This article is sponsored by Ridgewood Infrastructure
What does sustainable investment mean to you as a firm and why is it so important?
At the highest level our framework for sustainability is rooted in our responsibility to deliver strong risk-adjusted returns for our investors. We believe that by identifying and advancing sustainability – encompassing environmental stewardship, social impact and corporate governance – we will improve investment outcomes.
How do you factor climate risk into your due diligence efforts, from screening through to the final stages?
We undertake critical climate risk and transition climate risk screening, covering a range of climate scenarios. Unfortunately, over the past decade, we have seen rising sea levels and an increased incidence of major storms. We want to ensure that the infrastructure that we own continues to be resilient in the face of these ongoing weather pattern changes. We want to understand those risks on the way into an investment, and we create and implement plans to improve that resilience during our period of ownership, so that every asset in which we invest is prepared for climate change.
Which assets are most vulnerable to climate change, and what forms is that climate change risk taking?
Assets located in coastal regions and low-lying areas that are susceptible to flooding are most at risk from rising sea levels. But climate change is also causing damaging water shortages. In the US, for example, the Colorado River is running at historically low levels. That river is responsible for providing water to 40 million people and more than five million acres of farmland.
We are seeing states introduce stringent restrictions on water use as a result. California, for example, has experienced recurrent droughts for years. Water resource is therefore a sector that is being directly impacted by climate change today. We own several water infrastructure investments that are focused on resource preservation. In other words, managing this scarce resource in a more sustainable manner.
How do you work with assets to reduce greenhouse gas emissions during your ownership period?
Developing a sustainability plan is part of our due diligence and underwriting process. That means that once we close on an investment, we begin implementing that plan straight away. We have developed a proprietary set of processes and tools that we use to align ourselves with our management teams and we undertake a set of initiatives to bring those companies up the environmental, social and governance curve.
That can take many forms. Certainly, we ensure companies are undertaking greenhouse gas emission audits. You need to have that baseline. We also own an energy efficiency infrastructure business, and we are able to leverage the expertise of that business to look at ways that our portfolio companies can reduce their greenhouse gas emissions, including making sure that we have state-of-the-art, energy-efficient equipment on site.
How do the sustainability requirements of mid-market assets differ to their larger counterparts?
Prior to our investment, the mid-market assets and management teams that we work with typically have lacked the resources and knowledge to focus heavily on ESG and sustainability. We can therefore use our expertise and experience to generate an outsized impact in these areas. If you invest in larger and more mature companies, they will probably already have processes and procedures in place. They may have an ESG lead and already be producing a corporate sustainability report. But, in the space where we invest, at the smaller end of the market, it is possible to make a significant impact and quickly.
What role does benchmarking play in your approach? What are some of the challenges involved and how can these be overcome?
We find benchmarking very useful in ensuring we are implementing best practice. And as industries and regulations evolve, we want to ensure we are keeping up to date and continuing to hold ourselves to a best-in-class standard. We participate in UNPRI and GRESB benchmarking on an annual basis, and it is something that has proved highly beneficial to our portfolio companies. Our management teams are proud of their businesses and want to demonstrate quantitatively how they are performing against others.
In terms of the challenges involved in benchmarking, they are myriad. There tends to be a bit of a one-size-fits-all approach, and it can be hard for companies to demonstrate all the great work they are doing and all the positive impacts they are having. We overcome that with our own sustainability report, where we include case studies and other more qualitative elements that can highlight strengths overseen by standardised benchmarking.
How do you ensure alignment with portfolio company management on sustainability-related goals?
That alignment process starts during the due diligence phase when we ensure that we are culturally and philosophically aligned around sustainability and ESG. We believe that sustainability measures can equate to immediately improved profitability. For example, if you use less energy, the cost savings will drop to the bottom line.
Meanwhile, in the longer term, sustainability initiatives improve resilience, for example around climate change and transition risk. They can also help drive a premium when it is time to exit. If you present an asset to the marketplace that has strong ESG and sustainability credentials, that should create benefits from a dollars and cents perspective. Our job, therefore, is to make sure our management teams understand all of that and that they are aligned with us in achieving those goals.
While that philosophical alignment is critical, we also take concrete steps such as ensuring ESG and sustainability performance are built into the annual compensation of senior leadership and ensuring that ESG and sustainability are part of board-level discussions and that there are clear lines of responsibility. This combination of philosophical thinking, governance and compensation is what ultimately ensures alignment.
What role does the social component of ESG play in your sustainability strategy?
The social component of ESG is extremely important to us. Our efforts in this area include workplace diversity and inclusion initiatives, as well as health and safety, of course. All the businesses we have partnered with have strong records in health and safety and it is incumbent on us to ensure that this ethic continues to be front of mind.
We believe that focusing on the social element of ESG can have a direct impact on productivity by improving morale and reducing staff turnover. It can also enhance innovation and certainly reduces regulatory and reputational risk. We have a toolkit that we use which is a great starting point for evaluating how companies are interacting with their staff and their communities. We then explore the modifications we might want to make to corporate philanthropy and other forms of social engagement as we progress with the investment strategy.
What changes have you seen with regards to your investors’ focus on sustainability?
We have certainly seen an increased focus on ESG and sustainability in LP underwriting of potential fund investments. They are evaluating the dedicated resource that managers have in place and are ensuring they have the capability to execute systematic and opportunistic ESG activities, as well as the associated reporting. Of course, they also want to ensure that managers are compliant with various regulatory schemes such as the EU Taxonomy and SFDR, which are both relatively new.
Indeed, many LPs now have their own dedicated ESG and sustainability resource in house, and that knowledge and understanding is being transferred to the existing investment professionals, who are then charged with integrating these factors more prominently into their underwriting. We are seeing a pronounced cultural shift within our investor base when it comes to the issue of ESG and sustainability.
A little goes a long way
Ridgewood Infrastructure is an investor in Ecosave, an energy efficiency company targeting outsized reductions in cost and emissions.
Ecosave, which is focused on the large and highly fragmented US commercial and industrial market, provides turnkey infrastructure solutions that reduce energy-related operational costs. In turn, these solutions also help customers achieve their own ESG and CSR goals by helping them to reduce greenhouse gas emissions, according to Ridgewood’s Sam Lissner.
Ecosave’s offering encompasses state-of-the-art boilers and chillers, as well as building automation and rooftop solar plus battery installations.
“These measures really are the lowest-hanging fruit and can be highly impactful, both in terms of cost reductions for the building owner and for the environment,” Lissner says. “But they receive relatively little focus compared to the construction of huge solar farms or offshore wind. Going into the basement of an industrial complex and replacing a 50-year-old boiler might not seem all that exciting, but if that boiler is running at five times lower efficiency than modern equipment, the impact can be huge.
“By systematically ensuring that building owners and industrial companies, particularly those that have many facilities across a region, have the most efficient equipment possible in place, that can quickly make a substantial difference to emissions. Ecosave has also proved extremely valuable in helping many of our other portfolio companies in this regard.”