Catching the wave

CalPERS, the largest pension fund in the US, has announced its latest investments under its Green Wave initiative. But, as John Sterlicchi reports, there’s much more to come

It’s early days, but the ambitious multipronged initiative by the California Public Employees’ Retirement System (CalPERS) to add a tinge of green to its massive portfolio of investments is taking shape.

It was back in February 2004 that California state treasurer – and now a candidate for governor – Phil Angelides introduced the ‘Green Wave’ initiative, to "bolster financial returns, create jobs and clean up the environment".

Since then, staff at CalPERS – one of the largest pension funds in the world – have been working to make the initiative a reality. And, on each of the four aspects of the initiative, which cover private equity, public equity, real estate and corporate governance, there is progress to report.

At the end of March, CalPERS announced that it has allocated $185 million of the $200 million it had resolved to invest with venture capital funds to invest in environmental technology.

This follows the announcement, late last year, of the five public equity money managers to whom CalPERS has awarded $500 million of mandates to be managed in stock portfolios that are screened for their environmental friendliness.

Distant view: climate change and oil "will make winners and losers of investors"

In its vast real estate portfolio – worth $5 billion – CalPERS is committed to cutting the energy its holdings use by 20% over five years. In mid-April, it received its first annual update, showing that reported usage was down by 6.9%.

CalPERS is also using its muscle on the corporate governance front, putting pressure on companies to reveal corporate environmental liabilities and improve transparency and disclosure of environmental impacts. In March, it announced it was beefing up its efforts to gather information on corporate production of greenhouse gases (GHGs) and other environmental threats. It is particularly focusing on companies in the transportation, utilities, and oil and gas sectors that fail to meet minimum standards of environmental data disclosure.

It also will follow a new corporate governance guideline to back shareowner proposals for the reporting of environmental risks – especially those associated with climate change. In the past few months, CalPERS has supported shareowner resolutions requesting management at Ford and General Motors to shed light on environmental liabilities.

"We will strongly support shareowner resolutions at individual companies to address environmental impacts," said Charles Valdes, chair of CalPERS investment committee. "In the long run, we believe it’s possible to do well in business by doing what’s good for the environment."

Also, CalPERS is trying to increase transparency as a member of the Carbon Disclosure Project (CDP), which represents 211 institutional investors managing $31 trillion in assets.

The CDP surveys the world’s biggest companies asking for the disclosure of investment-relevant information concerning climate change risks and opportunities. It has just sent out its fourth iteration of its survey to 1,800 companies in Europe, Asia, Australasia and North and South America.

Winston Hickox, the CalPERS portfolio manager for the environmental initiative, notes that, as the CDP has gone through each iteration, the level of responsiveness has risen. The CDP reports that more than 70% of the FT500 companies sent the third CDP information request responded, a jump from 59% in CDP2 and 47% in CDP1.

And more than 90% of the 354 responding FT500 companies flagged climate change as posing commercial risks and/or opportunities to their business.

It is those risks and opportunities that align CalPERS’ groundbreaking environmental initiative with its fiduciary responsibilities to its 1.4 million members, Hickox says.

"I am often asked why is CalPERS undertaking these environmental initiatives," he explains. "Here’s a simple answer I give at every opportunity to respond. The [CalPERS] board and the senior staff at the investment office all firmly believe that it is very much their fiduciary responsibility to understand risk, manage it, mitigate it and – on many occasions – find opportunity in the exposure to risk."

Of particular concern to Hickox are two particular environmental risks: the first being climate change; and the second being the fact that the global supply of oil has peaked, or is about to. The world is entering a period of time that may be unprecedented in terms of risk for investors on a global scale, Hickox believes. Climate change and ‘Peak Oil’ "will quickly make winners and losers of countries, of

CalPERS is using its muscle on the corporate governance front, putting pressure on companies to reveal corporate environmental liabilities and improve transparency

companies and, most assuredly, of investors," he says. CalPERS aims to take advantage of these upheavals to make money but hopefully, along the way, also improve the environment.

However, while the sums of money involved may look significant, they account for a tiny proportion of CalPERS assets. The fund runs an $11 billion private equity portfolio, and manages a total of $207 billion in assets. According to Hickox, CalPERS "is simply probing an area that appears to have promise in the future because of the demand for new clean technology, particularly in the clean and renewable energy arena. If we dip our toe in the water early and learn about the space, we think we will be better investors as a result".

Indeed, some of the recipients of CalPERS’ dollars argue that the initiative will have influence beyond the sums of money involved. "I think the main thing that [CalPERS] brings is trying to be a knowledgeable investor and setting an example for other long-term investors; pension funds, foundations, etc of the importance of the sector," says Peter Grubstein, a founder and managing partner at NGEN Partners. His VC firm – one of the six chosen by CalPERS in the private equity arena – specialises in providing capital for materials and ‘cleantech’ innovations.

NGEN has wasted no time putting the CalPERS cash to work, using some of it in its last four investments. They are Sensicore, which developed a ‘lab-on-a-chip’ multi-sensor device for a variety of water and wastewater applications; Renaissance Lighting, which has a proprietary optical design which produces superior fixtures for light emitting diodes and conventional lighting; Textronics, which is developing ‘smart’ textiles, such as a sports bra that has a heart monitor woven into it; and CerOx, which designs onsite hazardous waste treatment systems using a proprietary electrochemical cell technology.

Grubstein’s assessment is echoed by David Lincoln, managing partner at the recently formed DFJ Element Fund – set up by leading technology VC house Draper Fisher Jurvetson – which was just about to announce its first investment as Environmental Finance went to press. "I think [the CalPERS initiative] is very important to the funding of companies in this area, not only because of the capital that is brought to the table, but also that they made a public announcement of their interest in technology in this area.

"They are such a well known and important investor I think it gives great validation of the strategy that we are going after. I think that has really helped in the eyes of other investors," he says. "CalPERS is clearly in this to make money and I think that they have done a lot of research around the opportunity and decided to invest."

The remaining four operations that CalPERS has entrusted with its cash are:The Carlyle Group’s Riverstone Renewable Fund; Paladin Private Equity Partners; Rockport Capital Partners, and Vantagepoint Venture Partners.

However, the commitment of the last of the $200 million will not be the end of the story in terms of CalPERS involvement in private equity, believes Hickox. Several different options are under consideration. One is the possibility that CalPERS acts as lead investor in a fund-of-funds investment that would provide a vehicle for smaller US pension funds to participate in the cleantech sector.

Hickox says there is a fair amount of interest in what CalPERS is doing from smaller funds, particularly in the US north-east. "Because of our size and resources, we are able to do an enormous amount of due diligence … for some of these other, more modest- sized funds, it is a little bit more difficult and it is taking them longer."

A decision will be made on the project later this year. "Of course, it is the CalPERS board’s decision to allocate more money to the

California state treasurer Phil Angelides – introduced Green Wave of environmental investment

space," he says. He believes the funds are waiting to see a track record from CalPERS so that they can judge better whether the returns are there. That, however, could take years, as is often the case with early-stage investments.

"I expect in the next year or two – which I consider fairly near term – we are going to see a fair amount of involvement from other funds," he says. And he plans to offer them advice about how they can emulate the CalPERS strategy.

On the public equity front, CalPERS has picked the five money managers for the $500 million that will be invested. According to an independent evaluation of the selections, carried out by investment advisory firm Wilshire Consulting, while "the depth of belief in environmental investing varies from firm to firm, it is clear that each has given considerable thought as to how to successfully implement those beliefs within the investment management processes".

For example, State Street Global Advisors uses ‘eco-efficiency’ ratings from its affiliate Innovest Strategic Value Advisors, which it applies to each company in its investable universe of US and international companies.

Much less specific is AXA Rosenberg, which tries to find under-valued companies in an ‘environmentally-friendly’ universe of US stocks.The company declines to provide further details about its investment approach.

The other money managers are Brandywine Asset Management, New Amsterdam Partners and Piper Jaffray.

In addition, starting in March 2005 CalPERS has made several investments, totaling $75 million, in the Barclays Global Investors iShares KLD Select Social Index Fund, which tracks an index of large-cap US stocks chosen by SRI research house KLD Research & Analytics.

CalPERS is very much a passive investor in the public markets and the pension fund leaves it up to the money managers to hit their return-on-investment targets. If they don’t their contracts are terminated, says Hickox, who adds that it is much too early to judge the financial performance of the environmental investments.

"We watch them; and monitor them carefully and if we are unhappy with the performance we fully expect to make a decision to part company, if they are not performing as expected. It doesn’t happen that often, but it happens often enough that everyone understands our intentions," says Hickox. But, in addition to the existing Green Wave initiative, Hickox sees CalPERS getting involved in other, still unannounced, investments. On the real estate front, the pension fund may put money into ‘green’ Real Estate Investment Trusts, or even look at timber investments from a new perspective, incorporating the potential value enhancement from carbon sequestration initiatives.

He says there may be a "fixed income play" financing renewable energy projects, particularly in California, where a state law requires that 20% of its energy must come from renewable sources by 2017. "I think we can invest prudently in that area as well," he says.