.


buy was less important than issues of strategic asset allocation and investment management. However, financial markets have become rather hostile environments — challenging even the largest of institutions to be effective. In this context, there is a premium on institutional innovation, whether internal or external to the institution. Cooperation and collaboration provide senior managers opportunities “to create, extend, or modify … the resource base” of their organisations for promoting innovation in response to a changing environment (Helfat et al. 2007, 1-2). The penultimate section of the paper applies our characterisation of cooperation and collaboration to the design of investment platforms that bring together financial institutions to invest in opportunities that are otherwise beyond their inherited capabilities and resources. Our approach is consistent with Bathelt and Glückler (2011) and Storper and Venables (2004) in that it is schematic, analytical, and systematic as regards the nature and scope of industry practice. This strategy can be justified by reference to the need for theoretical principles and related propositions to guide subsequent empirical analysis. As noted elsewhere, there is little research on the organisation of beneficial financial institutions, and some ignorance about how this sector differs from commodity producing sectors. Because our framework is sensitive to the environment in which financial institutions operate, our approach requires a greater degree of specificity than is often the case in theory-led models of the modern firm (compare Hart and Moore 2008). This paper and previous contributions are based upon field research, engagement with financial institutions via the Stanford research club, and case studies reported, for instance, in Bachher and Monk (2013) and Clark and Urwin (2010). Inevitably, our analytical framework is tentative in nature. Fundamentals of the Sector In this section, we set out the key characteristics of the financial services and institutional investment sectors so as to better appreciate the logic underpinning our argument about institutional innovation. The analytical approach of the paper seeks to marry theory and practice with due regard to the world in which agents and institutions frame strategy and decision-making. At the same time, we refer to organising principles which can be found in standard treatments of the firm and industry structure, competition, and financial markets. Our exposition is sensitive to space and time, acknowledging the embedded nature of information and knowledge (Shapin 1998). Persistence and competition At the heart of recent treatments of organisational behaviour and strategic management is a concern with the goodness-of-fit between the organisation and the market in which it must operate (Barnett 2008). While the competitive circumstances of markets vary over space and time, market competition is believed to be a fundamental mechanism whereby institutions are rewarded (e.g. increasing market share) and penalised (e.g. decreasing market share) for their adaptability to changing circumstances (Durand and Wrigley 2009). This logic provides a rationale for predatory behaviour and the elimination of rivals through mergers and acquisitions. While there are other explanations for mergers and acquisitions (Coffee et al. 1988), it is assumed that competition between firms in relation to market dominance is a key mechanism by which rent-seeking behaviour is contained and disciplined. By contrast, many beneficial asset owners have exclusive control over the accumulation, management, and disbursement of funds. By reason of their relationship to fund sponsors and beneficiaries, pension funds and sovereign funds rarely if ever face rivals for control of the flow of funds. In fact, ‘capture’ on both sides of the relationship between sponsor and agent is an ever-likely possibility. On the other side of the equation, however, it is apparent that pension and sovereign funds are not in competition with other similar institutions for their asset base, they do compete with one another on risk-adjusted rates of return on financial assets. If this premium is randomly distributed in time above and below industry benchmarks, customary practice becomes


the ruling ethic of management. Systematic underperformance can lead to significant shifts in strategy, changes to in-house and external service provision, and investment in institutions’ capabilities and resources. At the limit, where systematic underperformance relative to peers threatens the viability of institutions’ sponsors, poor performance can precipitate the dissembling or restructuring of the inherited form and functions of these institutions.2 Given the primacy of peer benchmarks and the imputed peer risks, there is a premium on learning from other institutions, especially those able to produce a return premium on investments, especially those investments that are located at some distance from their home domain (Clark and Monk 2013b). Economies of scale and scope Textbook treatments of firms’ competitive strategies often begin with the size of the firm relative to its market, and the advantages that accrue to large firms by virtue of scale. That is, relatively low average per unit costs of production and, at the margin, very low per unit costs of production as the volume of production expands. Theorists recognise that, at some point, the unit costs of production begin to increase in the face of increasing complexity, problems of coordination, and inertia (see Coase 1937; Williamson 1975). Economies of scope are also important. Size allows firms to produce more specialised tasks and functions, discounting the cost of overheads attributed to the ‘core’ activities of the firm. This is one reason firms extend the range of products and services offered as they grow in size (measured in terms of the volume of production etc.). Facilitating complementarities can also reduce the appeal of the market for existing consumers while attracting new consumers interested in a range of options within one commercial relationship (Clark 2002). Economies of scale and scope are significant in the investment sector. Funds unwilling or unable to incur the costs of being ‘small’ (measured in terms of the volume of assets-under-management); outsource the supply of financial services and products. Senior executives of such funds spend most of their time on investment strategy and monitor the performance of external investment managers with the help of investment consultants and actuaries. As assets under management grow in volume, funds tend to bring tasks and functions in house that are relatively inexpensive in terms of skill and expertise to provide and oversee. This can include, for example, investment in certain asset classes such as bonds and equities where skill and market knowledge is less important than the cost advantages of placing assets in generic or the easily-imitated products found in the market. Large funds can provide all the tasks and functions needed to manage assets and liabilities internally. However, realising the advantages of complementarity can place a large premium on organisational skills and management authority.3 Contingency and response Standard treatments of commodity production suggest that learning-by-doing is an important element in promoting labour productivity and, ultimately, firm-specific competitiveness within and between industries (Gertler 2001). However, financial theorists doubt whether these conditions obtain in financial markets over the long-term (Weitzman 2007). To the extent there are market regimes where expectations are realised, those regimes are moments of stability disrupted by unexpected events which discount past practices while raising doubts as to their applicability in the

2/. See recent moves in the UK to not only out-source the management of pension funds but to shift fiduciary responsibilities to a commercial entity. In a similar manner, there have been moves to sell-off to insurance companies and special-purpose vehicles both the management of assets and the obligation to pay future benefits. These developments are explained in Clark and Urwin (2010). 3/. This paper can be read as an analysis of the costs of size in the financial industry, focusing upon the costs of inertia for organisational innovation in the absence of a market for ‘institutional’ control. As such, it resonates with related treatments of large organisations, including Jensen (2000), even if our representative institution (and sector) is fundamentally different from commodity producing firms.


future. In Figure 1, the path of the FTSE 100 index is provided from 1984 to 2012 (Office of National Statistics 2013). Over the period 1984 to 1997, the FTSE moved steadily upwards with remarkably low volatility. Thereafter, momentum accelerated, then became subject to booms and busts, and (in one instance) brought the global economy to collapse. In the first phase, holding equities for the long term was rewarded; in the second phase, long termism was not rewarded. Sophisticated time-variant investment strategies were required simply to hold risk at bay. [Insert Figure 1 about here] There are various ways of coping with these circumstances. Rather than produce planned risk-adjusted rates of return within an institution, senior executives may outsource asset management functions, hopefully containing the possible losses associated with changing market conditions by switching mandates between providers on the basis of market performance in a timely manner. Alternatively, senior managers may benchmark internal providers against the leading edge found in the industry, varying the allocation of assets between internal and external providers so as to keep pace with the market. Yet another option is to leave the market altogether and establish internal investment offices that rely less upon public markets and more upon the private placement of investments in untraded opportunities such as infrastructure. These options are three amongst many, all of which depend upon the authority of senior managers relative to internal portfolio managers and the market for financial services (see generally Teece 2003). Objectives, Contract, and Authority Having established key aspects of the investment sector, the next step is to provide a schematic model of our representative financial institution. Our reference point is an asset owner, or an asset owner that also has many of the tasks and functions of an asset manager. Through the elaboration of our model, we explain the nature and scope of the ‘problem’ that may prompt senior managers of financial institutions to search for cooperation and collaboration with other entities. In doing so, a theoretical rationale is provided for observed practice (see Bachher and Monk 2013; Guyatt 2013), distinguishing between large and small institutions, their functional scope, and the authority of senior managers in relation to the inherited form and functions of their organisations. Objectives and constraints It is assumed that our representative institution maximises the risk-adjusted rate of return on assets-under-management. It does so while seeking to minimise costs although, as noted above, it is recognised that this is a weak constraint in that sponsors of the institution and its ultimate beneficiaries may have little effective control over the costs incurred in realising the rate of return. Electronic infrastructure costs, transaction costs, switching costs, salaries, and fees and charges are, basically, the responsibility of the institution’s board of trustees. Nonetheless, the institution sets its planned rate of return on the basis of forecast liabilities and obligations. In some cases, forecast liabilities and obligations may be ultimately the responsibility of the sponsor and/or beneficiaries, although this possibility may be of limited significance over the short to medium terms. It is also apparent, however, that the institution’s liabilities and obligations are priced in local currencies and the home jurisdiction of the institution imposes rules and regulations on funding such that the effective operating space-time horizon of the institution combines local circumstances with global financial markets. Furthermore, to the extent that customary practice is rewarded by a better than average performance over time local opportunities may come to claim the centre of our institution’s investment strategy even if the original conditions producing those returns no longer prevail. Not surprisingly, the institution’s strategic asset allocation (as with other similarly-placed institutions) exhibits home bias relative to the global map of market capitalisation. This may


reinforce competition between local financial institutions such that if alliances are sought with other institutions they tend to come from other jurisdictions. The employment relation The option to make-or-buy is a choice between in-sourcing and outsourcing the production of the institution’s target risk-adjusted rate of return. For financial institutions, this choice translates into a choice between directly employing the requisite portfolio managers or entering into service contracts with third-party providers on a fee-for-service basis. In effect, outsourcing bundles together desired services and capabilities into a service contract which sets the target rate of return, the related costs, and the mechanism for renewing or terminating the contract in the future. In-sourcing production of the target rate of return requires the institution to write a set of employment contracts, distinguishing between different classes of employees, their significance to the institution, and the market premium that certain types of employees may command by reason of their skills and talent (Clark and Monk 2013a). Being close or distant from the market for talent may also affect the choice between in-sourcing and outsourcing (Dixon and Monk 2014). In financial institutions, it has proven difficult to maintain standardised contracts applicable to the various investment and non-investment employees essential to producing the target rate of return. In part, this is because certain types of services (like accounting, actuarial, and custodial services) must be executed, whatever market conditions. By contrast, portfolio managers are literally ‘in the market’ in the sense that their performance is dependent upon their judgement and expertise as to the bets to be made for and against other market participants in their asset class or segment of the market. The more transparent a market segment or asset class, the more likely senior managers can discriminate between happenstance as opposed to skill and talent. The more opaque a market segment or asset class, the higher the reward successful portfolio managers can extract from the host institution. At the limit, successful portfolio managers at the margin-of-markets can trump the authority of senior managers and enterprise-wide employment norms and conventions. Service contracts Smaller financial institutions are unlikely to in-source the various tasks and functions that make-up an investment strategy and its target rate of return. In part, this is because these institutions have neither the economies of scale or scope consistent with delivering cost-effective investment strategies nor the managerial resources and capabilities required to function effectively in the context of market risk and uncertainty. For these types of organisations, the solution is to hire knowledgeable and experienced managers who can hire and fire external portfolio managers in accordance with the institution’s investment strategy and asset-specific goals and objectives. Even larger institutions may utilise external portfolio managers on service contracts. These types of agreements can augment existing asset-specific investment strategies, access financial products not covered by the institution, and impose discipline on internal portfolio managers who (otherwise) may engage in rent-seeking behaviour (see Ambachtsheer et al. 2013 on the costs and consequences of intermediation). These types of service contracts may be bilateral contracts in the sense that they can be terminated-at-will. Along the lines suggested by Bolton and Dewatripont (2005), bilateral contracts are assumed complete, Pareto optimal, and contestable in the sense that non-performance brings forth claims for redress that can be realised (if necessary) in court. However, these types of contracts are hardly ever exclusive in the sense that the tasks and functions provided by the external portfolio manager are for the sole interest of the institution. The larger investment management companies offer pooled investment vehicles by asset class, style of investment, and sector and geographical focus and are available to a wide variety of clients such that they tend to manage the product rather than manage long-term relationships with clients. Notice, external portfolio managers offer clients a


variety of services with and without preferential pricing and conditions depending upon the volume of assets placed with the provider. So, for example, a relatively large placement of assets is likely to attract a discount on costs, private briefings, and direct engagement on issues of relevance. In effect, smaller clients face significant costs including the possible costs associated with knowing little about the functional organisation and performance of external portfolio managers. Not surprisingly, smaller institutions are likely to come late to successful portfolio managers and are likely to stay longer with a portfolio manager whose luck has run out. In any event, large and small clients face significant search costs in finding appropriate external portfolio managers, judging their performance over the short and long terms, and judging their performance against competitors in circumstances where market conditions are rarely repeated. Not surprisingly, there is often a bias in favour of known opportunities as well as a bias in favour of the status quo. Furthermore, senior managers rarely directly monitor and observe the relationships between their own employees and external portfolio managers. Staying with a poor performing provider can assume a level of significance that goes well beyond the issue at hand. Notably the respective powers of senior managers compared to their own employees. Authority and convention Industry norms and conventions regarding the ways in which target rates of return are produced tend to discount the authority of senior managers. This is apparent when in-sourcing and outsourcing production, though for different reasons. The problem facing senior managers when promoting innovation amongst existing in-house portfolio managers is that any attempt to radically alter the process of investment management is likely to run-up against conventional norms (asset-specific and otherwise) in the industry. The best performing portfolio managers have, at hand, attractive opportunities in the market for talent and skill should they be unwilling to compromise their interests in favour of the institution’s interests. On the other hand, external portfolio managers resist at every turn attempts by asset owners to rewrite the terms of engagement. Indeed, for the vast majority of institutional clients terms and conditions are offered on a take-it or leave-it basis recognising the transaction costs in agreeing to a new kind of contract that concedes significant authority to the client (Clark and Monk 2013c). By our account, senior managers of financial institutions are predisposed to consider joining initiatives that break with industry convention; the options of make-or-buy do not necessarily add to managers’ authority or flexibility notwithstanding the respective advantages and disadvantages of in-sourcing and outsourcing. In the aftermath of the GFC and the ongoing euro crisis, senior managers of many financial institutions (large and small) have actively sought alternatives to the make-or-buy logic that hitherto has dominated the investment management industry. Quantitative easing, stock market appreciation, and the rush to and from emerging markets, have separately and together raised concerns about the sustainability of past ways of doing business. In this respect, senior managers have looked to cooperation and collaboration with other asset owners and asset managers as a means of breaking with convention.4 Modes of Innovation Cooperation and collaboration offer participants a level of informality missing in conventional modes of contracting, whether with in-house employees or with external service providers. The parties to cooperation and collaboration either do not need or do not require contracts to participate. It is deemed sufficient to operate in the shadow of contract, relying upon social norms and conventions to govern participation. While plausible, in a theoretical sense, we have only encountered a limited 4/. In this section we treat collaboration and cooperation as separate strategies, implying a discrete choice of action in relation to institutional form. In fact, these strategies are related, suggesting a continuum rather than absolute difference. This point is illustrated in the following section.


number of such instances—this type of informality is rarer than often imagined. Rather, contracts or memorandums of agreement are often invoked to protect the interests of participating institutions, focusing upon key issues instead of the panoply of issues typically addressed in investment management agreements (Clark and Monk 2013c). Cooperation Perhaps the simplest way in which senior managers of a financial institution can extend their knowledge and understanding of strategic options is through cooperation with other institutions. As we understand it, cooperation involves shared projects, agreed expected outcomes, and well-defined mechanisms governing entry and exit from such arrangements. More often than not, cooperation brings together institutions with shared interests such that joining a project provides an immediate gain in knowledge and understanding, if not an immediate gain in terms of the capacity of the organisations to realise target risk-adjusted rates of return. In this respect, cooperation is likely driven by a specific issue recognised as important by senior managers that see other financial institutions as peers rather than as rivals. For cooperation to be effective there must be symmetry such that one party does not expropriate the benefits of cooperation which are shared equitably if not equally by the parties to an agreement (see Olsen and Zeckhauser 1966, 269).5 Given the contingent nature of cooperation, the mechanisms governing cooperation, and the tangential nature of shared projects relative to the ongoing operations of institutions, it can be difficult for senior managers to devote new resources to cooperative arrangements. This may be especially the case when senior managers seek to circumvent standard ways of contracting with internal and/or external portfolio managers. It is apparent that cooperation is most effective when the parties to such agreements bring something different to the project. Learning is enhanced by difference (within limits). At the same time, institutions’ resources and capabilities must, in some sense, be complementary such that lessons learned through shared projects are useful for those who have joined the agreement (Cohen and Levinthal 1990). Complementarity also enables institutions to bring together resources and capabilities that, when combined, provide options and insight not otherwise available in whole or in part to the participating institutions. More formally, cooperation provides senior managers a variety of related benefits. First, it is a means of mobilising and sharing knowledge of options relevant to the formation of strategic planning. Second, it is a means of empowering senior managers relative to their own employees, thereby avoiding the compromises involved when relying upon existing providers to provide services and information on alternatives. Third, it is a means of identifying and evaluating the ‘fit’ of a party or parties to a cooperative venture in relation to other possible ventures which require much deeper commitment in the context of market risk and uncertainty. In these ways, cooperation is a means of discounting institutional myopia, while providing senior managers the expertise needed to drive innovation in their own institution (compare Barnett 2008, 65-66). Collaboration Collaboration involves commitment to a project or projects both in terms of the specification of shared objectives and the means of realising those objectives. Commitment involves allocating

5/. Cooperation is sometimes interpreted as an agreement of ‘equals’ with comparable payoffs. It is apparent, though, that cooperation can be effective amongst institutions that vary by size and inherited capabilities. In theory, it is assumed that institutions enter into cooperative agreements to realise some benefit even if marginal to the status quo (that is, such agreements are assumed Pareto optimal; see Olson 1965). However, any cost-benefit analysis of cooperation needs to be mindful of the differing time horizons of participating parties, the variable nature of expected benefits, and the trade in costs and benefits within and between cooperative arrangements by parties, who may seek longer-term relationships which promote common benefit rather than immediate payoffs that are claimed by each party (see Fehr and Schmidt 1999).


institutional resources and capabilities, monitoring and oversight of the project with respect to its objectives, and the support of senior managers who sponsor such commitments. Collaboration is likely to require a stronger legal framework than is the case with cooperation, specifying the respective shares of the benefits of collaboration, limits on actual and potential liabilities, and the boundaries of the collaborative agreement with respect to the operations of project partners. Furthermore, collaboration is likely to require a stronger governance framework than is the case with cooperation, specifying the mechanisms of objective-setting, decision-making, and conflict resolution. Where collaboration involves setting up a separate entity, the powers of that entity and its officers with respect to the collaborating institutions need to be well defined (as in contract). Like cooperation, the parties to a collaborative agreement are likely to pool their existing resources and capabilities. However, this may involve more than a marginal call on existing resources and capabilities, prompting investment in new resources and capabilities consistent with the needs of the shared project. Like cooperation, complementarity between institutions’ committed resources and capabilities may be required so as to facilitate effective collaboration. However, as collaboration evolves in relation to the shared objectives of the parties, the ‘fit’ between institutions’ resources and capabilities and the needs of the project may become a source of tension between parties. So, for example, where additional resources are needed to achieve the objectives of a collaborative project, the character and scope of those resources may be such that should the project be wound-up, those resources may not be useful if returned to the participating institutions (see Williamson 1975 on the costs of asset specificity). Like cooperation, senior managers have a stake in the success of collaboration. As such, they face the ever-present danger of escalating commitment: realising the planned outcomes of collaboration may require repeated calls on the resources of participating institutions leading to questions about senior managers’ authority within their own institutions. Most importantly, the success of collaboration depends upon the choice of partner or partners. Not surprisingly, the screening and evaluation of potential partners is a vital ingredient in ensuring success. As noted above, this can be achieved in a variety of ways, including trial-runs through cooperative ventures as well as the purchase of independent advice on the virtue or otherwise of potential partners. But, given the constraints on innovation associated with existing in-house and outsourcing arrangements, there are obvious incentives to take calculated risks on joining partnerships with other institutions less familiar and or not subject to the same types of constraints that bind senior managers in their own organisations. Not surprisingly, given the risks associated with departing from convention, collaborative deals are likely to start with rather modest commitments and goals and objectives. In stages, commitment may increase as milestones are realised. Equally, senior managers have an interest in maintaining their authority in these arrangements such that exit remains a viable option. There are a variety of risks associated with collaboration (see Archetti et al. 2011). Where knowledge and understanding of the motives of other institutions’ managers are imperfect, collaboration can provide a venue for some institutions and their senior managers to exploit the resources and capabilities of willing partners. Collaboration can prompt shifting alliances and dependencies amongst partners, especially where partners cannot honour, or are not willing to honour, initial commitments of their own resources and capabilities to shared projects. Just as importantly, some parties to a collaborative agreement may misrepresent the significance of the project to their own constituents and to the parties to the agreement. This can lead to ‘free-riding’ if the establishment of a collaborative partnership is based on trust. Given these possibilities, and given the premium on collaboration for promoting strategic innovation, senior managers may well consider whether, in establishing collaborative agreements, they might begin as one of the


dominant partners and thereby hold other parties to account in terms of meeting their commitments and obligations. Agency and governance Considering cooperation and collaboration, it is assumed that senior managers have sufficient authority to initiate and oversee projects in these two related domains. The scope of authority of senior managers is a policy issue of considerable importance, especially in the light of recurrent and competing claims for special treatment by skilled and talented portfolio managers. As markets evolve, and as investors become more or less sensitive to market volatility, realising an institution’s target rate of return may become increasingly difficult. Senior managers may persist with existing in-house and out-of-house providers, change the mix, even fire out-of-house providers and bring in-house those activities (Clark and Monk 2013a). In these situations, senior managers may have strong incentives to initiate cooperative and collaborative projects. Exercising in-house/out-of-house options involve significant transaction costs; cooperation and collaboration can be seen to sustain discretion in situations where it may be difficult to assess the advantages and disadvantages of other options. It was suggested that cooperation and collaboration can flourish in an action space which is less formal and certainly less bound by in-house employment relationships and the legal apparatus that regulates outsourcing agreements. This is only possible, however, if the institution provides senior managers sufficient authority to carry through on these ventures in ways that allow for experimentation, learning-by-doing, and alliance formation and deformation. Nonetheless, it is likely that successful cooperative and collaborative ventures will be absorbed into the organisation, whether on an in-house or outsourced basis. This is especially the case if and when these types of ventures claim a significant share of an institution’s assets and liabilities and their risk exposures begin to affect the risk exposure of the entire institution. But there is a price to be paid when incorporating these ventures into an organisation: the favoured status of such ventures may challenge the privileges of existing portfolio managers and add such a level of complexity to the organisation that discounts its benefits. In any event, institutions may prefer to spin-off these ventures, recognising that success during one phase of the market is no guarantee of future success as markets evolve and market agents adapt to changing circumstances (Lo 2012). Indeed, senior managers may wish to initiate new kinds of cooperation and collaboration in response to changing market conditions – jettisoning previous ventures that proved to be not as resilient as expected in the face of unanticipated circumstances. Larger institutions may contemplate implementing a sourcing strategy that combines in-sourcing and outsourcing with a series of ventures that seek to solve apparent problems found in the existing arrangement of the investment programme, without committing to those ventures over the long term (either internal to the organisation or as privileged external suppliers). This type of strategy presupposes a robust governance framework that simultaneously empowers senior managers while protecting against unjustified escalation in commitment and the costs that come with added functional complexity. Transforming Home Bias Here, we move from the formal logic of cooperation and collaboration to the various ways these strategies might be realised in practice. We begin with the simplest ways in which to facilitate senior managers’ knowledge and understanding of the options available and move on to more complex strategies which require the mobilisation and application of institutional resources and capabilities. These instances are meant to represent the various possibilities on offer rather than being an exhaustive list of what is currently available to industry.


Conferences and research clubs One of the simplest ways of scoping the available options is through attendance at international conferences and invited briefings. If commonplace, and an industry in its own right, it is apparent that conferences with specific agendas—tailored to the needs and interests of senior managers in different types of financial institutions—can make a difference to the choices made about how to proceed. Who is and who is not on the agenda, the topics presented, what can be gleaned from side conversations, and who has something fresh to say (beyond customary practice) are grist for the mill.6 This type of event provides senior managers information with which to challenge their internal and external advisers, placing proffered advice in the context of the ‘home’ market for ideas and strategies. Importantly, these types of events also allow senior managers to discriminate between that which is widely accepted and conventional from that which is unconventional and innovative. Recognising both the costs and benefits from attending these events, research clubs have been formed so as to explore together the interests of closely related institutions at a price that does not automatically engage the procurement procedures of participating institutions. These clubs tend to be relatively small (up to a dozen members), thereby allowing for the realisation of benefits otherwise lost when clubs become too large (Buchanan 1965, 8). Crucially, these clubs are comprised of members who can learn from one another, often providing first-joiners the opportunity to invite other institutions with resources and capabilities that are consistent with, but different from, the initial participants. As Grabher et al. (2008, 262) observed when discussing communities of learning, these types of organisations include those that are “deeply involved and widely focused at the same time,” switching the focus from the relationship between senior managers and internal and external suppliers to what can be learnt between senior managers about those relationships in different jurisdictions. These organisations tend to have a limited life, and depend upon the extent to which fresh ideas are offered to participants consistent with their interests. Seeding related ventures Having identified issues to be resolved, one way forward for senior managers is to provide start-ups the capital needed to carry forward investment programmes in ways consistent with their interests. Seeding start-up ventures is an investment in the skills and talent of those who claim a different perspective on problems that affect much larger investment institutions (contra Barnett’s 2008 discounting of the benefits of alliances). Typically, these ventures begin within an established institution whether an asset owner or an asset manager, and then seek independence from the ‘host’ institution and its priorities and decision-making mechanisms. Seeding provides the new entity with assets, services, and sponsorship which, over the longer term, can attract other institutions. For the sponsoring institution, the new entity can be a site for testing-out ideas and solutions without disturbing the existing arrangement of roles and responsibilities. In some instances, geography is the key to success: for example, seeding a new hedge fund in London, a database manager in Silicon Valley, and an emerging markets manager in Hong Kong. This mode of innovation supposes that the apparent imbalance of power between the sponsor and the new entity is mediated by the needs of the sponsor and the skills and talent embedded in the new entity. Nonetheless, there are obvious dangers in such relationships; the sponsor could simply walk away with the ideas of the new entity while the principals of the new entity could exploit the commitment of senior managers. If successful, new entities are likely to cast aside the shackles of the sponsor sooner, rather than later. An alternative approach is to set-up a jointly-owned entity

6/. So, for example, some events mix together asset owners and managers whereas other events discriminate against asset managers in the hope of building coalitions or alliances amongst clients. See Bathelt and Glückler (2011, Ch.9) for an extensive treatment of the benefits and orchestration of what they term ‘temporary clusters’. At the limit, these are networks rather than places in the manner suggested by Benkler (2006).


whose tasks and functions and investment responsibilities fall outside the scope of existing in-house and out-of-house portfolio managers. This type of entity could be domiciled in another jurisdiction and be the site for experimenting with new forms of compensation, a style or mode of investing which runs counter to portfolio managers in the home jurisdiction of the sponsor, and a system of decision-making which is less hierarchical and reliant upon a de-centred team-based approach. Inevitably, there types of ventures run the risks (costs) of being ‘out-of-sight’ and ‘out-of-mind’. Partnerships, informal and formal In many jurisdictions, financial institutions with similar mandates and sponsors coexist with one another and operate with many of the same functions even if, in the final instance, they are competitors with one another in realising target rates of return. As noted above, scale economies are such, that larger institutions can be more cost efficient than smaller institutions in terms of providing the services associated with investment management. Equally, larger institutions can claim significant discounts from external service providers. In these circumstances, senior managers of small institutions may seek cost-sharing and service-sharing agreements with larger institutions, piggybacking on the functional scope of these institutions so as to maintain their cost-effectiveness. These types of agreements are ‘informal’ in the sense that the larger institution is willing to do so because sharing services does not conflict with existing priorities. These types of arrangements can be the basis for establishing formal partnerships between local institutions that have an interest in compensating for their peripheral location relative to the global market for financial services (Dixon and Monk 2014). In these circumstances, large and small institutions often face the prospect of making deals with external providers that, because of the size of the local market, effectively control the terms and conditions for financial services. As well, the nature and scope of proffered services may be rather limited when compared to other financial centres which are at the core of the global financial industry. Enhancing the size and scope of the client side of the local market may be necessary if beneficial institutions are to bypass local providers in favour of the bulge-bracket global providers and the myriad of smaller institutions that offer boutique services from London and New York (for example). Whether these types of partnerships are possible depends, in part, on the home jurisdiction’s competition policies and practices, the balance of power between the buy-side and the sell-side of the market, and the rivalries between senior managers representing local institutions. For larger institutions, concerned about the organisational complexity that comes with providing the full range of services needed for effective investment management, being a partner in a ‘captive’ supplier can be a way of externalising the supply of services while remaining in control of the costs and quality of those services. For smaller institutions, unable to produce their own services and subject to the market for financial services, these partnerships provide for an equitable relationship with other institutions oftentimes missing in fee-for-service agreements. Notice, however, the inherent tensions between partners that are larger and those that are smaller; the former are always likely to consider the opportunity costs of remaining in such partnerships whereas the latter may have no real alternative. How these entities are governed, the allocation of voting rights, and the degree to which proffered services are innovative are key elements in any long-term partnership.7 Investment clubs and shared equity

7/. In a related vein, Hachigian (2013) argues that public-private partnerships (PPPs) joining together financial institutions, governments, and construction companies in the provision of urban infrastructure and other similar large-scale projects have often failed to realise the promised benefits for all parties because of fundamental mis-alignments of interest and very poor governance procedures and processes. Whether to join a partnership can be seen as a different problem to that of realising the benefits of a partnership over time (where the parties to partnerships may have very different time horizons and constituencies to serve).


Going beyond partnerships, investment clubs have been formed by asset owners so as to accomplish three separate but related objectives. The first instance, these clubs have sought to join together members whose interests are aligned, and whose goals and objectives are consistent over a sequence of deals extending into the future. The second instance, these types of clubs often depend upon relationships with investment managers whose own incentives are demonstrably consistent with members of investment clubs. In the third instance, the size and scope of the deals involved are such that they can justify the commitment of the time and effort of senior managers of investment institutions in realising shared goals. Here, the make-or-buy option is subsumed by a third option which is a form of collaboration underwritten by transparency and accountability within institutions, between institutions, and between institutions and their partners. These types of entities can be found, for example, in the private provision of urban infrastructure. This mode of promoting organisational innovation in the investment process is closely related to the private equity industry where general partners (GPs) organise a stream of investment opportunities orchestrated through a fund or funds which they control and in which asset owners or limited partners (LPs) invest. In some cases, these types of funds bring together LPs who have previous knowledge and experience with one another and with the sponsoring GP. Even so, the relationship between the GP sponsor and participating LPs can be highly differentiated according to the volume of assets committed, shared expertise and knowledge, and past relationships with one another. Indeed, notwithstanding common contracts and letters of commitment, side-deals are often struck between the sponsoring GP and privileged LPs excluding not-so-privileged LPs. It is arguable that these types of deals are less about cooperation and collaboration and more about fees and the disbursement of benefits. Nonetheless, to the extent that senior managers control entry and exit from these deals, these arrangements can provide opportunities for remaking or realigning the make-or-buy option spread. Conclusions The premise underpinning this paper is that there has been a surprising lack of institutional innovation amongst asset owners, including endowments and foundations, pension funds, insurance companies, and sovereign wealth funds. The current organisation and management of these institutions typically reflects their establishment, in many cases looking back over 50 to 70 years. This is remarkable given the transformation of the investment management industry over the past twenty-five years, and the rate of product innovation found in global financial markets. The stasis of the sector has been such that these types of financial institutions have, on the margin, taken higher levels of risk in the hope of realising returns that could compensate for low rates of institutional adaptation and development (see Clark and Monk 2013b with Lo 2012). At the limit, the crisis facing the US state and local public pension fund sector is illustrative of the costs and consequences of institutional stasis (Clark and Monk 2013c). The focus of the paper was on the senior managers of a representative financial institution. Drawing upon research which has identified these agents as the key to realising the objectives of strategic asset allocation through portfolio managers, it was suggested that the option to make-or-buy (in-house management or outsourcing) has not provided an adequate action space for innovation. Reliance upon the employment relation has often resulted in manager entrenchment, while reliance upon external providers has often been accompanied by an inability of clients to systematically discriminate between luck and skill and the informal alliances between asset managers, consultants, and advisors. In any event, senior managers’ authority and control over portfolio managers has been compromised by industry-wide norms and conventions that favour continuity over innovation. We have emphasised the benefits for senior managers of cooperation and collaboration which, in effect, bypass the make-or-buy option and provide an action space for experimentation and learning which can then be applied to their own operations or to their relationships with external providers.


Assessment of the nature and scope of cooperation and collaboration was based on field work, sponsored research, and case studies (see Clark and Urwin 2010). It was noted that cooperation facilitates the learning of institutional innovation, even if inherent limits on longer-term commitment can discount the implementation of these lessons internally and externally to the organisation. It was also noted that collaboration requires commitment, as well as the application of scarce institutional resources and capabilities. As has been widely observed, it is commonplace for institutions in the sector to economise on governance and management, assuming that professional standards are sufficient to carry these organisations in a rather benign financial environment. Recurrent crises in the core markets of the global financial system have challenged that assumption; indeed, recent research suggests that crises are endemic to developed economies’ financial markets (see Haldane and May 2011). Ultimately, the value of collaboration is to be found in institutional investment in related capabilities (see Helfat et al. 2007). Much of the research on innovation in the social sciences is on product innovation. Here, we are less concerned with what prompts the transformation of products, the ways in which the flow of product innovation is channelled and communicated, and the status of communities or networks of innovation (von Hippel 2005). Rather, we were concerned with the emergence of new forms of cooperation and collaboration in the context of institutional continuity (Padgett and Powell 2012, 1-2). Perhaps surprisingly, it was suggested that current practices (make-or-buy) are a constraint on the nature and scope of organisational innovation. Whether reliant upon employment contracts (in-sourcing) or service contracts (out-sourcing), senior managers face significant constraints on institutional innovation associated with the entrenchment of past practices (discounting the option value of make-or-buy; compare Coase 1937). On the other hand, we also showed that senior managers can create for themselves and for their institution action spaces that facilitate innovation which, if not particularly revolutionary, may well be transformative over the longer term. In any event, financial institutions are, more often than not, reactive to events. Even if senior managers are able to anticipate changing market conditions and the realignment of internal and external relationships, there is sufficient noise in financial markets such that doubts can always be raised about the urgency of ‘agendas for change’. On the other hand, the impact of big events such as the GFC and the on-going euro crisis can fundamentally alter perceptions about the desirability of the status quo. In these circumstances, senior managers may be empowered to rewrite the terms of employment contracts and service agreements with external providers. Indeed, entirely new initiatives may claim centre-stage. Here, innovation in organisational form and functions are perceived to be solutions to the apparent disconnect between that which is inherited and the new realities of global markets. If entirely obvious, it is also consistent with organisation psychology (March 1981; March et al. 1991). Bibliography Ambachtsheer, J., Fuller, R., and Hindocha, D. 2013. Behaving like an owner: plugging investment chain leakages. Rotman International Journal of Pension Management 6(2):18-27. Amin, A. and Cohendet, P. 2004. Architectures of Knowledge: Firms, Capabilities, and Communities. Oxford: Oxford University Press. Amin, A. and Thrift, N.J. 1992. Neo-marshallian nodes in global networks. International Review of Urban and Regional Research 16:571-87.


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Dicken, P. 2011. Global Shift: Mapping the Changing Contours of the World Economy. Sixth Edition. London: Sage. Dicken, P. and Malmberg, A. 2001. Firms in territories: Relational perspective. Economic Geography 77(4): 345-63. Dixon, A.D. and Monk, A.H.B. 2014. Frontier finance. Annals, Association of American Geographers (forthcoming). Available at SSRN: http://ssrn.com/abstract=2203656 Durand, C. and Wrigley, N. 2009. Institutional and economic determinants of transnational retailer expansion and performance: A comparative analysis of Wal-Mart and Carrefour. Environment and Planning A 41:1534-55. Fehr, E. and Schmidt, K.M. 1999. A theory of fairness, competition, and cooperation. Quarterly Journal of Economics 114:817-68. Friedman, B.M. (ed.) 2011. Reforming US Financial Markets. Cambridge MA: MIT Press. Gennaioli, N., Shleifer, A., and Vishny, R.W. 2013. A model of shadow banking. Journal of Finance 68:1331-63. Gertler, M.S. 2001. Best practice? Geography, learning and the institutional limits to strong convergence. Journal of Economic Geography 1:5-36. Grabher, G., Ibert, O., and Flohr, S. 2008. The neglected king: the customer in the new knowledge ecology of innovation. Economic Geography 84:253-80. Grossman, G.M. and Helpman, E. 2005. Outsourcing in a global economy. Review of Economic Studies 72(1): 135-59. Guyatt, D. 2013. Effective investor collaboration: enlarging the shadow of the future. Rotman International Journal of Pension Management 6(2):56-64. Hachigian, H. 2013. Markets hierarchies and exchange platforms: the geography of impact investing. Mimeo. Oxford. Haldane, A. and May, R. 2011. Systemic risk in banking systems. Nature 469:351-55. Hart, O. and Holmström, B. 2010. A theory firm scope. Quarterly Journal of Economics 125: 483-513. Hart, O. and Moore, J. 2008. Contracts as reference points. Quarterly Journal of Economics 123:1-48. Helfat, C.E., Finkelstein, S., Mitchell, W., Peteraf, M.A., Singh, H., Teece, D.J., and Winter, S. 2007. Dynamic Capabilities: Understanding Strategic Change in Organizations. Oxford: Blackwell. von Hippel, E. 2005. Democratizing Innovation. Cambridge MA: MIT Press. Holmström, B. and Tirole, J. 2013. Inside and Outside Liquidity. Cambridge MA: MIT Press. Jensen, M.C. 2000. A Theory of the Firm: Governance, Residual Claims, and Organizational Forms. Cambridge, MA: Harvard University Press.

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Source: London Stock Exchange; FTSE100=1000

Percentage of sector holdings by value

2015

Climate Exposure Impact on Equity Valuation: Case Study of Vail Resorts, Inc.

Donna Bebb, Research Fellow Steyer-Taylor Center for Energy Policy and Finance

STSTANFORDS

559 Nathan Abbot Way Stanford, CA 94305 www.steyertaylor.stanford.edu

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Executive Summary Climate exposure for investors refers to potential gains or losses in a portfolio due to climate change.1 To effectively manage this exposure, investors first need to accurately quantify and measure the potential impact. Unfortunately, the unpredictable nature of the risk and complexity of obtaining data have made the task difficult in practice. Most of the environmental data available for investors is historical or challenging to quantify financially so investors are not able to meaningfully incorporate it into forward-looking, fluid investment decisions. In addition, the challenge of effectively measuring climate exposure in a portfolio requires a unique approach for each sector and company.

Our model introduces a methodology to analyze the financial impact of climate exposure on a public company’s equity valuation. This climate exposure analysis differs from ESG (environmental, social and governance) and low-carbon portfolio tools because it measures near-term (three-five year) impact on equity valuation from climate change and related innovation, mitigation or adaptation. ESG tools typically generate qualitative ratings for each company rather than a quantitative value to apply to equity valuations, and low-carbon analysis tends to focus on longer-term potential financial impact (like stranded assets).

Utilizing Vail Resorts, Inc. (MTN) as an example, the model incorporates the financial impact from changes in snowfall, associated increased snowmaking costs, and energy efficiency improvements. Vail Resorts provides a glimpse into a company dealing with the direct, present-day impact of changes in climate without being too geographically or financially complex. The research integrates climate change into MTN’s investment valuation and demonstrates that climate exposure risk and opportunity can be quantified.

Purpose of Measuring Climate Exposure for Investors Climate risk presents a unique challenge to measure and isolate as an alpha-generating variable. As a result, many investors have considered climate risk in the past for reasons primarily disconnected from the goal of outperformance. Such reasons include a moral argument for divestment, response to stakeholder pressure, and the desire to differentiate an organization or product. Many large institutional investors are starting to establish investment principles that promote active engagement on ESG issues, but have not yet determined how to effectively integrate it into an investment decision to generate alpha. CalPERS created a set of ten investment beliefs that includes the idea that long-term value creation requires engagement of external managers and companies on ESG issues. Yale’s $20.8 billion endowment encourages active engagement by asking its external managers to discuss financial risks of climate change

1 CPI, February 2015

3

with company management teams. Our model illustrates that investors can track climate risk and that it represents a material financial element in the investment decision. The analysis illuminates a more comprehensive way of measuring climate exposure that can be integrated into equity and fixed income financial models in addition to the existing qualitative management tools.

Proposed Model

The model detailed in this paper illustrates the impact of climate exposure on financial statements and equity valuation utilizing MTN. For MTN, climate exposure from changes in snowfall, water scarcity, rising energy costs and energy efficiency improvements are near-term risks and opportunities that must be factored into an investment decision. The model compares financial estimates from a traditional equity valuation analysis (that does not specifically consider climate exposure) with financial estimates generated using a climate exposure analysis. The analysis uses both equity multiples and discounted cash flow valuation techniques.

Background on Vail Resorts and Ski Industry

MTN, the largest publicly-owned ski resort operator in North America, owns 9 properties in Colorado, California and Utah, and two small “urban” resorts outside Detroit and Minneapolis. (Attachment 1). Management most recently acquired the two Utah resorts, Canyons and Park City, in May and September 2014 respectively. MTN also owns and operates luxury hotels, condominiums and a transportation service and develops real estate near its resorts.

MTN and other ski resort operators contend with the impacts of changing weather patterns every year, as rising temperatures and declining snowfall have driven them to find ways to adapt and change to remain profitable. MTN’s California resorts, for example, have suffered through a three-year unprecedented period of drought (2012-14) and have experienced annual snowfall totals less than 60% of average. The 2013-14 ski season saw California snow total only 29% of average.2 Research has shown this is not a temporary weather phenomenon and can be expected to continue. A team of Stanford researchers found that the probability of atmospheric conditions similar to those that caused this most recent California drought has increased by at least three times due to human emissions of greenhouse gases.3

MTN has been aggressively expanding its summer resort activities to help balance the seasonality, yet winter quarters still generate 100% of its profit. As a financial tool to mitigate

2 Weather-Warehouse.com. “Past Weather Data for Tahoe City, CA: January 1903-2015.” 3 Swain, Daniel L,, Diffenbaugh, Noah, Rajaratnam, Bala. “Atmospheric Conditions Associated with the 2013-14 California Drought Are ‘Very Likely’ Linked to Human-caused Climate Change.” Stanford Woods Institute for the Environment, Fall 2014.

4

the volatility of winter revenue from weather changes, MTN markets its $729 Epic Pass. The pass provides unlimited seasonal access to all of MTN’s resorts plus several international partner mountains, and locks up a significant amount of revenue in the preseason. Epic Pass sales account for over 40% of lift ticket revenue.

MTN has invested heavily in snowmaking equipment to offset its exposure to warmer weather, lower snowfall and shorter ski seasons. However, energy costs are typically the second highest cost for a ski resort (behind labor costs), and are primarily driven by snowmaking. Estimates show energy usage comprises between 15-25% of a resort’s total operating costs, and snowmaking and other on-mountain use makes up over 50% of that amount.4 Ski resort operators are incented to find more efficient and lower cost snowmaking methods to replace older, energy intensive equipment.

Water resources are another critical environmental issue for ski resort operators, since snowmaking operations consume enormous amounts of water. A typical ski run of 200 feet wide with a drop of 1,500 feet would need three acre-feet of water (over 400,000 gallons) to make one foot of snow.5 Despite the exorbitant amount of water needed, most of a ski resort’s water usage is labeled non-consumptive because roughly 80% of the water is returned to the water source during spring run-off.6 The critical issue is access to adequate supplies of water – most ski resorts’ highest demand for water occurs when supplies are lowest, at the end of summer and early fall. MTN has resolved most of its water supply issues by purchasing water rights (which guarantee access and removes much of the uncertainty) and building storage reservoirs to store water during peak run-off. The company does not own water rights in California and could suffer interruptions to its snowmaking at some point in the future. Interruption of water availability was not factored into the model since it does not appear to be a near-term risk, even with the record three-year drought.

Methodology and Findings

The study began by performing a traditional equity analysis of the company similar to those generated by Wall Street analysts (Attachment 2). The analysis utilized public data available in financial statements, company presentations, Bloomberg and earnings reports. MTN publishes a significant amount of detailed financial data, including the number of skier visits to its resorts, revenue by segment (lift ticket revenue, ski school, dining, retail) and estimates of future performance. MTN’s frequent acquisitions over the past five years make it difficult to assess organic growth or decline in performance; the model adjusted certain metrics to remove the

4 Ward, Bob. The Aspen Times. “Vail: Bigger Resort, Smaller Footprint.” December 17, 2013 5 University of Washington, College of the Environment: Impacts of Climate Change on the Economic Viability of Selected PNW Ski Areas 6 Flynn, Casey. “Cost of Snowmaking.” Xgames.espn.go.com/skiing, Website.

5

impact of these acquisitions. The traditional discounted cash flow analysis generated an equity valuation of $97.05 per share, based primarily on company guidance for skier visits, season lift ticket sales and growth from recent acquisitions of Park City and Canyons resorts. This represents a premium of 13.2% over the current stock price of $85.70 and an indication that the equity is presently undervalued by the market.

Next, a second equity analysis was performed that incorporated MTN’s climate exposure into an alternative equity valuation. Much of the data for determining the company’s climate exposure came from sources other than the company’s financial statements or press releases due to lack of adequate disclosure (MTN does not self-report climate risk data such as carbon emissions or energy usage). The externally-farmed data proved tedious to find and calculate, and included historical snowfall and temperatures in Tahoe City, California and Vail, Colorado, ski season average length, snowmaking cost and water usage.

Public annual snowfall data for individual mountain resorts could only be found dating back to 2008, so the analysis instead used snowfall data for the nearby cities of Vail and Tahoe City from the National Weather Service. Over the last 20 years, annual snowfall in Vail and Tahoe City has trended downward (see Attachment 3), illustrating the long-term effect of changes in climate. Although annual snowfall is difficult to predict, the downward trend needs to be factored into a climate exposure valuation of any Colorado or California ski resort. Based on regression analysis, annual snowfall totals in both Vail and Tahoe City were highly correlated to the number of skier visits to MTN properties in Colorado and California (Attachment 4). MTN’s revenue is primarily driven by the number of skier visits, making the correlation with snowfall a significant climate exposure element to consider. The model also found a moderate correlation between operating costs and changes in snowfall – in seasons with lower snowfall totals, operating costs go up to account for higher snowmaking and other costs.

Adaptation measures like innovation and energy efficiency were also integrated into the climate exposure equity valuation, but were more difficult to calculate based on minimal public information available. MTN does not provide energy or water usage in its public disclosures, nor does it break out energy costs as a percentage of overall operating costs. The company publicized a 10% reduction in energy use between 2008-2012, and has announced a goal of an additional 10% reduction by 2020.7 As MTN replaces older snowmaking equipment with high efficiency machines, energy usage declines significantly. In 2013, the company replaced 15 older air compressors at Vail and Beaver Creek with a new high-powered compressor at each ski resort. The new equipment, used to power snowmaking machines, uses half the power and delivers 30% more compressed air than the replaced equipment.8 To estimate future cost savings from this more efficient snowmaking equipment and other energy improvements, the model extrapolated data based on total skiable acres, MTN’s energy use reduction goals, and company 7 Vail Resorts, Inc. Press Release. “Vail Resorts Announces the Company Achieved Its 10 Percent Energy Layoff Goal and Sets ‘The Next 10 Percent’ Energy Reduction Goal for 2020.” March 1, 2012 8 Ward, Bob. “Vail: Bigger Company, Smaller Footprint.” The Aspen Times, December 17, 2013.

6

energy cost and usage disclosures found in the press. The company will save over $2 million in 2015 and over $8 million in 2019 by meeting its energy reduction goal (or more if gas prices rise significantly), a positive climate exposure factor.

MTN does not provide any quantitative disclosure on water usage – only qualitative information on owned water rights and other agreements in its 10K - making it impossible to accurately assess the quantity of water utilized in its operations.

The climate exposure discounted cash flow analysis generated an equity valuation of $83.85, 13.6% lower than traditional analysis valuation and 2.2% lower than the current equity price. One notable explanation for the difference in prices: the climate model valuation assumes a 30% decline in California snowfall year over year in 2015 and a 6% decline in Colorado snowfall (based on season totals through January 2015).9 The climate model also assumes California snowfall remains below the long-term average for the foreseeable future.

The climate exposure equity model illustrates that climate change for MTN and the ski industry needs to be addressed in current valuations, and the financial impact can be measured. Despite efforts by MTN to offset the impact of lower snowfall on its valuation (by selling Epic Passes, increasing summer resort offerings, investing more in higher efficiency snowmaking equipment, and other methods), climate change negatively affects its financial performance. Equity valuations for MTN that ignore climate change implications risk overestimating the company’s value.

Conclusions:

• Climate exposure is both a near-term and longer-term valuation issue for MTN and the ski industry, with measurable financial impact.

• The methodology utilized in this model can be applied to other companies and industries. For example, a climate exposure analysis for a fast food company would consider some of the same elements as this analysis (energy usage, percentage of costs attributed to energy, energy efficiency improvements, and water usage) and then substitute beef for snow. Fast food restaurants have been contending with record high beef prices as a result of drought and dry conditions in Texas and Oklahoma. Many industries outside of the energy sector and utilities have material climate exposure as a result of changing resource availability, extreme weather, labor productivity, and real asset risk (sea and flood level impacts).

9 www.onthesnow.com. “Vail Historical Snowfall.” November 2014-February 2015.

http://www.onthesnow.com/

7

• Investors need more accurate data to be able to assess the positive and negative impacts of climate change on investments. SASB (Sustainability Accounting Standards Board) has made significant progress with standardizing data requirements by industry but corporate disclosure remains voluntary and largely inadequate.

• Public equity and bond investors need to continue demanding better disclosure on adaptation, mitigation and other climate financial impacts from public companies.

Many industries have material climate exposure as a result of changing resource availability, extreme weather, labor productivity and real asset risk (sea and flood level impacts).

Acknowledgements

The following individuals provided valuable input for this analysis and I would like to thank them for sharing their expertise and time. The views expressed in this paper are solely those of the author and do not necessarily reflect the views of these individuals.

Alicia Seiger, Steyer-Taylor Center for Energy Policy and Finance

Mark Hayes, Consultant

Doug Cogan, MSCI

Divya Mankikar, Trucost

Greg Elders, Bloomberg

Dylan Windham, Consultant

Felicity Hendrix, Barclays

8

Christina Zimmer, Barclays

Jason Rosiak, Pacific Asset Management

Attachment 1

9

Attachment 2

Ticker: mtnmtn Equity

Website www.vailresorts.com 390 Interlocken Crescent Broomfield, CO 80021 United States

Number of Employees 4,300 Phone : 1-303-404-1800

Ticker: MTN US Fax : 1-303-404-6415 88.42 0.8

Business Description

USD

Stock Quote & Chart (Currency: USD )

Last (delayed quote) 85.70 Market Cap (MM) 3,108.7

Open 85.69 Shares Out. (MM) 36.3

Previous Close 85.90 Float % 99.0%

Change 0.18 Shares sold short (MM) 880,677.0

Change % 0.21 Dividend Yield % 1.9

Day High/Day Low 86.3 / 85.3 Diluted EPS Excl. XO 0.9

52 Wk High/52 Wk low 94.2 / 64.5 P / Diluted EPS Before XO 92.0

Volume (MM) 0.05 Beta 0.95

Avg. Vol - 3 mo (MM) 0.22

Financial Information (Currency: USD, in mm) USD

Revenue - LTM 1,259.5 Cash & ST Invst. 44

EBIT - LTM 130.5 Total Assets 2,173.8

EBITDA - LTM 272.9 Total Debt 626.6

Net Income - LTM 37.6 Total Liabilities 1,339.0

Total Enterprise Value 4,041 Total Equity 834.8

TEV/ Total Revenue 3.1 x Cash from Operations - LTM 241.1

TEV/ EBITDA 14.4 x Cash From Investing - LTM -280.9

Cash from Financing -LTM -44.6

Source: Bloomberg data above this line

Recommendation

Traditional Model Overweight

Price target: $97.05 (DCF) $105.50 (multiple)

Based on current stock price of $85.70, the company appears undervalued. Despite the

continued record-low snowfall in California, MTN's Colorado and Utah resorts appear

to be capitalizing on increased destination travelers and higher per-skier revenue.

Climate Model: Underweight.

Price targets: $83.85 (DCF) $87.20 (multiple)

Based on current stock price of $85.70, Vail Resorts is overvalued when the impact of

cl imate exposure is factored into the equity valuation. Year-to-date snowfall is lower year-

over-year in both Colorado and California, which has not yet been fully factored into

traditional equity valuations of the company.

Financial History

For the Fiscal Period Ending 7/31/2009 7/31/2010 7/31/2011 7/31/2012 7/31/2013 7/31/2014 7/31/2015E 7/31/2016E 7/31/2017E 7/31/2015E 7/31/2016E 7/31/2017ECurrency USD USD USD USD USD USD USD USD USD USD USD USD

Total Revenue 977.0 894.8 1,167.0 1,024.4 1,120.8 1,254.6 1,634.6 1,826.9 1,918.3 1,558.7 1,594.9 1,659.4 Growth Over Prior Year (15.2%) (8.4%) 30.4% (12.2%) 9.4% 11.9% 30.3% 11.8% 5.0% 24.2% 2.3% 4.0%

Gross Profit 214.4 174.5 215.5 188.4 224.2 260.5 340.0 380.0 399.0 303.9 331.7 353.5 Margin % 21.9% 19.5% 18.5% 18.4% 20.0% 20.8% 20.8% 20.8% 20.8% 19.5% 20.8% 21.3%

EBITDA 213.3 179.9 212.4 186.9 229.6 257.9 340.0 380.0 399.0 303.9 331.7 353.5

Margin % 21.8% 20.1% 18.2% 18.2% 20.5% 20.6% 20.8% 20.8% 20.8% 19.5% 20.8% 21.3%

Net Income 49.0 30.4 34.5 16.5 37.7 28.5 99.7 123.6 130.3 73.2 87.9 96.7

Margin % 5.0% 3.4% 3.0% 1.6% 3.4% 2.3% 6.1% 6.8% 6.8% 4.7% 5.5% 5.8%

Diluted EPS Excl. Extra Items 1.3 0.8 0.9 0.5 1.0 0.8 2.7 3.3 3.5 2.0 2.4 2.6

Growth Over Prior Year (49.6%) (37.6%) 13.3% (52.1%) 128.9% (25.2%) 249.5% 23.9% 30.7% 1.6% 0.2% 0.1%

Total number of skier visits: 5,902.0 5,988.0 7,000.0 6,200.0 6,977.0 7,688.0 8,954.0 9,266.0 9,266.0 8,727.8 8,816.7 9,087.3

Growth Over Prior Year (4.0%) 1.5% 16.9% (11.4%) 12.5% 10.2% 16.5% 3.5% 0.0% 13.5% 1.0% 3.1%

Effective Ticket Price 47.16 48.13 48.99 55.75 56.02 58.18 60.45 61.66 62.89 60.45 61.66 62.89

Growth Over Prior Year 2.1% 1.8% 13.8% 0.5% 3.9% 3.9% 2.0% 2.0% 3.9% 2.0% 2.0%

Change in Vail, CO snowfall yoy (24.8%) (5.9%) 27.0% (56.7%) 29.8% 44.3% 0.0% 0.0% 0.0% (6.0%) 0.0% 20.0%Change in Tahoe, CA snowfall yoy (1.5%) 24.7% 35.3% (62.4%) 5.2% (50.9%) 0.0% 0.0% 0.0% (30.0%) 10.0% 150.0%

Segment Detail Resort Breakdown

Skiable Est. Annual # % of total Yrly Avg

Acres Skiers skier visits Snowfall (in)

Colorado

Resorts:

Vail 5,289 354

Breckenridge 2,908 353

Date Price Volume Keystone 1,861 235

1/22/2014 72.67 174994 Beaver Creek 1,625 325

1/23/2014 71.81 246816

Total CO

Resorts:

11,683 5,500 62%

1/24/2014 70.51 160796

California

Resorts:

1/27/2014 69.13 160601 Heavenly 4,800 360

1/28/2014 69.65 453298 Northstar 3,170 350

1/29/2014 68.61 296612 Kirkwood 2,300 600

1/30/2014 68.83 318820

Total CA

Resorts:

10,270 1,400 16%

1/31/2014 68.15 225413 Utah Resorts:

2/3/2014 68.21 386501 Canyons 3,500 355

2/4/2014 69.42 296740 Park City 3,300

2/5/2014 68.09 253485

Total UT

Resorts:

6,800 1,200 14% 355

2/6/2014 68.19 170754

Urban

Resorts:

430 788 9%

2/7/2014 69.44 302894 Total: 29,183 8,888 100%

2/10/2014 68.84 260676

Vail Resorts Inc (New York: MTN, Currency: USD)

Vail Resorts, Inc. operates resorts in Colorado. The Company's resorts include Vail Mountain, a ski mountain complex, and Beaver Creek Resort, a family oriented mountain resort. Vail Resorts also operates

Breckenridge Mountain, a destination resort with apres-ski activities, and Keystone Resort, a year-round family vacation destination.

85.70

Actuals Traditional Model Climate Exposure Model

Sector: Consumer Discretionary Industry: Hotels Restaurants & Leisure Sub-Industry: Leisure Facilities

Company Profile

Li ft Ticket,

46%

Ski School,

11%

Dining, 9%

Reta il/Rental

, 22%

Other, 11%

Mountain Revenue Breakdown

Lift Ticket Ski School Dining Retail/Rental Other

Mounta in,

96%

Lodging, 6%

Real Estate,

-3%

Segment EBITDA FY 2014

Mountain Lodging Real Estate

0

0.2

0.4

0.6

0.8

1

1.2

0

10

20

30

40

50

60

70

80

90

100

2/14 3/14 4/14 4/14 5/14 6/14 7/14 7/14 8/14 9/14 9/14 10/14 11/14 12/14 12/14 1/15 2/15

Vol

ume

Mill

ions

Pric

e

Volume Price

$0

$20

$40

$60

$80

$100

$120

Current Consensus Traditional DCF Climate Exposure DCF

MTN Equity Price Comparison

10

7/31/2009 7/31/2010 7/31/2011 7/31/2012 7/31/2013 7/31/2014 7/31/15E 7/31/16E 7/31/17E 7/31/18E 7/31/19E

USD USD USD USD USD USD USD USD USD USD USD

Total Revenue 977 895 1,167 1,024 1,121 1,255 1,635 1,827 1,918 1,995 2,035

yoy growth % -15.2% -8.4% 30.4% -12.2% 9.4% 11.9% 30.3% 11.8% 5.0% 4.0% 2.0%

EBITDA 213 180 212 187 230 258 340 380 399 415 423

Margin % 21.8% 20.1% 18.2% 18.2% 20.5% 20.6% 20.8% 20.8% 20.8% 20.8% 20.8%

Free Cash Flow 28 (33) 166 29 99 83 172 201 205 193 197

Present Value of Free Cash Flow (5 years) 160 173 164 143 136

Output Analysis

Perpetuity Growth Method - Value per Share EBITDA Multiple Method - Value per Share

Free Cash Flow at Year 5 197 Terminal EBITDA at Year 5 423

WACC 7.7% WACC 7.7%

Perpetui ty Growth Rate 3.5% Exi t Enterprise Va lue / EBITDA 12.5x

Perpetui ty Va lue at End of Year 5 4,846 Terminal Va lue at End of Year 5 5,291

Present Va lue of Perpetui ty (@ 7.7% WACC) 3,344 Present Va lue of Terminal Va lue (@ 7.7% WACC) 3,651

(+) Present Va lue of Free Cash Flows (@ 7.7% WACC) 776 (+) Present Va lue of Free Cash Flows (@ 7.7% WACC) 776

(=) Current Enterprise Value 4,121 (=) Current Enterprise Value 4,427

Short Term Debt 1 Short Term Debt 1

(+) Long Term Debt 626 (+) Long Term Debt 626

(-) Cash and Marketable Securi ties 44 (-) Cash and Marketable Securi ties 44

(-) Current Net Debt 582 (-) Current Net Debt 582

(-) Current Preferred and Minori ty Interest 14 (-) Current Preferred and Minori ty Interest 14

(=) Equity Value 3,525 (=) Equity Value 3,831

Shares outstanding 36 Shares outstanding 36

Estimated Value per Share (USD) 97.05 Estimated Value per Share (USD) 105.50 Current Price (USD) 85.70 Current Price (USD) 85.70

Perpetuity Growth Method EBITDA Multiple Method

Current Price (USD) Current Price (USD)

Consensus Price Target Consensus Price Target

DCF Estimated Value per Share (US DCF Estimated Value per Share (US

DCF Estimated Ups ide/(Downs ide) DCF Estimated Ups ide/(Downs ide)

Perpetui ty Growth Terminal EBITDA Multiple

2.5% 3.0% 3.5% 4.0% 4.5% 10.5x 11.5x 12.5x 13.5x 14.5x

6.7% 100.52 113.96 131.60 155.78 190.95 6.7% 93.44 101.87 110.30 118.73 127.15

Discount 7.2% 88.38 98.76 111.96 129.27 153.00 Discount 7.2% 91.40 99.63 107.87 116.10 124.33

Rate 7.7% 78.62 86.86 97.05 110.00 127.00 Rate 7.7% 89.41 97.46 105.50 113.54 121.59

(WACC) 8.2% 70.62 77.29 85.37 95.38 108.09 (WACC) 8.2% 87.48 95.34 103.20 111.06 118.92

8.7% 63.95 69.44 75.98 83.92 93.74 8.7% 85.60 93.28 100.96 108.64 116.32

11.4x 12.9x 14.4x 15.9x 17.4x

6.7% 17% 33% 54% 82% 123% 6.7% 9% 19% 29% 39% 48%

7.2% 3% 15% 31% 51% 79% 7.2% 7% 16% 26% 35% 45%

7.7% (8%) 1% 13% 28% 48% 7.7% 4% 14% 23% 32% 42%

8.2% (18%) (10%) (0%) 11% 26% 8.2% 2% 11% 20% 30% 39%

8.7% (25%) (19%) (11%) (2%) 9% 8.7% (0%) 9% 18% 27% 36%

13% 23%

Traditional Equity Analysis

85.70 85.70

102.50 102.50

97.05 105.50

Discounted Cash Flow

11

7/31/2009 7/31/2010 7/31/2011 7/31/2012 7/31/2013 7/31/2014 7/31/15E 7/31/16E 7/31/17E 7/31/18E 7/31/19E

USD USD USD USD USD USD USD USD USD USD USD

Total Revenue 977 895 1,167 1,024 1,121 1,255 1,559 1,595 1,659 1,655 1,685

yoy growth % -15.2% -8.4% 30.4% -12.2% 9.4% 11.9% 24.2% 2.3% 4.0% -0.3% 1.8%

EBITDA 213 180 212 187 230 258 304 332 353 323 367

Margin % 21.8% 20.1% 18.2% 18.2% 20.5% 20.6% 19.5% 20.8% 21.3% 19.5% 21.3%

Free Cash Flow 28 (33) 166 29 99 83 136 136 163 134 179

Present Value of Free Cash Flow (5 years) 127 117 131 100 124

Output Analysis

Perpetuity Growth Method - Value per Share EBITDA Multiple Method - Value per Share

Free Cash Flow at Year 5 179 Terminal EBITDA at Year 5 367

WACC 7.7% WACC 7.7%

Perpetui ty Growth Rate 3.5% Exi t Enterprise Va lue / EBITDA 12.5x

Perpetui ty Va lue at End of Year 5 4,411 Terminal Va lue at End of Year 5 4,587

Present Va lue of Perpetui ty (@ 7.7% WACC) 3,044 Present Va lue of Terminal Va lue (@ 7.7% WACC) 3,166

(+) Present Va lue of Free Cash Flows (@ 7.7% WACC) 597 (+) Present Va lue of Free Cash Flows (@ 7.7% WACC) 597

(=) Current Enterprise Value 3,641 (=) Current Enterprise Value 3,763

Short Term Debt 1 Short Term Debt 1

(+) Long Term Debt 626 (+) Long Term Debt 626

(-) Cash and Marketable Securi ties 44 (-) Cash and Marketable Securi ties 44

(-) Current Net Debt 582 (-) Current Net Debt 582

(-) Current Preferred and Minori ty Interest 14 (-) Current Preferred and Minori ty Interest 14

(=) Equity Value 3,045 (=) Equity Value 3,167

Shares outstanding 36 Shares outstanding 36

Estimated Value per Share (USD) 83.85 Estimated Value per Share (USD) 87.20 Current Price (USD) 85.70 Current Price (USD) 85.70

Perpetuity Growth Method EBITDA Multiple Method

Current Price (USD) Current Price (USD)

Consensus Price Target Consensus Price Target

DCF Estimated Value per Share (US DCF Estimated Value per Share (US

DCF Estimated Ups ide/(Downs ide) DCF Estimated Ups ide/(Downs ide)

Perpetui ty Growth Terminal EBITDA Multiple

2.5% 3.0% 3.5% 4.0% 4.5% 10.5x 11.5x 12.5x 13.5x 14.5x

6.7% 87.00 99.24 115.30 137.30 169.31 6.7% 76.75 84.05 91.36 98.67 105.97

Discount 7.2% 75.96 85.41 97.42 113.18 134.77 Discount 7.2% 74.97 82.11 89.25 96.39 103.52

Rate 7.7% 67.08 74.57 83.85 95.64 111.11 Rate 7.7% 73.25 80.22 87.20 94.17 101.14

(WACC) 8.2% 59.80 65.86 73.22 82.33 93.90 (WACC) 8.2% 71.57 78.39 85.20 92.02 98.83

8.7% 53.72 58.72 64.67 71.90 80.84 8.7% 69.94 76.60 83.26 89.92 96.58

11.4x 12.9x 14.4x 15.9x 17.4x

6.7% 2% 16% 35% 60% 98% 6.7% (10%) (2%) 7% 15% 24%

7.2% (11%) (0%) 14% 32% 57% 7.2% (13%) (4%) 4% 12% 21%

7.7% (22%) (13%) (2%) 12% 30% 7.7% (15%) (6%) 2% 10% 18%

8.2% (30%) (23%) (15%) (4%) 10% 8.2% (16%) (9%) (1%) 7% 15%

8.7% (37%) (31%) (25%) (16%) (6%) 8.7% (18%) (11%) (3%) 5% 13%

-2% 2%

Climate Exposure Analysis

85.70 85.70

102.50 102.50

83.85 87.20

Discounted Cash Flow

12

Attachment 3

13

Attachment 4

Impact Investing in the Energy Sector How Federal Action Can Galvanize Private Support for Energy Innovation and Deployment

Sarah Kearney Executive Director, PRIME Coalition & Visiting Researcher, MIT Sloan School of Management

Alicia Seiger Deputy Director, Stanford Steyer-Taylor Center for Energy Policy & Finance

Peter Berliner Managing Director, Mission Investors Exchange

October 2014

The federal government should take specific actions to catalyze impact investment in energy innovation and deployment, and to provide strategic coordination among a diverse set of impact-interested capital providers.

OCTOBER 2014 I Impact Investing in the Energy Sector 2

Executive Summary

Overwhelming social and economic imperatives exist,

both nationally and globally, for investment in the energy sector.

Investable capital from the philanthropy and family office community is underused in the energy sector, despite significant and growing interest.

Recent events hosted by the federal government serve as a stimulus

for high-level action.

Federal government resources could be valuable for impact investors.

•

•

•

•

•

•

•

•

•

•

•

•

•

Information asymmetries have prevented many types of asset

owners from participating in the energy sector.

Philanthropic investment in energy innovation and deployment has fallen

short, both in absolute terms and in strategic orientation.

High-profile failures in cleantech venture capital and government grants and loans have stigmatized energy solutions for mainstream investors.

Policy and capital markets are the only interventions large enough to mitigate

climate change on a reasonable time horizon, but activities are not currently

coordinated.

Information exchange platform(s)

Research on policies conducive to the work and dissemination of reports.

Intermediary organizations: strengthened and coordinated with private inves-

tors, as well as public-private partnerships.

Support a national task force led by the private sector to coordinate

action, propose public-private partnership opportunities, and surface

relevant policy issues.

Offer grant funding for private intermediary efforts.

Opportunity:

Problem:

Resources needed by impact investors that may be coordinated with the federal government:

Recommendations:


“A movement is afoot…the movement is called impact investing…[and it requires] a more intentional and proactive partnership

between government and the private sector.”US National Advisory Board on Impact Investing, June 2014 1

Economic and social imperatives require that energy innovation and deployment become an integral part of the

impact investing movement. While the overall market for impact-oriented capital is large and growing – a recent

report found $46 billion in impact investments under management globally – energy has remained on the

margins of impact investing in practice.2

In the spring and early summer of 2014, the federal government hosted a series of conversations to stimulate

high-level action. Now it is time for the federal government to leverage its resources to help put impact

investment in the energy sector into play at scale.

This paper builds on the following events held in Washington, D.C. over the past six months:

We believe in a broad definition of impact investing because of the speed and scale required for low-carbon energy innovation and deployment. This paper covers the motivations and approaches for what we call

“capital I ” Impact investors, whose primary desire is to achieve specific impact objectives and whose approach to investing involves sophisticated impact metrics and screens. It also covers what we call “lowercase i ” impact

investors, a large and growing pool of mission-interested capital providers for whom impact investing is simply

the evolution of traditional portfolio management. We use the term “concessionary” to indicate a strategic choice

to diverge from traditional asset class standards in terms of financial returns, risk, or timeline to achieve desired impact objectives. We use the term “nonconcessionary” investment to mean investments made at the market rate, where incorporating impact metrics also supports long-term performance objectives.3

Date

April 24, 2014

June 23, 2014

July 23, 2014

Energy Finance Roundtable for Foundations

White House Roundtable on Impact Investing

Driving Resources into Energy Innovation

U.S. Department of Energy’s Office of the Secretary

White House Office of Social Innovation and Civic Participation

American Energy Innovation Council

Event Title Host Organization

Introduction


Within the core impact investing movement, which is largely

characterized by “capital I ” impact investors, discussions of energy have generally been limited to development

work abroad or energy efficiency in low-income housing in the U.S. While both are critical pursuits for impact investors, investments in a broader set of energy innovation and deployment opportunities have the potential to

generate a much wider range of positive outcomes including job creation, advancing science and technology, stewarding natural resources, and protecting public health.

Experts believe that to avoid the most catastrophic impacts of climate change, investment in clean energy must

double by 2020 from a baseline of roughly $250 billion per year, and quadruple by 2030.4 While governments,

development banks, and traditional project financiers will deploy the majority of those dollars, impact capital has an important role to play in filling critical capital gaps and leveraging resources. Increased harmony and strategic coordination among “capital I ” and “lower case i ” impact investors will help drive success and

expediency in scaling up investment in clean energy.

This paper highlights specific actions the federal government can take to provide a strategic coordination function among the diverse set of actors with flexible, mission-interested capital, and to catalyze investment in energy innovation and deployment. Our primary goal is to advance a conversation among government

stakeholders that will lead imminently to action, putting energy at the center of the burgeoning impact investing

movement.

OCTOBER 2014 I Impact Investing in the Energy Sector

Introduction ( Continued )

5

Investable assets by families represent a significant, and largely untapped, pool of capital for impact investment in energy. In 2011, individuals were the largest source of charitable giving in the U.S., donating $218 billion to

public charities and accounting for 73% of total charitable giving. In addition to donating to nonprofit organizations, households with assets over a specific threshold – accredited investors – can make for-profitinvestments that may or may not be inspired by social impact. In 2013, angel investments from accredited

investors into companies across all sectors in the U.S. totaled $24.8 billion, which came from 298,800 separate

households and focused primarily on consumer-facing software and media investments.5 With the advent of

crowdfunding websites that facilitate donations from unaccredited investors (e.g., Kickstarter) and angel

investments from accredited investors (e.g., AngelList), the crowdfunding industry grew to more than $2.7 billion

in 2012.

One particular structure that has emerged as a popular resource for high-net-worth households is the single or

multi-family office – a private company that manages investments and trusts for one or many families. Experts estimate that one family needs at least $250 million in assets to justify the expenses associated with operating a single-family office; there are approximately 5,000 single-family offices in the United States.6 7

Separately, multi-family offices vary widely in terms of assets under management, number of families served, and services provided. Most offer travel and estate planning, accounting, and investment and philanthropy

advisory. Philanthropic services might include helping clients to establish a private foundation or providing

strategic guidance for grantmaking and endowment management.

Families

Types of Impact Investors


In 2011, U.S. foundations’ endowments were estimated to be worth approximately $600 billion and grant disbursements totaled $47 billion.8 There are three types of foundations in the U.S.: private foundations - typically

endowed by one individual or family (e.g., William and Flora Hewlett Foundation), corporate

foundations - operated by a for-profit company (e.g., Newman’s Own Foundation), and public foundations,including community foundations, that are focused on defined geographic areas (e.g., the Boston Foundation) or constituents (e.g., women and girls). Ninety-eight percent of the more than 86,000 foundations in the U.S.

have less than $50 million in assets under management, and 60% of foundations have less than $1 million.9

As of February 2014, the 100 largest U.S. foundations controlled approximately $300 billion in

assets,10 and capturing 1% of those assets annually would eclipse total current U.S. public spending on energy

R&D.11 The Internal Revenue Code (the Tax Code) mandates that private foundations spend 5% of total assets

on charitable purposes annually. Increasingly, foundations are forging impact investment strategies both to meet

the 5% distribution requirement and to manage the other 95% (i.e., foundation endowments).

Foundations


Types of Impact Investors ( Continued )

7

Institutional InvestorsBeyond families and foundations, a vast universe of asset owners make critical investment decisions pertaining to energy innovation and deployment. This group includes pension and insurance funds, university endowments,

and sovereign wealth funds. These capital providers are motivated to pursue investments in energy solutions for

one or both of these reasons: (1) to please stakeholders or shareholders and/or (2) to accomplish strategic

portfolio objectives. It is important to note that investment professionals at these institutions have a fiduciary responsibility to preserve and grow capital over time, making them primarily “lower case i ” impact investors.

Estimates vary for the amount of institutional capital with an appetite for impact in energy. One illustrative data

point is the Investor Network on Climate Risk (INCR), run by Boston-based nonprofit Ceres, which represents more than $11 trillion in assets managed by more than 100 institutional investors, and where all members have

committed to investing in opportunities tied to climate change.12 Because the majority of capital among institutional investors today is deployed via fund managers, public equity screens are currently the primary

mechanisms for these investors to achieve impact. The trend toward disintermediation (e.g., direct deployment of

capital at scale) creates the opportunity for institutional investors to more actively incorporate impact

considerations in their investment decision-making.13


Types of Impact Investors ( Continued )

8

Types of Impact Investments

One tool used by foundations to achieve their charitable end goals is to invest in market-based solutions using program-related investments (PRIs). PRIs are concessionary investments that count toward a private foundation’s 5% mandatory payout requirement; they can be made as equity investments, loans, loan guarantees, or other types of investment to either nonprofit or for-profit enterprises. Community and other public foundations may also make concessionary PRI-like investments but are not required to meet the same tax criteria as privatefoundations.

Despite their compelling value proposition to philanthropists, PRIs have been used sparingly since being added into the Internal Revenue Code in the 1960s. Best available data shows approximately 5,000 PRI transactions made since 1998, representing approximately $4.4 billion in total investment. More than 75% of those transactions focused on creating jobs, education, and affordable housing, while less than 2% of all PRIs made were relevant to the energy sector.14 PRIs remain a promising but underused tool across many charitable purposes related to energy innovation and deployment.

Program-Related Investments ( PRI )

Important regulatory details about Program-Related Investments ( PRIs )

A PRI can be counted as part of a private foundation’s charitable distribution if it meetsthese three requirements:

1) the primary purpose of the investment is to accomplish one or more of the charitable, religious, scientific, literary, educational and other exempt purposes described in sec-tion 170(c)(2)(B) of the Internal Revenue Code;

2) no significant purpose of the investment is the production of income or the appreciation of property;

3) no purpose of the investment is to lobby, support, or oppose candidates for public office or to accomplish any of the other political purposes forbidden to private foundations by section 170(c)(2)(D) of the Internal Revenue Code.15

The first prong – primary exempt purpose – requires a de-termination specific to each foundation, its mission, and its relation to the investment. There are two parts to the primary exempt purpose test for PRI-making – the invest-ment must significantly further the accomplishment of the foundation’s exempt activities, and it would not have been made but for the relationship between the investment and the accomplishment of exempt purposes. To meet the “significantly further” test, the foundation must determine that the PRI is consistent with one or more purposes de-scribed in section 501(c)(3) of the Code.

• Religious• Educational• Scientific• Literary• Fostering amateur sports competition• Preventing cruelty to children or animals• “Charitable”

• Relief of the poor• Protecting and preserving the natural environment• Lessening the burdens of government• Lessening neighborhood tensions• Eliminating prejudice and discrimination• Defending human rights• Combating community deterioration and juvenile delinquency• Economic development for distressed populations

Section 501c3 of the Internal Revenue Code defines charitable activities as:


Foundations may also invest funds from their endowments in ways that generate both social and financial returns, provided that those investments do not jeopardize the longevity of the endowment and long-term achievement of charitable purpose. Nonconcessionary investments from the endowment are oftentimes referred to as Mission-Related Investments (MRI).

Recently, a high-profile movement called Divest-Invest Philanthropy highlights how foundations have the power to influence discussions about the uses of investment capital within the philanthropy community and beyond.16 The movement calls for endowments to divest of fossil fuel interests for ethical and financial reasons and commit to investment in clean energy (e.g., renewables, clean tech, and other innovations).

Mission-Related Investments ( MRI )

Outside of the world of foundation capital, PRIs and MRIs become simply investments that also have an impact. As noted above, the majority of institutional capital that carries an “impact” label is managed through public equity funds with impact screens. While this type of investing, along with shareholder activism and divestment, can send important market and moral signals, for the purposes of this paper the focus is on capital and tools that will directly influence outcomes in energy innovation and deployment. Tools for managing direct investment include financial instruments such as equity or debt into companies and projects, as well as organizational designs such as hiring in-house expertise, participating in investor networks, and ring-fencing committed pools of capital for investment in energy innovation and deployment.

Dedicated impact funds are proliferating across the institutional investment landscape – from mainstream financial institutions and state pension funds, to new classes of impact asset managers and public-private collaborations. For example, the investment bank Morgan Stanley believed the impact capital trend was widespread enough to announce a five-year goal to reach $10 billion in client assets in its investing-with-impact program.17 The California Public Employees’ Retirement Program (CalPERS), which manages a $300 billion portfolio, has committed to “consider risk factors that are slow to develop, such as climate change and resource scarcity” as part of its ten governing “investment beliefs.”18 In the mold of a public-private partnership, the Over-seas Private Investment Corporation (OPIC) and the Rockefeller Foundation established an aligned capital fund for co-investment in the development of renewable energy projects overseas. Most recently, in the lead-up to the September 2014 UN Climate Summit in New York, the California State Teachers’ Retirement System (CalSTRS, the country’s second-largest public pension fund) announced a commitment to more than double its clean energy investments to $3.7 billion over the next five years,19 and the University of California agreed to commit $1 billion of its $91 billion endowment for direct investments in solutions to climate change over the next five years.20

Investor Toolkit


Types of Impact Investments ( Continued )

10

Opportunities abound for impact investors in energy.

The U.S. energy sector is a massive enterprise of interconnected and interrelated systems. The U.S. is fortunate to have a network of celebrated national labs and universities, venture capital resources and talented entrepreneurs supported by incubators and accelerators, a sophisticated financial industry, a legal system that protects the sanctity of contracts, and large technology and energy companies with the skills to scale technologies.21 Within this diverse ecosystem, there are many opportunities – both concessionary and nonconcessionary – for impact-interested capital to invest. 22

Examples of investment opportunities across the innovation and deployment pipeline:


Innovation

Deployment

Series C convertible note to a private company that conducts energy efficiency audits and retrofits, to support opening an office in an underserved community

Seed-stage equity to support a new venture developing a new, ultra-high-efficiency solar photovoltaic material

Series B equity for cleanweb startup building grid management software

Loan with a competitive interest rate to support new, price-competitive cleanenergy infrastructure projects

Recipient: CorporationInvestor: Corporate FoundationInvestment: PRI - convertible debtCharitable Purpose: Advancement of Science

Recipient: CorporationInvestor: Community Foundation - grantmaking (5%)Investment: PRI - equityCharitable Purpose: Economic Development

Recipient: CorporationInvestor: Single Family OfficeInvestment: Equity

Recipient: CorporationInvestor: Private Foundation - endowment (95%)Investment: Debt

Concessionary Nonconcessionary

11

Today, there is no shortage of breakthrough energy technologies being developed in universities, national labs, and garages. One salient place to look for examples is the ARPA-E website; since 2009, ARPA-E has funded more than 360 potentially transformational energy technology projects, and many of these projects have already demonstrated technical success.

Unfortunately, the current financial marketplace lacks patient, early-stage capital and expert support that can translate these projects into lasting companies. While one might expect traditional venture capital to fill this gap, the venture asset class has come to focus primarily on developing varieties of consumer-oriented digital innovation over short time periods.23 Concurrently, U.S. venture capital activity in clean energy has dropped more than 67% between 2011 and 2013.24

Philanthropic asset owners are in a unique position to contribute, invest, and leverage resources to meet this need. Unlike conventional venture investors, philanthropists are in a position to be more flexible and patient, and to accept significant levels of risk to achieve measureable social or environmental returns. As early investors, and by ab-sorbing a higher amount of risk, philanthropists can attract follow-on capital to promis-ing enterprises.25 Unlocking even a small portion of the $50 billion given as grants annually from U.S. private foundations or the $700 billion in foundation endowments would revolutionize the way we develop unproven energy technologies for applications in developed economies as well as the developing world.

Innovation

Imagine a $250 million PRI Fund focused on filling the gap between ARPA-E and venture

capital that supports 20 transformational companies over a 20-year time horizon – just

one price-competitive grid storage solution could drastically reduce annual greenhouse

gas emissions globally by 2050.OCTOBER 2014 I Impact Investing in the Energy Sector 12

Deployment

Imagine a $200 million PRI commitment to subsidize a first-of-a-kind nuclear facility,

bringing technology down the cost curve and promoting baseload electricity generation with

zero carbon emissions.

Rapid, large-scale investment in the deployment of proven clean energy solutions is critical in

order to meet the economic and social imperatives for emissions reduction at the pace and scale

required. In many cases, cleaner alternatives proven at a small scale exist but are not deployed at

a full scale because of financing barriers. Impact investors can play a valuable role in bridging this “commercialization gap” 26 by supporting technologies – such as advanced nuclear, carbon cap-

ture and sequestration, or deployment of wind and solar in critical geographies – through low-cost

debt, subsidized off-take agreements, and early-stage development capital.


In addition to commercializing technologies, there are opportunities for impact investors to support

business model innovations that drive commercialization, such as enabling distributed asset

financing at scale (e.g., SolarCity, Mosaic, Next Step Living). Additionally, opportunities abound to incentivize later-stage companies with proven technologies to work on projects they would not otherwise prioritize - opening an office that brings green-collar jobs to underserved neighborhoods, developing technology specifically for charitable applications, or deploying projects in the developing world.

Imagine a $5 million PRI to incentivize a small private company to deploy its water filtration

technology to clean up tailings ponds at oil drilling sites in the Rocky Mountains

to reduce harmful flooding.

rocky mountain


Deployment

14

Indeed, nearly every subsector of the clean energy economy could benefit

from catalytic or flexible impact capital, but this is especially true in the

developing world. Globally, 1.3 billion people lack access to electricity and

instead rely on heavily polluting and expensive kerosene, candles, and

flashlights for their basic energy needs.27 Fortunately, companies providing

services and deploying proven energy technologies – modern lighting and

mobile phone charging from solar power – are growing rapidly with 95%

compound annual growth rates in Sub-Saharan Africa, according to the

World Bank’s Lighting Africa program.28 These companies increasingly have

proven track records but struggle to raise the risk capital they need to expand.

Again,unlocking impact investment assets that are focused on absorbing the

first loss risk associated with deploying the proven technologies of today is

imperative in developed economies as well as the developing world.

Imagine a $40 million PRI loan guarantee reserve to kick-start solar electricity businessesin Sub-Saharan Africa that alleviate poverty by providing electricity to households currently living in the dark.


Deployment

15

It is important to note that the perceived policy barriers described here do not prohibit PRI-making to energy or climate causes per se, but are causing hesitation in the marketplace on behalf of those asset holders looking for clear guidance. The operational and educational barriers described above are the primary hurdles that need attention and smart government intervention.

High barriers currently prevent impact investment in energy.

In-house staff lack the deep expertise and organizational support

to find, screen and structure energy investments.

External advisors - accountants, lawyers, trustees and investment advisors - lack

resources to evaluate and facilitate investment in energy innovation and deployment.

There is an acute lack of awareness about the capital gaps in energy innovation and

deployment - those stages that are not currently covered by traditional investors or government.

The impact metrics for energy opportunities are difficult to quantify before and after investment..

Asset class silos obscure energy opportunities that span multiple investment types and asset classes.

Climate change (mitigation or adaptation) are not explicitly charitable purposes in the Tax Code.

The IRS has issued inconsistent written determinations regarding PRIs in the energy sector.

Regulatory uncertainty undermines long-term investment in the energy sector.

There remains a lack of familiarity and comfort with program-relatedinvesting among grantmaking foundations.

Transaction costs are prohibitively high on a deal-by-deal basis.

There are too few examples of energy-related PRIs to serve as precedent.

There is a scarcity of attorneys with experience making PRIs to energy-related causes.

PRI(philanthropic

investors)

X

X

X

X

X

X

X

X

X

X

X

X

X

X

X

X

X

X

X

MRI(returns driven

investors)

Perceived Policy Barriers

Educational Barriers

Operational Barriers

There is no educational or exchange forum dedicated to reducing the information asymmetries between charitable investors and energy experts.


To address the educational, operational, and perceived policy barriers enumerated above, it is essential that the federal government work side-by-side with private and social sector intermediaries to bolster and coordinate impact investment in the energy sector. Not only is the energy sector inexorably linked to government intervention, but the federal government also has the capacity to help impact investors break down barriers that currently prevent action. Most critically, there is a coordination function missing today to help impact asset owners achieve their goals in a sector defined by scale – the federal government could help fill this gap immediately.

Call to Action

At our Finance Roundtable for Foundations on April 24, I was struck by the opportunity for increased collaboration between the Energy Depart-ment and the foundations, donors and intermediaries comprising the philanthropic community. Our Loan Programs Office, ARPA-E, the Of-fice of Energy Efficiency and Renewable Energy, the Office of Energy Policy and Systems Analysis, and other Energy Department offices are all actively engaged in our ongoing outreach efforts and can deepen the Energy Department’s relationship with this community. The roundtable yielded several ideas for future exploration. For instance, various govern-ment agencies could partner with the philanthropic and impact invest-ment community to address early-stage finance gaps.”

John MacWilliams Senior Advisor on Finance, US Department of Energy 29


Efforts to address a number of the barriers noted above are being addressed through the emergence of intermediary organizations

and working groups, including the following::

Ceres: INCR Working Group for Families & Foundations | Ceres is a leading Boston-based NGO that mobilizes business and investor leadership. In 2003, Ceres created the Investor Network on Climate Risk (INCR), a consortium of asset managers, asset owners, foundations, and endowments focused on integrating climate risk comprehensively into investment policies and practices. Currently, there are 112 INCR members with a combined $13 trillion in assets under management. In Fall 2014, Ceres created a new working group for family offices and family foundations in INCR that will offer programming and peer-to-peer networking opportunities on climate-conscious investing.

Climate and Energy Funders Group | The Climate and Energy Funders Group (CEFG), supports, facilitates, and seeks to expand a network of funders responding to global climate change. CEFG is the only national forum of funders focused exclusively on addressing this issue and believes that phi-lanthropy has a critically important role to play as the impacts of global climate change become more evident. CEFG’s vision is a global transition to a clean energy economy, leading to a stable climate that protects human life and global ecosystems.

Confluence Philanthropy | Confluence Philanthropy supports and catalyzes the work of private, pub-lic and community foundations, individual donors, and investment advisors committed to moving phi-lanthropy towards mission-aligned investment. Confluence Philanthropy hosts conferences, webinars, trainings, and supports working groups focused on specific areas of investment and change strategies.

CREO | CREO is a network of qualified family offices, private investors and advisors focused on de-veloping and investing in the global environmental marketplace. Established in 2011, participation has grown from a small group of family offices and principals to over 100 private investors and asset owner representatives with over $50 billion of investable capital. To date, CREO has showcased 150 invest-ment opportunities with capacity of $1 billion, initiated programmatic content partnerships, organized eight events and, in June 2014, coordinated commitments of $300 million in new impact investments from members.

Energy Options Network | Energy Options Network is a nonprofit organization created to increase the portfolio of zero-carbon energy options available to accelerate large-scale global energy system de-carbonization. Its team and network possess significant real-world experience in energy technology development, moving forward complex, large-scale global energy projects, commercializing innovative technology, “getting things done” in China, and driving U.S. energy policy. Energy Options Network focuses heavily on the application of low-carbon energy technologies in the developing world.

Mission Investors Exchange | is a national network of foundations that are using investment strate-gies to achieve their philanthropic goals. It offers education, training and technical assistance to foun-dations and other philanthropic asset owners, and encourages and supports working groups on com-mon issues and concerns.

PRIME Coalition | PRIME is a nonprofit organization formed in 2014 with grant support from seven prominent family foundations. Its mission is to empower philanthropic families and foundations with the critical tools they need to invest in market-based solutions to climate change – companies that won’t otherwise be funded and projects that won’t otherwise be done without philanthropic support. PRIME’s vision is to harness the expertise embedded in the for-profit sector and within government agencies to help lower barriers that currently prevent philanthropic investment in energy.

Stanford Steyer-Taylor Center for Energy Policy & Finance | Founded in 2011 as a joint initiative of the Stanford Law and Graduate School of Business, the Steyer-Taylor Center develops and explores economically sensible policy and finance solutions that advance cleaner, more secure energy. Affiliated faculty and fellows research, publish, teach, and engage market players and policy makers on solutionsfor increasing the flow and reducing the cost of capital to scale up clean energy. The center runs re-search and programs focused on opportunities for philanthropic and long-term investors to fill critical information and financing gaps in clean energy innovation and deployment.


Nonprofit intermediaries rising to answer the call

18

Support the creation of a National Task Force led by the private sector.

Objectives |

Summary | The National Task Force will identify and propose strategies to stimulate and coordinate impact-interested capital for energy innovation and deployment and facilitate public-private partnerships related to impact investing in the energy sector.

Grant Award | The Department of Energy’s Office of Energy Efficiency & Renewable Energy would offer a grant award to support the National Task Force over a two-year period.

Recipient | Private nonprofit organizations would apply to become the recipient of the DOE’s grant award in order to become Secretariat of the National Task Force. Each applicant would propose their own Task Force structure, prioritized workflow, deliverables, budget, prospective Task Force members, and plan for sustain-ability beyond the two-year grant.

Recommendation 1

( continued )

a) Map the landscape of impact-investing actors and platforms as well as relevant state and federal agencies and resources.

b) Track and evaluate state and federal tax, budget, procurement, and regulatory policies that present material barriers to, or opportunities for, the flow of impact capital into energy innovation and deployment.

c) Research and describe best practices among previous public-private partnerships in other sectors.

d) Deliver a formal and ongoing public-private partnership proposal for impact investing in the energy sector that includes an implementation timeline, an action plan, performance metrics, and a theory of change.


Examples of potential public-private partnership structures to be considered by the National Task Force:

• Community development financial institution program for energy

• Contract for differences program for commercializing energy technologies

• Matchmaking service for impact investors around energy technology due diligence

• Office of philanthropic engagement at the DOE

• Enhanced financial information related to impact investing in energy: grants, PRI,

venture capital, private equity, project finance

• White House initiative equivalent to My Brother’s Keeper

• State-based public-private finance partnerships (e.g., Connecticut’s Clean Energy Finance and Investment Authority and NYSERDA)

• Existing and proposed energy-related state and federal tax policy

• Federal energy procurement strategies

• Examination of the regulatory language for concessionary investors related to energy innovation and deployment, such as:

o PRI Examples in the Tax Codeo Charitable purpose language in the Tax Code, including:

• Adding climate change as a charitable purpose• Defining “lessening the burdens of government” as it relates to energy

Examples of potential policies the National Task Force may consider from the perspective of impact investors:


Recommendation 1 ( Continued )

20

Summary | We view the Department of Energy’s recent National Incubator Initiative for Clean Energy (NIICE) as an award that could be replicated to jumpstart the efforts of impact investment intermediaries. The NIICE Program funded awards in two topic areas: (1) creating a national organization to serve as a coordinating body for clean energy incubators and a central source of information for clean energy stakeholders; and (2) setting a benchmark to develop top-performing, clean energy-focused incubators by funding three to five incubators across the United States.30 Similarly, we suggest an Impact Investment for Clean Energy Program to support the National Task Force (above) and a suite of nonprofit intermediaries.

Grant Award | The Department of Energy’s Office of Energy Efficiency & Renewable Energy would offer multiple grant awards to support impact investment intermediaries over a two- or three-year grant period.

Recipients | Single organizations or consortia of existing organizations with capacity to engage, organize, and facilitate co-investing among impact investors or create investment opportunity exchange platforms in the en-ergy sector would apply for the grant award. Applicants would need to be specific on which investor type (e.g., philanthropists, family offices, institutional investors), investment type (e.g., PRI, MRI, investor toolkit), and en-ergy opportunity type (e.g., innovation or deployment) will be included in their DOE-supported program.

Objective | Accelerate the pace and volume of private sector investments designed to meet critical funding gaps and leverage new investments into clean energy companies and projects.

Support impact investment intermediaries working in the field.Recommendation 2


Acknowledgements

The development of this white paper benefited from the input of the following individuals. We would like to give special thanks to each of them for sharing their time and expertise with us. While we benefitted from their guidance, the views expressed here are solely those of the authors and do not necessarily reflect the views of our reviewers.

Jason Bade, Stanford UniversityMike Berkowitz, Third PlateauPaul Brest, Stanford UniversityArunas Chesonis, Cranberry CapitalMark Hayes, Stanford Management CompanyJesse Jenkins, MIT Engineering Systems DivisionRachel Pritzker, Pritzker Innovation FundDan Reicher, Stanford UniversityJason Scott, EKO Asset Management PartnersMartin Whitaker, JUST CapitalLindsey White, Ceres


References1 US National Advisory Board on Impact Investing, “Private Capital, Public Good. How Smart Federal Policy Can Galvanize Impact Investing – and Why It’s Urgent.” June 2014.

2 JP Morgan and GIIN’s Investor’s survey, 2014, pg 6.

3 Brest, Paul and Kelly Born, “Unpacking the Impact in Impact Investing,” Stanford Social Innovation Review, August 14, 2013.

4 Fulton, Mark and Reid Capalino. “Investing in the Clean Trillion: Closing the Clean Energy Investment Gap.” A Ceres Report. January 2014.

5 Sohl, Jeffrey. “The Angel Investor Market in 2013: A Return to Seed Investing,” Center for Venture Research, April 30, 2014. Print.

6 Pollack, Marv. “How Many Family Offices are there in the United States?” Family Office Exchange. September 2014.

7 Prince, Russ. “How Many Family Offices Are There?” Forbes. Forbes Magazine, 11 Nov. 2013. Web. 23 June 2014.

8 Bugg-Levine, Antony, and Jed Emerson. Impact Investing: Transforming How We Make Money While Making a Difference. San Francisco: John Wiley & Sons, Inc, 2011.

9 Connolly, Paul. “Creating a Smarter Philanthropic Marketplace.” Stanford Social Innovation Review, 7 Mar. 2014. Web. 23 June 2014.

10 Foundation Center. “Top 100 US Foundations by Asset Size.” September 2014.

11 American Energy Innovation Council, “Catalyzing American Ingenuity: The Role of Government in Energy Innovation,” 2011.

12 Ceres Investor Network on Climate Risk. Website. September 2014.

13 Monk, Ashby HB. “The New Dawn of Financial Capitalism.” Institutional Investor. September 8, 2014.

14 Wood, Sarah J. The Role of Philanthropic Capital in Entrepreneurship: An empirical analysis of financial vehicles at the nonprofit/for-profit boundary of science and engineering. MS thesis. Massachusetts Institute of Technology, 2012.

15 IRC Section 53.4944(a)(1)(i-iii)

16 Dorsey, Ellen. “Philanthropy Rises to the Fossil Divest-Invest Challenge.” Divest Invest. Huffington Post, 30 Jan. 2014. Web. 23 June 2014.

17 Morgan Stanley. “Investing with Impact: Creating Financial, Social and Environmental Value.” 2012.

18 Stausboll, Anne. “Analyzing Climate Risk: Why Mandatory Reporting Matters.” Institutional Investor. August 16, 2014.

19 Burr, Barry B. “CalSTRS announces big boost in clean energy, technology investments ahead of the U.N. Climate Summit.” Pensions & Investments. September 19, 2014.

20 UC Office of the President. “UC Announces New Approaches to Combat Climate Change.” September 10, 2014.

21 American Energy Innovation Council, “Catalyzing American Ingenuity: The Role of Government in Energy Innovation,” 2011.

22 Brest, Paul and Kelly Born, “Unpacking the Impact in Impact Investing,” Stanford Social Innovation Review, August 14, 2013.

22 “Program-Related Investments,” US Internal Revenue Service. September 2014.

23 Kearney, Sarah, Fiona Murray and Matthew Nordan, “A New Vision for Funding Science,” Stanford Social Innovation Review, August 2014.

24 MIT Tech Review. “35 Innovators Under 35” Fall 2014. Pg. 46.

25 Kearney, Sarah, Fiona Murray and Matthew Nordan, “A New Vision for Funding Science,” Stanford Social Innovation Review, August 2014.

26 Jenkins, Jesse and Sara Mansur, “Bridging the Clean Energy Valleys of Death: Helping American Entrepreneurs Meet the Nation’s Energy Innovation Imperative,” Breakthrough Institute. November 2011.

27 International Energy Agency. “Energy Poverty.” Website. October 2014.

28 World Bank’s Lighting Africa Program. Website. October 2014.

29 MacWilliams, John. “Building a Stronger Foundation for Philanthropic Energy Investments,” June 24, 2014.

30 Department of Energy. “Funding Opportunity Announcements.” DE-FOA-0001042: NATIONAL INCUBATOR INITIATIVE FOR CLEAN ENERGY (NIICE). eere-exchange.energy.gov. 22 Aug 2014


SARAH KEARNEYExecutive Director, PRIME Coalition &Visiting Researcher, MIT Sloan School of Management

Sarah Kearney serves as Executive Director of PRIME Coalition, a nonprofit organization whose mission is to empower foundations and families with the critical tools they need to invest in market-based solutions to climate change. Before PRIME, Sarah served as Execu-tive Director and Trustee of the Chesonis Family Foundation, a grantmaking organization that supports transformational energy innovation. Based on her work, Sarah has been inducted into the Raven Society at the University of Virginia, and awarded the 2012 MIT Ronald Heller Entrepreneurship Award, 2014 Caltech Resonate Award, 2014 Echoing Green Fellowship, and the MIT Technology Review 2014 35 Innovators Under 35. Sarah currently sits on the board for Saha Global, a social enterprise bringing civil services to rural Africa. She holds a B.S. in Commerce from the University of Virginia and an M.S. in Technology and Policy from MIT’s Engineering Systems Division.

ALICIA SEIGERDeputy Director, Stanford Steyer-Taylor Center for Energy Policy and FinanceAlicia Seiger serves as Deputy Director of the Stanford Steyer-Taylor Center for Energy Policy & Finance, where she manages the center’s research, programming, operations, and market engagement. Alicia also leads the center’s work to identify opportunities for philanthropic and long-term investors to fill financing gaps to scale up clean energy. A se-rial entrepreneur and pioneer of new business models, Alicia was at the forefront of the web advertising and carbon offset industries before pursuing solutions in the rapidly evolving area of climate finance. Prior to joining the center, Alicia founded Climate Strategy Part-ners, a strategic advisory services provider that designed and executed climate and en-ergy programs for foundations, investors and NGOs. She has served on the management teams of multiple startups, including TerraPass, a pioneer of the US carbon offset market, and Flycast Communications, one of the first web advertising networks. She holds a MBA from the Stanford Graduate School of Business, where she also served as a case writer for the Center for Entrepreneurial Studies, and a BA in Environmental Policy and Cultural Anthropology from Duke University.

PETER BERLINERManaging Director, Mission Investors Exchange

Peter Berliner is the managing director of Mission Investors Exchange, a national network of foundations and related organizations that are using investment strategies to accom-plish their philanthropic goals. Peter has served in a number of leadership roles within philanthropy and the not-for profit sector, including program director for the Paul G. Allen Family Foundation and, executive director of the Children’s, a policy advocacy organiza-tion based in Washington State. He is a contributor and editor to the Community Founda-tion Field Guide to Impact Investing and Strategies to Maximize Philanthropic Capital: A Guide to Program Related Investments. Peter has an MPA degree from the University of Puget Sound; a Masters in Teaching from Oberlin; and a BA from Earlham College.

OCTOBER 2014 I Impact Investing in the Energy Sector24

Stanford Social Innovation Review Email: [email protected], www.ssireview.org

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50 Stanford Social Innovation Review / Fall 2014

The gap between the lab and the fi eld—between the work of scientifi c discovery and the achievement of social impact—has grown wider in recent years. So, not coincidentally, has the gap between philanthropic

funding for university-based research and venture funding for the commercialization of products and services. But the emerging practice of philanthropic investment holds the potential to close this dual gap.

,

By SARAH KEARNEY, FIONA MURRAY, & MATTHEW NORDAN

A New Vision for Funding Science

The gap between the lab and the fi eld—between the work of scientifi c discovery and the achievement of social impact—has grown wider in recent years. So, not coincidentally, has the gap between philanthropic

funding for university-based research and venture funding for the commercialization of products and services. But the emerging practice of philanthropic investment holds the potential to close this dual gap.

A New Vision for Funding Science

Over the past three years, we have explored the role that impact investment by philanthropists can play in funding science. Philanthro-pists, we have found, are overlooking the middle ground that lies be-tween their grantmaking to universities and their investment in venture funds. This middle ground is precisely where exciting and potentially life-changing technologies can thrive. Instead of focusing on ways to “fi x” venture capital, we argue that the philanthropy and impact in-vestment communities can join to create new vehicles that support the creation, translation, and deployment of socially benefi cial innovations.

In this article, we outline the parallel histories of science phi-lanthropy and venture investing. That dual history, in our view, has culminated in a bifurcated fi nancial system and has contributed to

The power of science to change the world should be self-evident. Consider the immeasurable impact that science and engineering innovation had on social conditions during the 20th century. The first half of the century produced

the assembly line, the airplane, penicillin, and a vaccine for tuberculosis; the second half brought the eradication of polio and smallpox. Scientists harnessed the power of the sun with photo voltaic cells, invented the birth control pill, and sequenced the human genome. Work done in research laboratories sparked a Green Revolution: In the 1960s, rice yields in India were about two tons per hectare; by the mid-1990s, they had risen to six. In the 1970s, rice cost about $550 a ton; in 2001, it cost less than $200. By June 2012, more than one-third of all people on earth had used the Internet—a system built on the backbone of science and engineering research conducted in the 1960s.1 In each of these cases, the results of scientifi c discovery yielded both public goods and private fortunes.

Today, research discoveries languish in ivory towers for lack of entities that are willing, able, and properly structured to invest the capital necessary to build lasting organizations that can move those discoveries from the lab to the fi eld.2 People in the university commu-nity lament the growing “idea-to-impact gap” (sometimes known as the “valley of death”).3

Because of this gap, corporate leaders fi nd few promising innovation-driven companies to acquire. Government agencies in scientifi cally advanced nations cite this gap as a rationale for allocating taxpayer funds to domestic commercialization eff orts.4

Conventional wisdom holds that venture capital can fi ll this gap. But the venture asset class has come to focus on developing varieties of consumer-oriented digital innovation over short time periods. It’s optimized to support Instagram, not impact. And its investment crite-ria are very narrow: nothing too long-term, nothing too expensive, and nothing that involves too much technology or market risk. In “What Happened to the Future?”—a manifesto issued by the Founders Fund, a Silicon Valley-based investment fi rm—the author notes, “In the late 1990s, … venture investing shifted away from funding transformational companies and toward companies that solved incremental problems or even fake problems.… VC has ceased to be the funder of the future, and instead become a funder of features, widgets, irrelevances.”5 PH

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Stanford Social Innovation Review / Fall 2014 51Stanford Social Innovation Review / Fall 2014 51

the idea-to-impact gap. We also propose a solution to that problem: philanthropic investment, or the use of grantmaking to fund early-stage technology ventures that hold the promise of achieving sig-nifi cant impact at a large scale.

THE BIFURCATION OF SCIENCE FUNDING

Why, in our own era, has it become so challenging to fund the com-mercial development of transformative scientifi c discoveries? To answer this question, it is useful to observe the history of invest-ment in science for social and economic purposes.

The story of fi nancial support for science research and commer-cialization in the United States is one of increasing bifurcation. In the

beginning, those who conducted scientifi c work also funded it. In the early 19th century, gentleman scholars like Thomas Jeff erson worked at science as they worked at politics, literature, and farming; it was, in short, an important part of being a gentleman. By the middle of the century, however, science had emerged as a matter for specialists. This transformation had implications for funding: Scientists now focused on securing external patronage for their research.6

Foundation support | After 1880, philanthropists began to orga-nize their eff orts formally, and they introduced a greater degree of regularity into science funding, particularly by helping to establish the new research-oriented universities that emerged during that period. Philanthropic foundations hired professional staff members PH

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52 Stanford Social Innovation Review / Fall 2014

to engage with the scientific community, and they commanded the resources necessary to support an increasingly complicated and expensive search for knowledge.7

In the period after World War I, the visibility and prestige of science reached new heights. Foundations invested $100 million in science between the two world wars. Between 1918 and 1925, for example, the General Education Board (established by John D. Rockefeller in 1903) invested $20 million in astronomy, physics, chemistry, and biology. Similarly, the Carnegie Corporation and the Rockefeller Foundation each gave approximately $8 million to the National Research Council, which served as a trade association for science. The council developed markets for PhDs in industry, created communication networks, and encouraged cooperative research projects.8 By 1925, at least a dozen large foundations sponsored research on a large scale.9

In part because of changes in tax policy, charitable donations of all kinds—including donations to support science and engineering—increased steadily throughout the 20th century. In 1955, annual giving from individuals, foundations, and corporations totaled $7.7 billion. By 1998, annual giving had risen to $175 billion.10 Scien-tific discovery, engineering, and medicine have always received sig-nificant funding from individual givers. Today, philanthropic contri-butions account for almost 30 percent of US universities’ funding for research expenditures.11

Venture capital | In parallel with the expansion of philanthropy to support fundamental discovery in universities, wealthy individuals were pioneering the use of for-profit investment vehicles to fund en-trepreneurial start-ups—a practice known today as venture capital.

Consider the case of Venrock, an early-stage venture capital firm that originated as an investment arm of the Rockefeller family. In 1938, members of the family invested in Eastern Air Lines, then headed by CEO (and former World War I flying ace) Eddie Rickenbacker. To make that investment, Laurance Rockefeller, a grandson of Standard Oil mag-nate John D. Rockefeller and an aviation enthusiast, pooled his money with personal checks from five siblings. In the years that followed, the Rockefeller group backed dozens more early-stage companies, and nearly all of them were science- and engineering-driven enterprises in fields such as aviation (McDonnell Aircraft), imaging (Itek), rocketry (eReaction Motors), analytical instruments (Thermo Electron), and power (United Nuclear). In 1946, the Rockefeller family formalized its ad hoc investing activity into a fund called Rockefeller Brothers Inc.

Other wealthy families followed a similar pattern in their invest-ment activity. In 1911, for example, Carnegie Steel cofounder Henry Phipps formed Bessemer Securities. In the 1930s, the financier John Hay Whitney began investing in high-tech start-ups such as Pioneer Pictures and Technicolor Corporation. These investors were amateurs, but they blazed a trail for the venture capital asset class as a whole.

In the late 1960s, the Rockefellers brought in outside managers to professionalize the firm’s venture investment activity and dubbed the new entity Venrock. These managers continued to invest family money on an “evergreen” basis (that is, by re-investing proceeds with no fixed date of liquidation), and the firm continued to focus on science- and engineering-driven enterprises, both in established industries such as electronics and computing (Intel, Apple, and 3Com) and in other catego-ries marked by rapid technological change—in particular, health care.

In the meantime, a new breed of venture capital partnerships emerged. Partners in these firms didn’t invest their own cash, but

rather drew their funding from foundations, trusts, pension funds, and other third-party investors. American Research and Develop-ment (ARD), founded in 1946, was the most influential of these firms. ARD alumni founded other East Coast VC firms, among them Greylock, Morgan Holland Ventures, and Fidelity Ventures. Similar operations sprang up on the West Coast—among them Draper and Johnson Investment Company, Sutter Hill Ventures, Kleiner Perkins Caufield and Byers, and Sequoia Capital. What distinguished these newcomers was a financing model that matched the needs of third-party capital providers: Instead of developing “evergreen” funds, these firms offered “closed-end” funds. Typically, those funds have a nominal 10-year lifetime that requires portfolio companies to go from initial investment to acquisition or IPO within a decade.

The rise of the Internet in the 1990s saw two changes in the venture asset class. First, the amount of money invested in venture funds grew dramatically, from $8 billion in 1995 to $105 billion in 2000, at the height of the Internet bubble. (More recently, that figure has stabilized at $25 billion to $30 billion per year). Second, the investment focus of VCs shifted toward software and Internet companies that require less capital to scale up and produce faster returns than science-driven companies. In other words, businesses like Groupon, Twitter, and Instagram stole the limelight from busi-nesses like Intel, Genentech, and 3Com.

INSIDE THE IDEA-TO-IMPACT GAP

By the early 21st century, the separation of capital along the idea-to-impact continuum was complete. Today, the process of funding science operates within established legal boundaries that delineate how investors interact with nonprofit and for-profit organizations. Nonprofit institutions (including universities) receive grants from government agencies, corporate donations, and private philanthropy to conduct basic science and engineering research. When that research yields ideas (and intellectual property) with commercial potential, for-profit entities step in to license those ideas and to translate them into marketable products. This bifurcated system isn’t equipped to support innovations that have a long time horizon for development.

The energy sector offers a prime example of a technology field that suffers from a lack of early-stage investment. Energy is one of the world’s most important industries, accounting for 10 percent of global GDP. (By comparison, only about 3 percent of global GDP derives from commerce on the Internet.) Yet energy has historically accounted for only 1 percent to 2 percent of venture capital invest-ment. A burst of VC investment entered the energy field in the sec-ond half of the 2000s, when fossil-fuel prices soared, but by 2013 investment had plummeted back to historical levels.

When we look back at earlier radical energy innovations that reached broad deployment, we see that the funding sources that

SARAH KEARNEY is founder and executive director of PRIME Coalition, a nonprofit organization that enables families and foundations to make philanthropic investments that mitigate climate change.

FIONA MURRAY is associate dean of innova-tion and Alvin J. Siteman (1948) Professor of Entrepreneurship at the MIT Sloan School of Management. She is also faculty director of the Martin Trust Center for MIT Entrepreneurship.

MATTHEW NORDAN is cofounder and managing partner of MNL Partners, a firm that develops energy and environmental projects in global markets.

http://www.primecoalition.org

https://entrepreneurship.mit.edu

http://www.mnlpartners.com

http://www.carnegie.org

http://www.rockefellerfoundation.org/

http://www.nationalacademies.org/nrc/index.html

http://www.venrock.com

http://www.bvp.com/about/history

http://lifesciencesfoundation.org/events-The_American_Research_&_Development_Corporation.html

http://lifesciencesfoundation.org/events-The_American_Research_&_Development_Corporation.html

http://www.greylock.com

http://www.fidelityventures.com

http://www.shv.com

http://www.kpcb.com

http://www.kpcb.com

Stanford Social Innovation Review / Fall 2014 53

enabled their development are essentially gone. Nuclear fission origi-nated with the Manhattan Project, an unprecedented mobilization of public money; no comparable stream of government funding ex-ists today. Photovoltaic cells emerged from AT&T Bell Laboratories, a corporate R&D institution; Bell Labs—and similar entities like Xerox PARC—are now just shadows of their former selves.

Recent efforts to reverse this trend have gone only so far. Since 2009, the US Advanced Research Projects Agency-Energy (ARPA-E) has spent more than $800 million to fund more than 350 breakthrough energy technology projects. ARPA-E focuses its grantmaking explicitly on projects with commercial potential. Even so, only a handful of its awardees have been able to raise institutional risk capital to supple-ment their ARPA-E funding.

Most explanations of the science funding gap fail to recognize that the shortfall has two causes: First, compared with software invest-ments, many science-driven investments have a relatively unappeal-ing risk-return profile. Second, and equally important, the financial interests of investors who participate in the innovation process are often not in alignment with the social goals of scientist-entrepreneurs. One venture capitalist, speaking in 2013 at an American Academy of Arts and Sciences roundtable on energy finance, put it this way: “I

will not invest because of climate change. My limited partners expect financial returns within a certain timeframe.”

For-profit investment vehicles for early-stage companies fail to account for investors’ charitable objectives or the potential social re-turns of such innovations. Conversely, tax-shielded charitable funds are rarely used to support for-profit technology companies, even when those companies advance desirable social outcomes. In each case, nei-ther purely philanthropic motives nor purely profit-based motives are sufficient to justify investment. As a result, capital to build companies in areas such as energy, water, and health care remains in short supply.

A NEW ROLE FOR PHILANTHROPY

We believe that a solution to this problem lies in the emergence of a new breed of philanthropic investors—individuals and institutions that aim to bridge the divisions that mark the funding of science today.

Consider the Bill & Melinda Gates Foundation. Over the past half-decade, the Gates Foundation has deployed a considerable amount of capital to bridge the idea-to-impact gap within the health-care field. In 2011, for example, the foundation made a $10 million equity in-vestment in Liquidia Technologies, a for-profit venture that develops and commercializes vaccines that prevent infectious diseases. The

foundation made this transaction as a program-related investment (PRI); for financial and legal purposes, therefore, it counts as a grant. And in 2013, the foundation made a PRI in the Global Health Investment Fund (GHIF), a tra-ditionally structured venture fund that supports medical research and develop-ment. That PRI took the form of a loan guarantee that allowed investors in GHIF to hedge as much as 60 percent of their invested capital, and it helped GHIF raise $108 million.

Following the lead of the Gates Foundation and other pioneering phi-lanthropists, we advocate a model that occupies the space between re-search grants and for-profit risk capi-tal. Of particular interest to us are impact investment approaches that blend philanthropic and financial perspectives. A handful of organiza-tions are already blazing trails at the boundary between nonprofit and for-profit investment in science and engi-neering, and they are pursuing a wide variety of methods. (See “Funding Lab-to-Field Innovation: Pioneering Approaches” on this page.)

The model that we propose will be compelling to a wide range of philan-thropic asset owners. Here, we will fo-cus on charitable foundations. The US Internal Revenue Code requires each foundation to spend at least 5 percent

Funding Lab-to-Field Investment: Pioneering Approaches

FUNDER DESCRIPTION LEGAL STRUCTURE Nonprofit For-Profit

Breakout Labs San Francisco

Breakout Labs makes small grants to science projects that are too speculative for venture capital but also unsuitable for traditional grants. It aims to generate concessionary financial returns as well as social returns.

Private foundation (grantmaking)

Chesonis Family Foundation Rochester, N.Y.

The Chesonis Foundation has made grants to support university-based science and engineering research in energy and the environment. In addition, the Chesonis family and its co-investors have made angel investments in spinout companies that originated in university labs. Those investments, which target clean-tech companies, occur at an earlier stage than venture capital firms are typically willing to invest.

Private foundation (grantmaking)

Angel Investing

Cystic Fibrosis Foundation Bethesda, Md.

The Cystic Fibrosis Foundation invested nearly $75 million to help Vertex Pharmaceuticals, a for-profit biotechnology company, develop a cystic fibrosis drug called Kalydeco. In return, the founda-tion received rights to a royalty on sales of the drug. Following the launch of Kalydeco, the foundation sold part of its royalty rights for $150 million, and it intends to re-invest that money in other projects at large, for-profit pharmaceutical firms.

Public Charity copy

The Harrington Project Cleveland

The Harrington Project encompasses two investment organizations: the Harrington Discovery Institute (nonprofit) and BioMotiv (for-profit). The Harrington Discovery Institute makes grants to support projects by physician-scientists who conduct research on unmet clinical needs. Subsequently, BioMotiv invests in those projects and links them to late-stage commercialization partners.

Public Charity Venture Fund

MIT Deshpande Center for Technological Innovation Cambridge, Mass.

The Deshpande Center, although it is based in a traditional nonprofit setting, focuses on enabling rapid venture creation. Founded with a grant by the Deshpande family, the center awards grants to MIT faculty members whose work has the potential to achieve social and economic benefits. The aim of its grantmaking is to enable researchers to move from the discovery stage to the proof-of-concept and technical prototype stages.

Public Charity (account within MIT)

copy

Village Capital Atlanta

Village Capital runs accelerator programs around the world and acts as a convener of people with an interest in early-stage impact investment. In some cases, those efforts focus on science-based domains such as energy and agriculture. Although Village Capital is a grant-supported nonprofit, it works closely with investors who operate in the for-profit sector.

Public Charity Venture Fund

http://arpa-e.energy.gov

http://www.gatesfoundation.org

http://www.liquidia.com

http://ghif.com

http://ghif.com

http://www.breakoutlabs.org

http://www.duksauce.com/gallery/design/web/cff/index.html

http://www.duksauce.com/gallery/design/web/cff/index.html

http://www.cff.org

http://www.cff.org

http://www.uhhospitals.org/services/harrington-discovery-institute/about/harrington-project-for-discovery-and-development

http://www.uhhospitals.org/services/harrington-discovery-institute/about/harrington-project-for-discovery-and-development

http://deshpande.mit.edu




http://www.vilcap.com

54 Stanford Social Innovation Review / Spring 2014

of its assets annually on efforts to further one or more charitable purposes. (The advancement of science counts as one such pur-pose.) To fulfill the 5 percent mandate, foundations historically have made grants to public charities without an expectation of receiving a financial return. In 2011, grant disbursements from foundations totaled $47 billion.12

Today, however, foundations are increasingly forging impact in-vestment strategies that involve deploying assets on both sides of their house—on the 5 percent side, where grantmaking takes place, and on the 95 percent side, where endowment managers work to preserve foundation capital.

On the endowment side, foundation leaders have begun to apply positive and negative screens to the investments they make. A recently launched movement called Divest-Invest Philanthropy, for example, highlights the power of large foundation endowments to shape social outcomes.13 Citing both ethical and financial reasons, the movement calls on foundations to divest their endowments of holdings in fossil-fuel companies. To date, the dialogue around this movement has focused on avoiding harmful investment activities (“divest”). But no less im-portant, in our view, is the need to support helpful activities (“invest”).

The use of direct investment—often called Mission-Related Investments (MRI)—allows foundations to put the full weight of their assets toward the pursuit of philanthropic goals. (In 2011, the endowments of US foundations were collectively worth an estimated $600 billion.) With an MRI, a foundation uses endowment funds to sup-port a business whose products or services align with the foundation’s mission. As a rule, MRIs promise a market-rate return and therefore meet “prudent investor” requirements. Endowment managers have a fiduciary duty to preserve capital over time, and the US tax code mandates that they refrain from making high-risk investments that might jeopardize the longevity of their foundation. As we have noted, however, many early-stage ventures in science and engineering cannot meet that standard. MRIs offer one tool for philanthropic investors to deploy, but they will not be sufficient to fill the idea-to-impact gap.

THE PROMISE OF PROGRAM-RELATED INVESTMENTS

There is another side of impact investing that has greater potential to close the idea-to-impact gap in science and engineering. By its nature, that gap can be filled only by concessionary investment—by vehicles in which investors concede, or give up, something that they would otherwise expect in return for their money.14

Foundations can make such investments in the form of a PRI. With a PRI, a foundation channels grant funds (that is, money that comes from the “5 percent” side of its operations) to a for-profit company that does “program-related” work. Such work is program-related insofar as it advances a programmatic goal of the foundation. The US tax code requires a PRI to meet a two-part test: The invest-ment must “significantly further” the charitable goals of a founda-tion, and it must be such that the foundation would not have made it “except for [its] relationship” to those goals.15

The concessionary nature of a PRI is not based solely on the magnitude of expected returns. A PRI-making foundation can make concessions according to various investment criteria—the timeline for drawing financial returns, for example, or the perceived market, technology, or regulatory risk of the investment in question. Although it has become the norm to structure a PRI as low-interest debt, doing

so is not a requirement. In any event, the value proposition for phi-lanthropists is clear: Making a grant in the form of a PRI gives a foun-dation a powerful tool for moving critical ideas out of the laboratory and into the commercial marketplace. Even though PRIs come out of grant coffers, they offer a foundation the possibility that it will recoup money that it can redistribute to other charitable causes.

Given this compelling proposition for grantmakers, it is surpris-ing that the use of PRIs to bridge the idea-to-impact gap is not more common. According to the best available data, foundations made fewer than 5,000 PRIs between 1998 and 2010, and together those invest-ments constituted less than 2 percent of total grantmaking. Among those PRIs, less than 1 percent—about 35 in all—went to grantees in science and engineering fields.16 Although few in number, most of those PRIs went to support technology as it moved from a lab environ-ment to commercial development. These data lead us to two conclu-sions: First, PRIs do have the potential to bridge the idea-to-impact gap in science and engineering innovation. And second, there are high barriers that prevent asset holders from using PRIs in this way today.

Some of those barriers are philosophical. Many philanthropists ex-press concern that PRI-making might cross well-defined boundaries and violate important institutional norms. Is it inappropriate to direct grant dollars away from traditional public charities and toward profit-seeking businesses? How can philanthropists and investors ensure that PRIs do not duplicate traditional, finance-first investment activities?

In addition, our research suggests that these barriers arise be-cause of the historic separation of the social logic of philanthropy from the economic logic of endowment management. These two areas of practice are organizationally distinct within private foun-dations: The grantmaking side of a foundation aims to advance a charitable mission by funding programs, whereas the endowment side strives to preserve a corpus of assets. People on each side of the divide have their own affinity groups, their own governing bodies, and their own best practices.

Three barriers related to that separation are worth noting.Mismatch of expertise | PRIs, by construction, require the expertise

of both grantmakers and for-profit investors. But these groups do not have a common language or a common body of expertise. Sourcing deals, conducting due diligence, structuring investment terms, and making board-level strategic decisions for technology start-ups are not activities that grantmakers are trained to do. Money managers, for their part, have little expertise in analyzing the social impact of an investment or the concessionary nature of a financial vehicle. On the contrary, they are trained to focus on financial returns and to follow prudent investing practices.

Legal uncertainty | Another formidable barrier—one that is grounded both in regulatory reality and in the risk-averse culture of the legal community—involves the legal consequences of accepting investment risk. Attorneys are systemically inclined to discourage PRI-making in order to protect their clients, and few attorneys to-day have experience in advising clients on transactions of this kind.

Policy-driven inertia | Many foundation administrators shy away from making grants to recipients other than public charities. After the Tax Reform Act of 1969, which tightened the tax rules that ap-ply to the philanthropic sector, US foundations began to avoid risk-taking behavior and settled into a routine in which the easiest grant to make is a general-purpose grant to a public charity.17

Stanford Social Innovation Review / Fall 2014 55

Given the urgent nature of global problems like climate change, water scarcity, and poverty—and given the need for science- and technology-based solutions to those problems—we believe that taking action to break down these barriers is imperative.

AN AGENDA FOR PHILANTHROPIC INVESTMENT

The idea-to-impact gap should matter a great deal to the individuals, families, corporations, and foundations that have already invested in science, engineering, and medicine. It should matter to any investor who yearns for real-world results. And it should matter to the bil-lions of people affected by a lack of electricity, an absence of clean water, a changing climate, an inefficient manufacturing sector, and the persistence of diseases like cancer and dementia.

As scientists, funders, and other stakeholders explore various forms of philanthropic investment, some parts of their journey will be straightforward. Within the university-philanthropy complex, structures already exist to find good ideas in university labs, to cre-ate entrepreneurial start-ups, and to partner with government agen-cies and large corporations in supporting those young companies.

But the work of expanding access to much-needed risk capital will be more complex. That is where pioneering needs to happen. Our hope is that leaders will emerge who have the courage to explore this new territory where impact investing overlaps with funding for science. Here, we offer an initial agenda for those leaders to follow.

■■ Entrepreneurs need to educate themselves about the decision-making processes and legal constraints that are unique to phil-anthropic asset owners. Appealing to that group of funders requires a different approach from the one that they use in pitching to traditional venture capital firms.■■ Asset owners need to collaborate with each other in order to aggregate funds at a sufficient scale. Collaboration at this level is especially crucial in domains that have certain common ele-ments: large charitable goals, a misalignment with the struc-ture of traditional venture capital, and the potential for mar-ket adoption of commercial products. PRIME Coalition, an entity that we are helping to lead, is one such effort. It is a net-work of philanthropists who share an interest in market-based solutions to climate change. That model, we believe, holds promise not only in the climate field, but also in other areas that depend on advances in science and engineering.■■ Scholars need to refine the vocabulary of impact investment so that investors and other stakeholders can untangle the various policy, tax, and accounting issues that affect this emerging field.18

■■ Investment managers need to be willing to move from one com-pensation structure (in which they receive management fees and carried interest) to another (in which they receive budget-based salaries and impact-based bonuses). Likewise, grantmak-ers need to be willing to pay top salaries for high-quality talent.■■ Impact investment intermediaries need to acknowledge the importance of science and engineering. They need to build impact measurement regimes around projects that fall be-tween the traditional categories of charity and investment. And they need to expand their focus from the deployment of proven technologies to the development of technologies that are unproven but highly promising.

In 2013, Sir Ronald Cohen and William A. Sahlman put forth a striking claim: “Social Impact Investing Will Be the New Venture Capital.” They called on impact investors to find the same courage that the early institutional backers of the venture capital industry displayed, and they offered a vision of how investors could enable progress on social issues while also delivering financial returns.19 Our proposal is a concrete response to that broad agenda. Also in 2013, Peter Buffett issued a bold call to his fellow philanthropists. He urged them to “[try] out concepts that shatter current structures and systems.”20 Although Buffett made no mention of science and engineering innovation, we believe that building a philanthropic bridge between the ivory tower and traditional capital markets would meet the standard that he set. In that spirit, we encourage philanthropists of all stripes to pioneer new forms of philanthropic investment—new approaches that support the kind of innovation that the world desperately needs. ■

NOTES

1 Jason Pontin, “Why We Can’t Solve Big Problems,” MIT Technology Review, November- December 2012.

2 Eric M. Meslin, Alessandro Blasimme, and Anne Cambon-Thomsen, “Mapping the Translational Science Policy ‘Valley of Death,’” Clinical and Translational Medicine, 2, 2013.

3 Members of the 2005 “Rising Above the Gathering Storm” Committee, Rising Above the Gathering Storm, Revisited: Rapidly Approaching Category 5, Washington, D.C.: The National Academies Press, 2010.

4 Erika Check, “NIH ‘Roadmap’ Charts Course to Tackle Big Research Issues,” Nature, October 2, 2003; House of Commons Science and Technology Committee, “Bridging the Valley of Death: Improving the Commercialisation of Research,” House of Com-mons (United Kingdom), March 4, 2013.

5 Bruce Gibney, “What Happened to the Future?” Founder’s Fund, January 7, 2014, http://www.foundersfund.com/uploads/ff_manifesto.pdf

6 Howard S. Miller, Dollars for Research: Science and Its Patrons in Nineteenth-Century America, Seattle: University of Washington Press, 1970.

7 Waldemar A. Nielson, The Golden Donors: A New Anatomy of the Great Foundations, New York: E. P. Dutton, 1985.

8 Robert E. Kohler, “Philanthropy and Science,” Proceedings of the American Philosophical Society, 129, 1985.

9 Ibid.

10 Thomas J. Billitteri, “Donors Big and Small Propelled Philanthropy in the 20th Century,” The Chronicle of Philanthropy, January 13, 2000.

11 Fiona E. Murray, “Evaluating the Role of Science Philanthropy in American Research Universities” (working paper), National Bureau of Economic Research, June 2012.

12 Antony Bugg-Levine and Jed Emerson, Impact Investing: Transforming How We Make Money While Making a Difference, San Francisco: John Wiley & Sons, 2011.

13 Ellen Dorsey and Richard N. Mott, “Philanthropy Rises to the Fossil Divest-Invest Challenge,” Huffington Post, January 30, 2014, http://www.huffingtonpost.com/ellen-dorsey/philanthropy-rises-to-the_b_4690774.html

14 Paul Brest and Kelly Born, “Unpacking the Impact in Impact Investing,” Stanford Social Innovation Review, August 14, 2013, http://www.ssireview.org/articles/entry/unpacking_the_impact_in_impact_investing

15 “Program-Related Investments,” US Internal Revenue Service, http://www.irs.gov/Charities-&-Non-Profits/Private-Foundations/Program-Related-Investments

16 Sarah J. Wood, “The Role of Philanthropic Capital in Entrepreneurship: An Empiri-cal Analysis of Financial Vehicles at the Nonprofit/For-Profit Boundary of Science and Engineering,” master’s thesis, Massachusetts Institute of Technology, 2012.

17 John R. Labovitz, “1969 Tax Reforms Reconsidered,” in The Future of Foundations, The American Assembly, 1973.

18 Brest and Born, “Unpacking the Impact in Impact Investing.”

19 Sir Ronald Cohen and William A. Sahlman, “Social Impact Investing Will Be the New Venture Capital,” HBR Blog Network, January 17, 2013, http://blogs.hbr.org/2013/01/social-impact-investing-will-b

20 Peter Buffett, “The Charitable-Industrial Complex,” The New York Times, July 27, 2013.

http://www.technologyreview.com/featuredstory/429690/why-we-cant-solve-big-problems/

http://www.clintransmed.com/content/2/1/14

http://www.clintransmed.com/content/2/1/14

https://www.uic.edu/home/Chancellor/risingabove.pdf

http://www.nature.com/nature/journal/v425/n6957/full/425438b.html

http://www.publications.parliament.uk/pa/cm201213/cmselect/cmsctech/348/348.pdf

http://www.publications.parliament.uk/pa/cm201213/cmselect/cmsctech/348/348.pdf


http://www.amazon.com/Dollars-research-Science-patrons-nineteenth-century/dp/0295950587

http://www.amazon.com/Dollars-research-Science-patrons-nineteenth-century/dp/0295950587

http://www.amazon.com/Golden-Donors-Anatomy-Great-Foundations/dp/0765809125

http://www.jstor.org/stable/986975

http://philanthropy.com/article/Donors-BigSmall-Propelled/50895/

http://philanthropy.com/article/Donors-BigSmall-Propelled/50895/

http://www.nber.org/papers/w18146

http://www.nber.org/papers/w18146

http://www.amazon.com/Impact-Investing-Transforming-Making-Difference/dp/0470907215

http://www.amazon.com/Impact-Investing-Transforming-Making-Difference/dp/0470907215

http://www.huffingtonpost.com/ellen-dorsey/philanthropy-rises-to-the_b_4690774.html

http://www.huffingtonpost.com/ellen-dorsey/philanthropy-rises-to-the_b_4690774.html

http://www.ssireview.org/articles/entry/unpacking_the_impact_in_impact_investing


http://www.irs.gov/Charities-&-Non-Profits/Private-Foundations/Program-Related-Investments

http://www.irs.gov/Charities-&-Non-Profits/Private-Foundations/Program-Related-Investments

http://dspace.mit.edu/handle/1721.1/78503




http://blogs.hbr.org/2013/01/social-impact-investing-will-b/

http://blogs.hbr.org/2013/01/social-impact-investing-will-b/

http://www.nytimes.com/2013/07/27/opinion/the-charitable-industrial-complex.html

24 APR 2014 - ASHBY MONK

Impact Investing: Six Principles forEffecting Change and Returns

Impact investing would seem to be a hot topic these days. For example, this very

magazine has run at least four different articles on the subject in the past few

months (see here, here, here and here). Also, my very own research center was

recently given a multi-year research grant to try to make sense of the impact

industry. In short, there’s a lot that’s going on, but there’s also a lot missing, such as

a consensus around definitions of impact investment or even an understanding of

the impact investment ecosystem. So, grab a cup of coffee and a biscuit and let me

tell you what I think about impact investing, and why I believe it could be a very

powerful force for positive change in the world.

The broad idea of impact investing — at least the version of impact investing that I

can get behind — seeks to leverage capitalist means to achieve social and

environmental ends. Put simply, it uses financial investments to drive extra-financial

outcomes. In my mind, impact investing in its most elegant form resembles artfully

executed judo; it works within capitalism’s institutions and organizations

and leverages its own power to undo the problems that capitalism itself helped to

create. After all, if you’ve got a global problem to solve, why not tap the same force

that gave us globalization?

Admit it, that’s at least a little bit compelling, and it’s also not unfathomable. We

know that capitalism in the right hands can drive profound impact. After all, every

investment — every single one — has an impact of some form or another on

somebody or something. It’s just that some of those investments will wind up also

Impact Investing: Six Principles for Effecting Change and Retur... http://www.institutionalinvestor.com/Popups/PrintArticle.aspx?A...

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having positive social or environmental impacts (externalities). Silicon Valley, where

I live, has launched companies that help bring down dictators (Facebook,Twitter);

that change the way we consume energy (Tesla, Nest, Opower); that help manage

scarce resources through unique insights (Climate Corp, OpenGov, Palantir); that

create a more sustainably built environment (Solar City, Clean Power Finance,

Project Frog); or provide access to the final frontier (SpaceX). It’s in this sphere that

I think impact investing can be most powerful.

Now, there are those that view impact investing as a sort of middle ground between

charity/philanthropy and the icy-veined, take-no-prisoners business of Wall Street.

Viewed in this light, however, impact investing becomes "‘fence-sitting" — a way to

recycle capital without giving it all away or giving up on ethical objectives. But rather

than viewing this as impact investing, I’d say this is really impact indecision. There

are also those that want to think that institutional investment in infrastructure counts

as impact investing, and, in general, I’m fine with that; infrastructure is immensely

powerful in terms of its impact on communities. But is that really what we mean

when we say impact investing? Infrastructure?

In my mind, impact investing is about catalyzing companies and industries that

generate positive social and environmental outcomes (without negative secondary

or tertiary effects), while also positioning to profit from their rise and impact. With

this in mind, I’ve pulled together some key principles that reflect my current, though

not fixed, thinking:

*Catalyze: Impact investors should look for opportunities to create new companies,

markets or industries. This can be done in simple ways, such as bridging a

company across a funding gap or signaling to the world that an opportunity is

investable (simply by investing in it as a credible party). The best impact

investments are those that identify "titration" opportunities; this refers to a chemical

reaction where a solution suddenly switches from being acidic to basic after a

reagent is added. There exists in the world opportunities where a few impact dollars

(the reagent) can change an entire environment (solution) from un-investable to

investible (acidic to basic). And once it’s investable, the power of capitalism can

take it forward to the marketplace.


2 of 6 4/21/15, 9:26 AM

*Optionality: If you do catalyze a new industry or help bridge a company across the

"valley of death," why wouldn’t you want to participate in the upside? As I see it,

impact investors have to be adept investment bankers, putting creative transactions

together that allow for different risk appetites and lots of optionality along the way.

*Deadweight Loss: Impact investors should avoid doing things that either the

government or the free market would do on their own. If impact dollars are there to

be catalysts, there’s really no social or environmental value in catalyzing something

that would have happened anyway.

*Unintended Consequences: Impact investors should learn from the failures of

government and capitalism and try not to make short-term decisions that lead to

long-term problems. It’s a relatively simple concept that warrants lots of scenario

planning.

*Profits: Different pools of capital will have different return objectives. And I

definitely see the value of philanthropic capital that has relatively low or even no

return objectives. (In fact, some would say this capital is the most valuable to

society.) But my personal opinion is that impact investors should not, a priori, take a

hit to their financial returns or underwriting. Why? Because if they are trying to use

capitalism to maximize impacts beyond the capitalist system, then high financial

returns for impact investments are crucial. To me, that implies rapid growth of a

socially or environmentally positive company, therefore, returns.

*Rigor: Impact is not an excuse for a lack of rigor in investments. In fact, if you’re

going to try to use financial markets to drive extra-financial benefits, you need to be

more rigorous and savvy than the average investor. Or, at the very least, you better

understand your strengths and weaknesses very well.

So how can you do all of this? As I see it, the best way to combine all of the above

themes is to get involved with small- and medium-sized enterprises (SMEs) and

then work hard to have a real influence on their future trajectory. You help the good

ones succeed commercially. You push the ones that are ambivalent about impact to

integrate impact thinking into their day-to-day operations. And as for the ones that


3 of 6 4/21/15, 9:26 AM

are potentially going to play a negative role in society, you roll up your sleeves and

push them (hard) to pivot — and in return for pivoting, you help them succeed.

And you only do these things in sectors where you are highly credible and carry

influence. Could impact investors have an influence on large companies? Sure. For

example, private equity shops have big impacts on medium and large corporations

– it may not be the kind of impact you’d like to see, but their impact is undeniable.

For the rest of us, focusing on small- and medium-size opportunities may be the

best path. Doing this demands a new set of investment logics and tools. For

example, you need to catalogue the areas where you feel you can add value and

indeed influence SMEs. And then you need to identify companies or opportunities

where you can personally (or organizationally) influence outcomes. And then you

need to get to work.

So, that’s my vision for where impact investing can truly have an impact. This raises

a question: Why aren’t more people within the impact investing universe talking

about this sector in these kinds of terms? It’s a tough question and the answer won’t

make me make me many friends in the mainstream finance world (not that I have

many at this point anyway).

As I see it, most impact investors don’t really understand what they are trying to

accomplish. They don’t understand the business of finance and investment. In fact

they are often frustrated by the finance industry and the role it has played in creating

short termism and negative externalities. And, yet, they still often revert back to the

traditional finance industry for help in this domain. Check out this actual blurb from a

recent article describing the amazing opportunity that impact investing represents:

"There are a number of big players on the scene to help understand where your

impact investing can be most successful. Among these are investment firms such

as JPMorgan Chase, Goldman Sachs, and Morgan Stanley, which have dedicated

staff to advise on impact investing." Ugh. Really? Oh I bet they do have dedicated

staff. And plenty of fees.

Most of the financial intermediaries I see in today’s impact investment ecosystem

aren’t really in the business of driving impact; they are in the business of selling


4 of 6 4/21/15, 9:26 AM

product. It just so happens that slapping an impact label on their product seems to

create higher demand and thus allows for higher margins. (See "organic" in the food

business as a similar case.) But don’t kid yourself; the powers-that-be at the big

Wall Street banks didn’t get to be where they are by pushing for more social and

environmental appreciation. These banks are moving into impact investing because

it’s very profitable for them to do so. And what frustrates me about this is that the

impact dollars going to these banks are diverted away from real impact

opportunities, as I’ve described above.

Anyway, this has gotten to be a very long post, so let me stop here with some final

thoughts:

*Beware of bankers slangin’ products that claim to deliver impact. Those products

probably don’t create the kind of impact that you want (especially when you

consider the secondary and tertiary impacts of the access point).

*Every investment — every single one — has an impact of some form or another on

somebody or something. All investing is impact investing; it’s just a matter of

understanding what that impact is, where the attribution lies and how certain types

of impacts can be prioritized over others. (Are you part of the Rebel Alliance? Or are

you working for the Empire?)

*Impact investing isn’t hard. But it is time consuming. There’s no such thing as a

passive impact investor — don’t let the banks fool you. Sending your money to Wall

Street in the hopes of creating enduring social and environmental change in the

world is... foolhardy.

*Add value to companies that are good (helping them reach commercial scale) and

help companies that are bad pivot before it’s too late. Don’t let those companies that

are ambivalent stay that way.

Do all of those things and you’ll be an impact black belt in no time...


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About the Global Project Center

The Stanford Global Projects Center (GPC) is an interdisciplinary research center at Stanford University that seeks to facilitate understanding of the financing, developing and governance of strategic assets that underpin dynamism and competitiveness in today’s global economy. The GPC conducts interdisciplinary research on the many “projects” to develop these strategic assets and facilitates engagement among academic, governance and industry leaders. GPC also provides education to current and future leaders.

VISIONWe believe the evolving global economic and financial geography requires innovative

mechanisms for financing, developing and governing strategic assets to ensure dynamism and competitiveness in today’s global economy.

MISSIONTo collaborate with government and industry in pursuit of the necessary insights to

develop and sustain strategic assets, both physical and intellectual, through projects that are core to modern economic growth and development.

OBJECTIVESTo conduct research that informs and advances our vision and mission. To facilitate

engagement among government, industry and academic leaders to improve the financing, development and governance of strategic assets. And to provide education

to current and future leaders.

Management Team

Dr. Ashby Monk Executive [email protected]

Dr. Ashby Monk is the Executive and Research Director of the Stanford Global Projects Center. He is also a Senior Research Associate at the University of Oxford and a Senior Advisor to the Chief Investment Officer of the University of California. Dr. Monk has a strong track record of academic and industry publications. He was named by aiCIO magazine as one of the most influential academics in the institutional investing world. His research and writing has been featured in The Economist, New York Times, Wall Street Journal, Financial Times, Institutional Investor, Reuters, Forbes, and on National Public Radio among a variety of other media. His current research focus is on the design and governance of institutional investors, with particular specialization on pension and sovereign wealth funds. He received his Doctorate in Economic Geography at Oxford University and holds a Master’s in International Economics from the Universite de Paris I - Pantheon Sorbonne and a Bachelor’s in Economics from Princeton University.

Professor Raymond Levitt [email protected]

Dr. Raymond Levitt earned his BSCE at Witwatersrand University and his MSCE and Ph.D. at Stanford University. He served on the MIT CE faculty from 1975-80 before moving to Stanford in 1980. Ray teaches undergraduate, graduate and executive education classes in strategy, organization design and governance for development of capital facilities and other project-based endeavors. Ray’s Virtual Design Team (VDT) research group has developed new organization theory and computer simulation tools to optimize the execution of complex, fast-track, projects and programs. His current research focuses on governance of private-public partnerships for development and delivery of infrastructure services. In 1988, he co-founded and was the initial Director of Stanford’s Center for Integrated Facility Engineering. He founded, and serves as Academic Director of, Stanford’s Advanced Project Management Executive Program and The Collaboratory for Research on Global Projects. The SAPM program now has more than 2500 alumni and is recognized internationally as the premier executive program for strategic project and portfolio management. Ray has supervised dozens of dissertations, written more than 100 scholarly papers, launched two major research centers and three software companies. He was elected to the rank of Distinguished Member of ASCE in 2008. In 2009, Governor Schwarzenegger appointed Dr. Levitt as one of the initial commissioners for the State of California’s Private Infrastructure Advisory Commission.

Michael Bennon Managing [email protected]

Michael Bennon is a Managing Director at the Stanford Global Projects Center, developing new initiatives for the GPC and managing our student programs and industry affiliations. Michael’s research areas of interest for the center and work experience are in Public Sector finance, infrastructure and real estate investment, and project organization design. Michael served as a Captain in the US Army and US Army Corps of Engineers for five years, leading Engineer units, managing projects, and planning for infrastructure development in the United States, Iraq, Afghanistan, and Thailand. Michael received a bachelor’s degree in Civil Engineering from the United States Military Academy at West Point and received an MSCE and MBA from Stanford University.

Peter Clark Project [email protected]

Peter Clark is Project Manager at the Stanford Global Projects Center (GPC). In his role with the center, Peter develops new initiatives for the GPC and manages interdepartmental projects and relationships. Peter’s research interests include frontier finance, investment operations and organizational strategy, and investment innovation. Peter leads research projects regarding novel approaches to the design and management of institutional investors, as well as new research involving investing for impact. Prior to his employment at the GPC, Peter helped create the Institutional Investor’s Sovereign Wealth Center, an independent provider of intelligence on sovereign wealth and development funds. Peter has also held positions at leading management and investment consultancies, as well as global strategy and macroeconomic forecasting firms. Peter holds a Masters in Business and Financial Management from the University of Cambridge’s Judge Business School, and a first class Bachelor’s in English from Queen Mary, University of London.

Terra Strong Research Program [email protected]

Terra Strong is Research Program Administrator at the Stanford Global Projects Center (GPC). Terra received a bachelor’s degree in Multimedia and Information Technology from George Mason University in Fairfax, Virgina and completed academic placements at organizations including the National Geographic Channel, Clear Channel Radio, and a PBS-production company. Prior to working at the GPC, Terra led SEO and social media campaigns for global brands at a web marketing agency in Emeryville, CA, building on her experience supporting development initiatives at non-profit organizations central to Washington D.C. and California.

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