Capital Series: Vikram Raju, Morgan Stanley
This episode is part of our Capital Series hosted by MCJ partner, Jason Jacobs. This series explores a diverse range of capital sources and the individuals who drive them. From family offices and institutional LPs to private equity, government funding, and more, we take a deep dive into the world of capital and its critical role in driving innovation and progress.
Vikram Raju is Managing Director, Head of the 1GT Platform and Head of Climate Investing for the private credit and equity division of Morgan Stanley Investment Management.
Morgan Stanley, of course, is a big player in the investing world, and seeing that they are entering climate tech and doing so at the growth equity stage is intriguing. Jason and Vikram cover a lot in this episode, including Morgan Stanley's journey to standing up this 1GT Platform and also Vikram's journey to doing the work that he does. We also discussed the energy transition generally, barriers holding it back, and changes that could unlock faster progress.
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Episode recorded on June 28, 2023 (Published on July 19, 2023)
In this episode, we cover:
Morgan Stanley and Vikram's role within the firm
Morgan Stanley's 1GT strategy for private capital in the climate space
Vikram's personal journey and professional background that lead him to his current role in climate investing
Morgan Stanley's focus on CO2 emissions and how it came about
How the firm assesses carbon reductions and the transparency of its methodology
Where impact assessment kicks in during the deal process
Sources of capital for Morgan Stanley's 1GT strategy
Some of the areas that Vikram spends most of his time on, including mobility, energy, circular economy and food and agriculture
Some of Morgan Stanley's investments to date
Opportunities for Morgan Stanley to provide crucial capital to promising climate tech companies during a challenging investment landscape
Vikram's thoughts on the gap between venture capital and project finance
His skepticism toward the regulatory landscape
The importance of working with incumbents while also disrupting the system to make progress
Vikram's perspective on fossil fuels and the role of asset owners and big banks in helping steward the clean energy transition
Who Vikram wants to hear from
ESG and the politicization of the word
Disclaimer from Morgan Stanley: This a general communication, which is not impartial and all information provided has been prepared solely for informational and educational purposes and does not constitute an offer or a recommendation to buy or sell any particular security or to adopt any specific investment strategy. The views and opinions and/or analysis expressed are those of the author or the investment team as of the date of preparation of this material and are subject to change at any time without notice due to market or economic conditions and may not necessarily come to pass. Forecasts and/or estimates provided herein are subject to change and may not actually come to pass. Information regarding expected market returns and market outlooks is based on the research, analysis and opinions of the authors or the investment team.
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Jason Jacobs:
Today on the MCJ Capital Series, our guest is Vikram Raju, Managing Director, Head of the 1GT Platform and Head of Climate Investing for the private credit and equity division of Morgan Stanley Investment Management. I was excited for this one because Morgan Stanley, of course, is a big player in the investing world and seeing that they are entering climate tech and doing so at the growth equity stage is intriguing. We cover a lot in this episode, including Morgan Stanley's journey to standing up this 1GT Platform and also Vikram's journey to doing the work that he does. We also have a great discussion about the energy transition generally, barriers holding it back, and changes that could unlock faster progress. But before we get started-
Cody Simms:
I'm Cody Simms.
Yin Lu:
I'm Yin Lu.
Jason Jacobs:
And I'm Jason Jacobs. And welcome to My Climate Journey.
Yin Lu:
This show is a growing body of knowledge focused on climate change and potential solutions.
Cody Simms:
In this podcast, we traverse disciplines, industries, and opinions to better understand and make sense of the formidable problem of climate change and all the ways people like you and I can help.
Jason Jacobs:
Okay. Vikram Raju, welcome to the show.
Vikram Raju:
Thanks, Jason. Thanks for having me.
Jason Jacobs:
Thanks for being here. Super excited to have you. It's great to see players like Morgan Stanley getting more active in climate, and so I'm excited for that. But also from a personal standpoint, you've been working in this area for a long time and I'm sure have quite a few lessons learned. So for relative newcomers like myself, it's just invaluable to get a chance to understand your perspective better. So, much appreciated.
Vikram Raju:
You got it.
Jason Jacobs:
Well, for starters, maybe just talk a bit high level about Morgan Stanley and your group and role within the firm.
Vikram Raju:
Sure. So Morgan Stanley, big firm, many different areas, investment banking, asset management, and so on. Equity research. Our firm in 2009 took the view that this is not a cute, nice CSR thing to do on the side and to have a paragraph in your annual report, this is going to be the next big asset class and we better be geared towards it in a serious way and let's build that expertise so that when it comes, we're positioned as a front-runner for it. I came on board at the end of 2014 to set up in the private markets platform, a climate impact platform, which has evolved over those eight years to our 1GT strategy today.
And the firm as a whole, I should take a step back and say is a front-runner in terms of making a net zero commitment, I think ahead of our peers on Wall Street, although we're very happy for them to be partnering with us in this journey and has published some very meaningful interim commitments with respect to how we get there in 2030.
Jason Jacobs:
And can you talk a bit about the 1GT strategy?
Vikram Raju:
Yeah, so 1GT is a culmination of eight years of work, ever since I came across from the World Bank. And it is the best expression we have of what private capital should be doing in the climate space, specifically with respect to the growth equity strategy. So we're big fans of what people in the venture capital world do. They're the heroes of the story. They create companies that don't exist. And folks on the bio infrastructure side deploy increasingly large amounts of capital to this space. So that's all really welcome. The gap we see is in the middle in the growth strategy where somebody needs to step up and take that scaling risk. And that is where our strategy focuses on. We back companies which have come out of venture capital world, have established proof of concept, but really need that capital to be able to go and scale and become a mature business. And we invest in anything that moves from fish to fashion as long as we can make a good private equity style return out of it. And we find enough carbon impact being created through the business model. And so it is investing in Europe and North America in largely things that collectively solve for a gigaton being achieved by the companies themselves.
Jason Jacobs:
I have a lot of questions about that, but before we get too far down the path, maybe let's just switch gears for a moment and talk about your personal journey in terms of, you're a bit hard to put in a box because certainly the financial services thread runs through and through in your career professionally, but climate does too. And so how did that come about and which one came first and when did they intersect?
Vikram Raju:
So I'm an accidental environmentalist. Up until a dozen years ago, I wouldn't know what climate investing was if you hit me on the head with it. I had a more traditional background as a management consultant. I'd worked in growth equity investing and found myself 2011 at the World Bank in Washington. And the World Bank, specifically with IFC, which is the division with the World Bank that does invest in private sector companies. And I got there in 2011, which is the absolute rock bottom window in climate 1.0. So much capital has been invested, much capital has been destroyed. Many people are heartbroken about how that whole space has turned out. And just because I happened to be at the right place at the right time, they said, "Okay, new guy, you are now the climate lead for this particular strategy." And I had no expectation, no understanding, no interest, no passion for this.
So it was a job I was given. Most people didn't want the job at the time because what had happened in Climate 1.0. It was seen widely as a career limiting move. And I agreed to do it with some reluctance. I said, "I'll do it for a year and then you have to give a real job. I'll take one for the team now." And so that one year turned into two years, turned into three years. And effectively it was getting a PhD in how not to do climate investing, because I got to see 20 years worth of investments people had made; well-meaning, highly intelligent people, but believing in certain trends that didn't come to pass. And we all know what those trends are. And what'll happen in terms of a global carbon price? What's going to happen in terms of how consumers are going to change behavior? What's going to happen with respect to the large motor companies and oil and gas companies and how they're going to make way for this trend?
None of those things came to pass. So a lot of those business models didn't work out. And people I was working with very with a lot of foresight took the view that, "Hey, if it hasn't worked out, that's bad, but we're not going to stop doing this because the problem's only getting worse. So Vikram, your job is to go and figure out a strategy that we can do this and actually make sense because now we're talking about a license to operate issue." And so unless you can put money to work and actually show that it makes money, we really can't ask for more capital in the space. And we scrubbed our entire thinking about how you do climate investing and went in with a simple question. Whatever company we're investing in, does it make money? Because people buy the product or service because they value it for what it is.
The fact that it happens to be green is separate from the story. They're buying it because it's cheaper, faster, lighter, saves them money, something. And if you buy that company because it's got good product and you scale it, then you've got yourself a good private equity growth exit. But if you're scaling it, what is fundamentally driving that attribute in the product, the cheaper, lighter, faster, better, is also creating the climate impact. So just by scaling a company from a pure business perspective, you have created that climate impact and delivered on that. And that is the core of what we develop there and what we do at 1GT today.
Jason Jacobs:
And when you think about this 1GT strategy or sustainable investing, or I guess there's a lot of words thrown around, ESG, impact investing, catalytic capital. How do you think about sectors and types of technologies and business models that are in play versus not in play for you? And also how do you think about the return profile relative to other investment areas of focus that are not sustainability focus?
Vikram Raju:
Can I first answer that question about all the noise there is in terms of the various... And then come to this thing about where we find attractive returns and how it compares. Eight years ago, I would've given you a different answer to this question. We were, like a lot of people, trying to solve all problems for everybody in this impact space. And there are many problems. And some of them are social problems, some of them are environmental problems. And even in the environmental problems, there are manifold things you can spend your time trying to figure out and address. It took us a few years to say we really need focus. We need clarity. And we leave the social impact work to others who are good at it. And even within climate, we're not going to try to solve for water or biodiversity or pollution.
We really need to be laser focused on one thing and one thing alone. And that is CO2 emissions. And it's pretty obvious on a podcast like this why CO2 emission is important, but it helped us focus our efforts on what really mattered to us. And sure, all these other things also matter, but if you don't fix CO2 by 2050, we're toast. And so we said, we'll simplify our lives by focusing on one thing. We're solving for one KPI so investors know what it is we're trying to do. As a deal team, it helps us because when you look at company A and company B, you know that you're solving for financial metrics and you're trying to evaluate, okay, where do I have greater carbon impact?
The second thing that stems from that is, okay, we've got clarity. Where's the ambition in this? Because the problem is 50 gigatons a year by some estimates from now to 2050. If we're trying to do an environmental strategy, a climate strategy, we have to be talking at the gigaton level or we're not really talking. We could be taking a bunch of cans and recycling them and feeling happy about we're doing something positive, but something isn't enough. It has to be at a meaningful scale. And I'm not for a second suggesting that our strategy is by itself going to solve all of the climate problem, but I think we're trying to make it part of a sea conversation. So we've got clarity and we've got ambition.
And then the third thing you add to that is accountability, where you say that, okay, a significant portion, it has to be at least half of what we're trying to do with respect to our economic benefit comes from that climate metric. And it's very important not to mark our own homework. So if someone independent does that and not someone independent that we determine using metrics we develop, but rather someone our investors bring in. So long story short, until our investors determine that we've got to this point, we don't get paid. And we are able to do that because we clarified upfront what it is we're trying to solve for.
Jason Jacobs:
Just to clarify, are you saying that your carry is dependent on the emissions reduction of the portfolio?
Vikram Raju:
Correct.
Jason Jacobs:
And in terms of the methodology to determine that, I know a lot of people and firms aspire to reduce carbon. The methods to assess, especially in some of these early stage businesses that have so much road in front of them before they're at meaningful scale is subjective and hard to quantify. How have you, or it sounds like an outside firm, gone about that process? And how transparent is that work? And the reason I ask is just selfishly, because I think us and a lot of other firms in the ecosystem could benefit from not only more sophisticated impact tracking, but also more consistency so that it's more of an apples to apple's comparison across. Because if everyone uses a different methodology, then it's impossible to know how you're actually doing relative to your peers.
Vikram Raju:
Both great questions and you obviously have spoken to a lot of people grappling with this problem. And as I said, we spent eight to 10 years grappling with how to do this and before we came up with our solutions. So the first part of the question is we're not super early stage. So by the time we get in, we have a lot more clarity about, okay, how is the order book building up and what will that look like over our ownership period? What will it look like when we leave the company? And then what very conservative assumptions can you make about growth? In our case, we almost assume zero growth after we leave because you have to have confidence in the long tail. So we get into a point where there's a lot more clarity, number one.
Number two is we could wait until there's a universal gold standard and then do our work or we can jump in as we have now saying, look, on a best efforts basis, working with some of the best minds out there, what is a very highly credible, repeatable, to your point, consistent methodology that we can create? So we've done that. A lot of work goes around baseline. A lot of work goes around dynamically forecasting how it changes in the future. But we did that upfront and our investors came in and looked at that and said, "Okay, yeah, we believe this." Now using that methodology, and I'm sure three years from now, four years from now, five years from now, there are going to be flaws in how we thought about it and there'll be room to tweak it. But as of today, we think it's state of art. And we'll then go around doing our work based on the forecast impact, using that methodology, using external best in class analytics firms.
But the real kicker is five years from now, seven years from now, there's going to be somebody who emerges or maybe a few people who emerge who are the gold standard in carbon analytics. And at that point there is a good understanding of what the industry standard is and who's good at doing this, and maybe there's a big four of carbon accounting present at that point. Because private equity is a long-term asset class, my portfolio, the portfolio and the strategy will still be around at that point. And so the investors can collectively decide that they're going to bring in someone who may not exist today but exists at that point in time who can come in and retroactively look at all the assumptions we made, all our forecasts, all our inputs and recast that as they see fit. And they can turn around and say, "You know what? This is not the one gigaton strategy. This is 0.7 gigaton, or this is 1.2." Whatever they come up with is the answer. Because why preempt that and say, "No, this is exactly what I tell you and you have to be believe it, and I'm the ultimate arbiter of that number." Then my investors won't have that confidence.
So giving them the ability to sign off on it and allowing for time for things to develop and become more sophisticated and for those standards to emerge puts the power back in their hands and eliminates all these questions of greenwashing or impact washing or anything else associated with it.
Jason Jacobs:
So at what point during the diligence process does this impact assessment kick in? Is it a ticket of admission upfront to even engage where it's the first thing you do? Or is it the final step before proceeding? Because it seems like it's a lot of work and I would imagine you evaluate a lot of companies and invest in very few. So how do you do that without burning your resources into the ground?
Vikram Raju:
Well, so we have built a reasonable amount of carbon expertise internally. So deal flow is pretty broad. And now this gets to your second question. But there's only, we know upfront based on the sectors you operate in and based on the sub-sectors and the kinds of companies, there are only a specific group of sub-sectors that will give you the kind of climate impact you want. And then that has to match with the deal characteristics we are looking for. So is it a three X deal and is it likely to give us 50 million tons of CO2 is your Goldilocks deal. And this is all high level. Every deal varies, every industry varies assumptions. So we're starting to look very narrowly in certain sub-sectors. Every week when we have a triage meeting, we reject a whole lot of very attractive deals because they don't fit in those dimensions.
And that's based on our internal homework just because of what we know. A testing company, great concept, doesn't really move the needle for us. Root optimization, interesting, potentially commoditize, not really our thing. And that allows us to focus on the areas where we have a good idea that already we're going to get that carbon impact. And then once other things in the deal checkout, okay, we like the price, we think there's a good exit here, we like the CapEx intensity of it. At the point we're starting to negotiate the deal and do our commercial due diligence is when we are also then bringing in the climate impact assessment full scale so that when it goes to our investment committee, we say, "Hey, we like this deal because it's got these characteristics and we're going to exit at this point, and this is what the independent assessment says about the carbon." And so those two pieces of data go to the investment committee.
So it's at the time when we are getting serious about the company and committing diligence resources anyway, is when the carbon diligence kicks in.
Jason Jacobs:
So I'll ask a kind of a devil's advocate kind of question, but let's say there's two Morgan Stanley strategies that I'm evaluating as a potential investor and one is a generalist technology growth equity focus, and the other one is a growth equity focus, but we can't look at anything that doesn't pass this high bar of carbon threshold. It seems like to my untrained eye in this role play that the second strategy would be handicapped from a returns standpoint. How do you think about that?
Vikram Raju:
Yeah, so this answers your second question. Are we operating in a smaller pool? Yeah, we reject about 90, 95% of what we see. I think if you look at the sector coverage, about 80% of the global economy is covered by what we do. Some of it like healthcare and financial services and telecoms, it's probably not. But within that, we have to do four to five deals a year, which means you probably get very serious about eight or nine deals. Have we seen a shortage of deals coming in that fit our criteria for making that climate impact, that carbon impact? We've now sidestep given up the water impact, biodiversity. This is a price you pay for narrowing your focus. There are many very attractive deals that don't have the carbon impact that we just set out. But it allows us then to go very narrowly after the things we're interested in.
And I've got to tell you, when we came up with this strategy, we thought there's about 4 billion of deal flow, good deal flow that we could go after. And so if we were trying to invest a billion dollars, there's a good pool to select from. Today, I would say that's between six to $8 billion. And what has driven that? Three things, energy price, war in Ukraine, and what has happened as a result of that. Anybody who had any interest in doing energy efficiency or anything along that value chain suddenly wants it done tomorrow because it makes real financial difference to their bottom line.
Number two is inflation. And I would add the supply chain shocks we saw from COVID. So as a COP 36 and Nike had a stall there and they had a pair of sneakers made entirely recycled materials. Good story. But if you look at the business logic behind that, when inflation is driving the costs of all the inputs up and there's only so much of that you can pass on to the customer, margin protection becomes very important. So recycling and getting your hands on any kind of recycled material allows you to drop your cost. Now add to that the fact that if you are now able to rely on local materials and not long term supply chains, long distance supply chains, it becomes much more of a compelling proposition. So there's a lot more deal flow in that area. And I'll say everything from medical devices to building materials and now have a recycled component to it. That's driving our deal flow.
And the third thing is if you just look at what large corporations like a Unilever, et cetera, when they stand up and say, "Hey, we're going net zero by 2050," it means everyone in their supply chain from the people who do packaging for them, to the people who do transportation for them, to the people who provide nutrients for their products, all of them have to figure out how they're going to go to net zero and they need active base to decarbonize their own supply chains and their own processes.
So those three things combined have given me enough deal flow for me to be able to say, for the number of deals we need to do, there's a compelling number of opportunities that we can pass on and still end up with a pretty good portfolio. And the proof of the pudding is I don't necessarily compete with other people who are doing climate only.I competed with people who want to do technology and want to do ag and want to do food services and things like that, because ultimately this is where all business is going. And just as any company has to have a digital strategy, I think any company that's worth its salt has to have a climate strategy.
Yin Lu:
Hey everyone, I'm Yin, a partner at MCJ Collective, here to take a quick minute to tell you about our MCJ membership community, which was born out of a collective thirst for peer-to-peer learning and doing that goes beyond just listening to the podcast. We started in 2019 and have grown to thousands of members globally. Each week we're inspired by people who join with different backgrounds and points of view. What we all share is a deep curiosity to learn and a bias to action around ways to accelerate solutions to climate change. Some awesome initiatives have come out of the community. A number of founding teams have met, several nonprofits have been established, and a bunch of hiring has been done. Many early stage investments have been made as well as ongoing events and programming like monthly women in climate meetups, idea jam sessions for early stage founders, climate book club, art workshops and more. Whether you've been in the climate space for a while or just embarking on your journey, having a community to support you is important. If you want to learn more, head over to MCJcollective.com and click on the members tab at the top. Thanks, and enjoy the rest of the show.
Jason Jacobs:
And in terms of the 1GT strategy, what are the sources of capital for that? Is it balance sheet investing? Is it a closed-end fund? And if so, what types of investors are the right profile and/or what buckets of investment from those investors would this capital come from?
Vikram Raju:
So speaking generically about investors in a strategy and their strategy, I'd say it's almost a dual track dialogue. The leadership of a lot of these organizations be their pension funds or endowments or insurance companies have made big commitments in terms of what they themselves want to do with their own portfolios and where they want to go. Bear in mind, they're a pretty small piece of the puzzle. Most of them have to decarbonize their portfolios, which is taking the quote unquote "bad companies" and making them good.
We're in the relatively lucky spot of getting into the good companies and helping them scale and actually helping some of these guys transition. So they've made those commitments intellectually. But we find that there aren't that many dedicated pools. So when push comes to shove, someone's making a decision to give you their private equity dollars, not from any special bucket, just from their PE bucket. So you really have to compete on a commercial basis and say, "Hey, this is a good strategy. It's going to make you money and it has the added benefit of delivering this climate impact and you probably should be looking at climate impact anyway if you want to look at where the growth markets are, if you want to look at where their margins are, if you want to look at where the good exit opportunities are coming from" and make that sort of commercial argument. So I'd say there's a full spectrum of people who've come in and their motivations. And even within individual organizations, often you interact with multiple motivations.
Jason Jacobs:
And when you think about things like returns expectations or timelines of the strategy or anything else structurally, are there things that are different given the carbon focus than they would be if this was just more of a traditional general technology growth equity play?
Vikram Raju:
No. So we are underwriting things for a three to five year time period. We've sold companies 18 months after we got into it. Because someone wanted the technology and wanted to pay us six times money for it. We've sold things two and a half years after we got into those companies. And so as long as you're doing something that's critical for people, it's adding value and they want to own that technology and plug it into whatever else they're doing, there's no reason to expect that this is a longer term hold. If I was in the pure de-carbonization business where I was buying companies, then I would need many things. I would need a lot more capital, I would need control, and I would need more time because that's hard work to be able to turn that, literally turn the tanker around. Whereas in our case where you should think of us no different from you would think of any company that's investing in NFT technologies or business services or widgets that are helping people who are capitalizing on these very big long-term trends and deploying a lot of capital, making very small dollar purchases to acquire our companies for substantially massive return for them, ROI.
Jason Jacobs:
And you mentioned given that you're making a relatively small amount of concentrated investments and the steep carbon threshold, that there's a concentrated number of areas where it makes sense to go deep. Can you give me and listeners an idea of some of the areas where you are most excited and/or spending the most time?
Vikram Raju:
Yeah, I'd say it's not super concentrated, so call it four deals a year over a five-year period. So 20 companies in a portfolio, which collectively are generating that gigaton over a period of time. But as I said, somewhat glibly initially, everything from fish to fashion. We look at the four usual suspect sectors, mobility, power, circular economy, which isn't really sector, and food and ag. And within that, if you flipped it the other way around, if you looked at tech and business services and consumer facing companies and things that are more industrial in nature, there's also a nice exposure to those things across the board. And it could be something pretty basic like energy efficiency software, which self-evident what you would do. We invested in a company for example, where we told investment committee, "Hey, we think this makes three times money, it also saves as much energy as city of San Francisco consumes in a given year." And we ended up making four times money and saving a lot more energy. So that's at the most basic end of the spectrum.
You could also be investing in something that we are currently looking at in the food space. And if you're looking at what it would mean to back fermentation technologies. Where you're not taking the end risk of having a branded product where you're dependent on consumer tastes and the difficultness that goes with that, but you're saying if there's a substantial trend away from carbon intensive need production to some of the other substitutes, there's a lot of attention that has to be paid into the hill fermentation area. And we are looking at some very compelling opportunities there. Everybody wants to switch to, well everybody in Europe, wants to switch to renewables overnight, because of what's happening in the conventional energy businesses, it takes a lot of time to do that.
It takes a lot of time to actually build out a renewable generation capacity and then you have to worry about whether you've got adequate transmission, et cetera. But if you've got bits of kit, small bits of hardware that actually make conventional existing facilities a little more efficient, reduce the loss of electrons in the system by just a little more, then that is massive value to the existing operators and it adds dollars immediately to the bottom line. And so we're in invested in things like that. And there is any number of fruit and vegetable in some places as something like 50% of what gets grown gets wasted before it actually makes to the table. So if you can find your ability to capture some part of that wastage and turn it into productive consumption, that itself reduces a whole amount of CO2 emission and pays for itself in terms of the economic return there.
Jason Jacobs:
How many investments have you made to date? And are there any that have been publicly announced that you could speak to just as examples of what makes it over your bar?
Vikram Raju:
Sure. So we are here in June. We had our close in March. So we're just starting to deploy capital. Deal number one is publicly announced. It's a very cool company called Everstream Analytics. Everstream basically is a supply chain software business that tells its customers who are people who use large global shipping for their products and services. It tells them three things; how do you get your goods from point A to point B in a more efficient manner? How do you save time? How do you save money? And how do you save carbon as a result of that? You know that one big problem in this current carbon climate is most people say they don't know what their scope three is. It's often an assumption.
This company essentially helps people understand their scope three, track it, map it, and reduce it as time goes on. So that's a company we're very excited about. We're partnering with them as a firm. We are Morgan Stanley at a larger picture is very much deeply connected in the whole transportation business, in ports, infrastructure. And we want to use our connectivity expertise and ecosystem there to help have a stream grow its presence and be able to be the one-stop solution to any number of large multinational companies who want to understand, okay, how do I get things faster from Bangkok to Vancouver, for example, and track my carbon and reduce my carbon and save some money in the process?
Jason Jacobs:
One thing I've heard from other growth investors in the space is that there's not that many companies in the farm system, if you will, that are on deck to be big enough to be ready for scaling capital. Similarly, one knock I've heard on the climate tech investing landscape is while with this new crop of capital that's been flowing in over the last several years, there are some fancy markups, there's not a lot of DPI, and especially now that the IPO and exit landscape has gotten a lot more difficult, what are the implications as it relates to climate tech investing and growth equity specifically?
Vikram Raju:
So I'll fully agree with you on the trend that was going in terms of where the markups were going and where valuations were. As someone who developed my initial scar tissue at the very bottom of Climate 1.0, I've seen how that story plays out and we're very hyper-focused on not letting any of the froth come in. So again, we passed on a lot of deals, which would've been very impactful from a carbon perspective, potentially made us a lot of money, but you had to believe things that we knew we couldn't underwrite with confidence. And look, some of that has come to pass.
In this environment where the capital markets being where they are, where people had aspirations for doing a SPAC or doing a listing and they can't do that anymore, that's our opportunity. So with our ability to put capital to work and give them the essential capital, we write 30, 50 million checks, that is critical. That allows them to then develop the company to the point where when markets open up, when the larger buyout investors step in, when the strategics want to come looking, they've got something ready for that.
And so that is actually one very, I'd say we're lucky to be in the spot where we are able to provide folks with good companies with that capital to help them get to that point. And two is there's a recognition of that. So it plays out in terms of not just pricing but also in our ability to get a lot of terms and conditions, which we find absolutely valuable, which in a more frothy environment you wouldn't be able to secure. And on the DPI question, we basically got our confidence to set this up after we had that initial spate of exits. Sold companies, whole companies for four times and six times and so on. Do we expect to see those valuations come back? Maybe there's a more normalized three X return that really we should be underwriting for. But we got capital out, which gave us confidence that okay, there is a genuine pool of buyers, not just from the large buyout climate funds. Look at any number of those who raise multi-billion dollars from the strategics, all of whom are doing this for different reasons, either to greenify their own portfolios or be able to service people who are doing that.
If you made a net zero commitment, the way to do that is either you divest your brown assets or you buy enough green assets so your profile of your revenue changes. Or when the markets come back and Europe at 1.1 out of 2, every new mutual fund that was being launched was a quote unquote "ESG fund", so there is market for that paper. We're not predicting when any of that happens, but we like the fact that if you invest today in three years time or four years time, when we look to exit, hopefully we have multiple avenues.
Jason Jacobs:
You talked about growth equity being a gap, which I agree with. Another gap that I've heard consistently is between venture capital and project finance. From a debt standpoint, how to get these first of a kind plants built, for example, where it requires significant capital, but there's still significant risk. How are you thinking about that generally as it relates to the scaling of these important technologies? But also how are you thinking about companies that have those needs from an investment standpoint?
Vikram Raju:
It is a gap and I think different people are trying to step in to address it in different ways. I don't think it's been addressed fully enough. But you have this interesting confluence where venture capital funds are talking to people like the development financial institutions where I came from and the marriage of Silicon Valley and Washington DC to try to come up with things that work for scaling and demonstrating proof of concept and being able to take some of that, provide debt, but take some venture risk maybe for a first loss or a preferred return or something like that. That is increasingly happening and I don't think it's happening at the scale. So there is still a lot of equity being used for essentially what should be debt. But it is a fact that you don't see a lot of debt, especially now with interest rates being what they are in the growth space.
Jason Jacobs:
How do you think about the regulatory landscape and how does that factor into your investment decisions?
Vikram Raju:
I'm a big skeptic of regulation and this is a Climate 1.0 lesson. When you wake up and you find governments have retroactively taken away subsidies and entire business models have been killed because they were reliant on that has led me to be very skeptical of factoring in regulatory economics in a business model. To me, something has to survive fundamentally on its own two feet for it to be backable. There are now some very positive tailwinds. Of course you can't deny that. And I think capital has to go into things where commercial capital cannot step in and develop that proof of concept, exactly what you were just talking about. Providing debt for some of that scaling, providing the subsidy for the shard to prove sectors.
I think there is a role for government money. I think there's a role for philanthropic money, all of that needs to be done in order for some good to come out of it and go through that J curve and fund it and develop the cost points where it can be scaled. But if all of that were to go away tomorrow, then I think climate strategies should be robust enough to say, look, "We're saving people money. We're making assets more resilient. We're protecting margins. We're investing in where the growth markets are in the future, where consumers and corporates are moving." And I think those four factors alone should be enough for things to be attractive with zero rig support.
Jason Jacobs:
This is more of an existential question, but there are people that say that the existing system can't get us to where we need to go fast enough. And I tend to agree. At the same time, there's people that say, "We're not going to make progress unless we work with the incumbents and put one foot in front of the other to essentially iterate the existing system incrementally," which I think I also agree with. But given those two contrasting realities, how does this play out? Because we can't get there fast. And again, I guess I'm editorializing, so maybe you disagree, but we can't get there fast enough working with the existing system, but we can't make progress without working with the existing system. So what do we do?
Vikram Raju:
It's all of the above answer. You have to work with the incumbents, you have to disrupt, you have show that there are attractive opportunities. People have to vote with their dollars, make consumer choices. And I think all of those play out in a way that gets us to the solution. And I'm an optimist. I think push come to shove, we tend to find a solution. And it may not be the solution we thought we were going to find, but somewhere from this mix will emerge something that gets us to the point where we may overshoot the 1.5 degrees, but we can potentially bend the curve back down. That's what I believe. So I think combinations of major actors in this space, changes in technology, in consumption patterns, some of which will be forced on us just by the way the ecology is changing and extreme weather events are happening gets us to the point. So I think it takes a little more crisis than we're experiencing right now. But through the crisis will come a more sharp focus of the mind, which then results in all the efforts we've been making, which may seem incremental up to this point, actually translating into the solution there.
Jason Jacobs:
If you look at a assumptions that you need to believe to believe that this growth equity strategy, the 1GT will be a successful one, which are the assumptions that keep you up most at night?
Vikram Raju:
So the first thing to admit in all humility is human beings are very bad forecasters, both on the upside and the downside. As I said, things that we don't know now will emerge. So we, in all modesty, we can forecast five years forward. But after five years we should assume there's zero growth in our companies, because at that point in time, stuff will grow. These companies are growing 20, 30% per annum, but you cannot underwrite that. You don't know where the world is going. So just flatten that curve out, assume it's terminal value.
And number two is, and this may be an optimistic assumption, but it's negative from our perspective in terms of trying to get that gigaton. Because the gigaton we're trying to get is basically what our disruptor company, the delta between the disruptor company's carbon footprint and the incumbent's carbon footprint. But what we're actually saying is we are hoping we live in a world where even the incumbent gets better and better and better from a carbon perspective to the point that our disruptor really doesn't have much of an advantage.
And so if you forecast that forward, we're talking about living in a world where all of these companies I hope are growing and selling more and scaling, et cetera, but ideally the world has moved to the point where no one is saying that these are companies that are making a massive climate difference because the baseline itself has shifted. So we are saving energy today. That's a great thing because it translates into saved carbon, but in the future, ideally we're saving a lot of energy, but there is no carbon impact because all of that energy's come from renewable resources. Or we're investing in things in the EV system, which is great because EVs today displacing IC engines, ICEs. But in the future, if everything's EV, then you're not really having an impact. You could be just selling more. And I want us to be making ourselves redundant from that perspective where it's not a question because that's just business as usual.
Jason Jacobs:
If you just look at the transition more generally outside of just the world of small high growth privates, what other gaps do you see that you think if addressed would help us collectively transition faster?
Vikram Raju:
Look, the big stuff is happening in the infra world. Everything that's happening in hydrogen and nuclear and carbon capture takes big, big dollars to get done. It takes a big ecosystem shift to happen. It takes some amount of scale and pricing power to get done. And I think that's happening. I think a lot more of that could be happening. And when all of it clicks into place, if it does, I would be very happy.
Jason Jacobs:
This is also I guess more of an existential question, but when you think about the transition, there is quality of life and that tends to be associated with energy abundance. There's population growth, which will also increase our needs for energy. At the same time, there's the carbon up in the atmosphere and the symptoms that are baked in, and the sooner we phase out fossil fuels the better. Given that backdrop, there are some many, in fact in the climate community that look at the big banks as an example, who continue to fund fossil fuel projects and call them evil. On the one hand, there's a transition and transitions take time. On the other, there's some inevitable foot dragging and protecting self-interest of the incumbents that make them maybe less inclined to transition until they realize we're past the point of no turning back, in which case it's purely in their self-interest to dive in the deep end. What role do you think the banks have in helping steward that transition? And are fossil fuels evil?
Vikram Raju:
A lot of human progress has happened because of fossil fuels. We'll admit that. And there's some wonderful functionality for things like plastic, which has enabled lifesaving, which we look at injections and blood pouches and so on. So no one's knocking that. I think we have to look at a world, to your question of resources and population, et cetera, where we're all living smarter, living better on less, and ripping off, I think there's some famous Japanese designer who said this, live better with less. But that's the world we have to go into. If you look at the fossil fuel companies, it's a finite resource. And the very best of them are all figuring out, okay, how do we get into the renewables action? How do we look at alternative sources of energy? So we'll use all our technology that we've spent digging stuff out of the ground to figure out, okay, how do we take this technology and do geothermal? How do we look at all the offshore wind stuff? Which is technically complex and actually requires a lot of this transition.
So I would say there is a spectrum if you look at where the oil and gas majors are in terms of how they're approaching this. And I think if you look at a company which is nothing but a series of future cash flows, what is the future cashflow for such a company that doesn't have a long term view? And let's say we shouldn't rely on the goodness of people's hearts to say, you know what? We're going to make a change in our strategy because that's where we're going to go. We should look at where the big money is. And the big money is in the asset owners. And there are trillions of dollars in the net zero asset owners alliance. So when they speak and they say, "We want to decarbonize our portfolios, or we're selling this company and therefore it's cost of capital is going to become very expensive," that should drive a lot of people to say, "Look, if you want to ultimately be owned by the large asset owners in their portfolios, we better get our act together." Quite apart from the fact that this is actually good business.
And so I think that banks such as ours, which have made commitments in terms of our own financed emissions and getting that down to zero have a role to play. But a bank is an intermediary. And so ultimately the real owners of capital, which is the pension funds and the insurance companies and the sovereign wealth funds have to make a decision of what color they want their capital to have and what role they want to play in it. And then everyone down the value chain from a bank to fund managers like us and the other players in this world actually enable that to happen. So it's a little bit of chicken and egg. Sometimes you have to go forward and say, "Hey, one gigaton and independent measurement of the impact and carry and all of that stuff," but really the driver is the deep pockets of capital.
Jason Jacobs:
It leads me to another existential question, and maybe I'm just feeling philosophical today or something, but should financially oriented capital have a conscience? And if so, what is the best way to ensure that capital, broadly speaking, in our global economy, has a conscience to the highest degree possible?
Vikram Raju:
I'm going to sidestep the conscience question. I'll say capital has a duty to return the best returns to its investors over a long period of time sustainably. And when I say sustainable, I mean just over a long period of time. To do that, you have to back, as I said, companies that are going to be viable going concerns in the future, which have strategies for the future, which have understood how they're going to operate in a world with extreme weather events, with shrinking lakes, with large portion of climate refugees on the move, et cetera. And what kind of actors do they want to be in that world?
And so again, I'm not relying on conscience or enlightenment or goodness of people's hearts and especially corporations for us to get there, I'm relying on people to say, "Okay, what makes business sense for us to do on a sustainable basis so our consumers don't turn around and say, 'Hey, we really don't like how you got that food, or you've actually been responsible for a lot of pollution in terms of your packaging or just look at your own transportation footprint'", and all of that.
So I think organizations that are forward looking are factoring all of these things in a world where they want to reduce their own bills, but they want to have customer loyalty, they want to have the support of those large pools of capital I mentioned, and want to be good corporate citizens because that gives them the license to operate and sell whatever they sell.
Jason Jacobs:
We have a pretty diverse audience in terms of functions, industries, geographies. Given that, who do you want to hear from? If there's people listening that are inspired by the things that you've talked about today, how can we be helpful to you? And what kinds of people do you hope get in touch, if any?
Vikram Raju:
Look, I'm gratified to be on platforms like this where like-minded people come in and join the conversation. The real conversation I'm hoping happens outside this where the newbie to your podcast, that's who I'm after. I'm after folks who are looking at this and may have some perceptions about what climate investing is and are actually saying, "Okay, look, just from a pure existential point of view, but I mean financially existential point of view, this is something that is worth doing. This is something that we need to do to protect our portfolio. This is something we need to do to keep our stakeholders happy, or we don't have a business." Ultimately, that's who I think all of us need to reach out to. Because this group, I think all of us are on that journey, as the name suggests, and we're there, but we need to bring in a lot of people who haven't started that journey yet and get them to see that this is not some touchy, feely, fuzzy thing that's going on. This is the real world, and it's changing, and large amounts of capital need to move, but it's not all doom and gloom. There's some very exciting opportunities here that just makes life a little more efficient, little more... There's just more compelling ways to deploy capital and technology, and you should be as excited about this as people were about the internet in the nineties.
Jason Jacobs:
I thought I was going to move to wrapping up, but there's one other question I thought of that I didn't ask that I'd love to sneak in, and that's just what do you think about ESG and the politicization of the word?
Vikram Raju:
Look, I said in Europe. And it's bread and butter, it's like table stakes here. You can't even have a conversation if you're not mentioning ESG. But for some reason, if you take away the concept and associations people have both at the extreme ends of the spectrum, either people who say, "Oh, ESG is just label for greenwashing," or people who say, "This is extreme bulk capitalism," and you rip apart the label and see what is that fundamentally ESG does. If you apply an ESG screen to a company, what you're basically saying is, and this is separate from the climate impact, but ESG itself is saying, "Do we want to invest in a company where we wake up one morning and read that they dumped chemicals in the river? Or they hired underage labor? Or someone was cooking the books in the accounting department?" The answer is no.
It's common sense business hygiene. So you would never invest in a business where you didn't have these checks and balances in place because you don't want something to blow up. And that's fundamentally what ESG as a process in investing is about. I think, frankly speaking, people have been doing different bits of this forever. They now put it together in that combination of things and called it ESG. But I think time has come. No more than you would say, "Hey, do we have a good set of accounts in place?" It's essentially a mirror of that.
Jason Jacobs:
Well, thank you for humoring me for all of my questions. Is there anything I didn't ask that I should have or any parting words for listeners?
Vikram Raju:
No, this is great. I've really enjoyed this conversation. I think we've had about five existential questions, and it is both very sobering when we think of the scale of what we have to do and the time within which we have to do it. But it's also very exciting when you look at the opportunities to actually do stuff and be able to make a difference and have fun along the way.
Jason Jacobs:
Well, I agree, and that's a great point to end on. Vikram, thanks so much for coming on the show and looking forward to seeing how the 1GT strategy evolves and also just finding more ways to collaborate between Morgan Stanley and MCJ Collective. So, thanks again.
Vikram Raju:
Thanks, Jason. Over and out.
Jason Jacobs:
Thanks again for joining us on My Climate Journey Podcast.
Cody Simms:
At MCJ Collective, we're all about powering collective innovation for climate solutions by breaking down silos and unleashing problem solving capacity.
Jason Jacobs:
If you'd like to learn more about MCJ Collective, visit us at MCJcollective.com. And if you have a guest suggestion, let us know that via Twitter at MCJpod.
Yin Lu:
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Cody Simms:
Thanks, and see you next episode.
