Meet the Expert - Alessandro Panerai

Meet the Expert, is a Primo Ventures format exploring boiling topics with industry experts.
______________________________

Alessandro Panerai, experienced alternative assets Investor, shared with us his point of view on climate finance and ESG frameworks.

1. Sustainability and investments, a lot has been said. But what does everyone overlook when it comes to sustainable investments?

Climate finance started to emerge in the early 2010s, and it has since then become a recurring theme. In 2012, I joined the world of strategy consulting and I witnessed the ascent of climate finance through the first ESG and climate funds strategies alongside due diligence activities for Private Equity funds (on which I worked). However, the ecosystem surrounding this new topic was evolving in a randomic way.

While there was growing pressure for individuals and entities to align with the concept of climate finance, nobody was conducting an educated exercise of what climate finance really was nor which areas would be the most impactful ones to invest in. Few were investigating which areas we should have doubled down on or if there were existing technologies that could have been applied to the finance industry to make it more sustainable.

Many sought for shortcuts, trying to get the climate finance label without genuine foundational work.

Relatively quickly, financial institutions and banks were compelled to introduce ESG-related products. This rush, however, prompted the adoption of arbitrary methodologies to classify assets as falling within the ambit of climate finance. This collective behavior caused a race to the average, which only prompted shortcoming and drawbacks, both in terms of expected appraisal by the larger audience and relevance of the solutions created.

As a result, this new wave of ESG products was randomic and not substantially correlated to the broader concept of sustainability. Investors became skeptical. Some started to point out at greenwashing, while others bandwagoned without asking further questions, coming soon to the realization of the unsatisfactory nature of these new products, both in terms of impact and actual results.  At the end of 2010s, the first climate-oriented funds began surfacing in the alternative investments’ market, providing a countermeasure to this race to the average. This is how the first wave of influential players within this sector started to emerge (i.e.Contrarian Ventures, Giant Ventures…).

Soon after, a similar phenomenon began unfolding within private markets. In just a couple of years, hundreds of funds were created, claiming to be somewhat related to climate finance. However, yet again, the majority overlooked what this connection truly meant, failing to identify the areas most impactful in the sustainability game, and thus most relevant to focus on. At the time, many new generalist funds materialized, making the space crowded quickly. They were investing randomly in all kinds of climate solutions, but with a focus on such a broad range of solutions the challenge of expertise deficiency became really apparent. Only a select few, and not as-fast-growing, verticalized funds were steadily emerging. 

It remains imperative to identify the areas that are the most important to double on under the sustainability umbrella. The Drawdown Project is a publication that undertakes exactly this endeavor: it identifies the numbers related to the climate domain to discern pivotal problems and sectors that are most contributing to the climate crisis to then pinpoint the most promising solutions to address these concerns. Despite its existence, this framework has not been applied yet to the realm of investment decisions.

To conclude, in the past decade, a lot has been done by interested parties to be in the market without first defining the market itself and its most pertinent sectors. A lot of effort was placed on constructing taxonomies, even at the European level. This focus however overshadowed the need for a deeper focus on quantitative evaluations that can define the impact of potential solutions or the identification of the most efficacious investment avenues. Randomness is not yet gone.

2. In terms of the near future - do you see this market become more structured ?

Public markets

When it comes to public markets, not much has been happening in terms of ESG practice structuring. Most generalistic products lack a distinct investment thesis when it comes to sustainability. Simply put, the companies selected for investment are just chosen through a somewhat defined ESG score sheet. The fund does not proactively analyze which ones are the best to pick from a sustainable impact perspective. Exceptions, of course, exist.

Nowadays, several software platforms and data providers offer their own framework defining what ESG is and what it is not. However, each software platform employs its own methodology, contributing to the lack of any industry structure or standardization.

And that is why the remedy to this randomness should not come from the software or data providers but rather from the corporate managers. They should research and outline which sectors we should double down on when it comes to sustainability and provide the rationale for such decisions.

What is happening right now in the public markets is positive but it is not a final solution.

Sustainable investments are being democratized, especially thanks to the proliferation of ETFs vertical on sustainability, often oriented on more specialized sub-sectors such as food, water, or biodiversity. Nevertheless, this is only the starting point of a longer trajectory.

Private and Alternatives Markets

In the private and alternative assets market each asset class advances at its own distinct pace.

Real Estate (RE) and Infrastructure have already matured a lot when it comes to sustainable assets. There are, in fact, many Infrastructure funds or project finance structures that provide investors with capital intensive opportunities ranging from renewable energy ventures to water projects and beyond. The same applies to the RE asset class, where sustainable RE funds or sustainable RE projects continue to emerge steadily.

With Private Equity there were a few instances of greenwashing, especially during the inception of this phenomenon. At first, there weren’t many funds venturing seriously into climate-related assets. That was because, in the end, investing in this new category was seen as punitive. The reason being that it was tough to assess if something was truly sustainable or not: in many cases the overarching purpose or objective of a company was assessed as sustainable but then its modalities or actual practices were discovered to be polluting or environmentally detrimental. Other companies were doing good on the environmental side of things but lacking in the social compartment. Overall, conducting a true and in-depth sustainability assessment could have had a boomerang effect for the PE firm, because of the complexity of each peculiar situation and all the intricacies that had to be considered during buyout due diligence.

Nowadays, some funds are trying to position themselves as climate-oriented funds while others are launching climate-centric vintages, albeit largely for marketing purposes (i.e. raise money). PE remains an unclear space when it comes to position itself in the sustainability landscape.

The Venture Capital (VC) segment is a crowded market. As a result, differentiation is key for each company’s identity and success. Being verticalized on climate (or deeptech) is becoming a tool to do so.

Now it is a good moment to be a fund specialized in sustainability because the structural tail wings are already in place. Furthermore, if you are investing in early-stage companies you can bet that the sector is going to expand significantly in the next 10 years.

Additionally, a considerable amount of money will be funneled in this vertical because of the regulatory incentives that are emerging. Although climate tech currently commands a relatively small fraction of the financial market (around 1 to 2% of the total), it is virtually certain that this figure will experience substantial growth in the foreseeable future.

3. What’s your investment philosophy? What are the values and criteria that guide your activities when it comes to financial decisions?

When it comes to these decisions I tend to put my entrepreneurship glasses on and I value investors by education.

When I have to choose companies instead, I look for very high quality at very discounted or equitable valuations.

Naturally, this prompts the question of why venturing into VC then? Within this asset class I tend to promote EBITDA-positive companies (i.e. Bending spoons, Poke House), therefore companies that are inherently sustainable because they are growing by themselves, without necessitating capital infusions.

When choosing VC investments I would focus on a mix between easy-to-implement solutions that have been already validated in the market (think climate softwares, B2B opportunities in the decarbonization sector) with a couple of potential home runs with game-changing potential, creating a balance between prudent bets and more risky ones.

To be specific, I would check out companies like Pachama Colossal, NotCo that border between colossal triumphs and speculative bubbles.

In each alternative asset class I look for something different both in terms of risk profile and returns.

In RE and Infrastructure I gravitate towards cash-cow opportunities, anticipating a more predictable stream of income on a yearly basis. In terms of investment strategy, I would look into things that are already going relatively well and show stability (i.e. telecommunication powers, paddle camps, parking lots…), lowering the risk profile.

In terms of returns, PE stands in the middle of the alternatives class, but it does not provide the same advantages as RE and Infrastructure in terms of liquidity. Here, choosing well your managers and maintaining a consistent line of communication with them becomes paramount.

We can also mention Search funds, investing in microcaps and applying a VC framework to PE. They expect VC returns  (4-5X returns) leveraging a buyout strategy. They buy series A sized companies (in terms of metrics) and infuse them with new talents to see what can happen. Historically, it has been a high returns investment strategy but it is still a relatively unexplored class.

All in all, equity assets tend to form the bulk of our investments, reason being (aside for volatility) that we tend to proactively keep investing and buy more positions when it's time to do so to secure good returns.