«Private equity is key to global decarbonisation»

Charlotte, Zürcher Kantonalbank recently launched a private equity fund for qualified investors that specialises in investments in decarbonisation solutions. Why this focus on decarbonisation?

Undoubtedly the global economy needs to be decarbonised as quickly as possible. We are therefore at the beginning of a global sustainability revolution. This means that the current emissions of around 40 gigatonnes of CO2 per year must be reduced to net zero by 2050. This requires an estimated 2,500 billion dollars of annual investment, which corresponds to around 2 to 4 percent of global gross domestic product. The potential market is thus huge, providing numerous attractive investment opportunities. Companies developing technologies and services for decarbonisation solutions offer potentially high returns as they enjoy a sustainable and long-term competitive advantage as well as growing demand. With our new investment vehicle, the Swisscanto Private Equity Carbon Solutions Fund, we are therefore offering qualified investors simple, cost-optimised and diversified access to precisely these opportunities in the private equity sector.

Okay, but to what extent does this require private equity?

Private equity is key to global decarbonisation. Innovative companies in the field of decarbonisation need capital to scale up efficient and new technologies, especially in growth phases. However, capital is scarce in these phases. Private equity investors step in to fill this gap. They finance the scaling of the business model, thereby creating the basis for growth. In addition, private equity investors make their expertise and network available.

They expect an attractive return. What can generally be expected?

Measured by the internal rate of return, between 12 and 14 percent net per year. This is a return expectation commensurate with the risk.

To what extent are these returns realistic, given rising interest rates and the threat of a recession?

Generally speaking, private equity is more resilient to rising interest rates than exchange-traded equity capital, as there is less financing with borrowed capital, especially in growth phases. As a result, the companies in which we invest are less dependent on borrowed capital. Moreover, fund managers have the opportunity to cushion negative inflation effects more quickly by actively managing their portfolio companies or they can align exit timing with more favourable market conditions.

The fact remains that the impending recession is pushing valuations down.

Yes, but this has the advantage that we can acquire participations more cheaply than before. As already mentioned earlier, it is also possible to adjust the exit timing, as we remain invested for years. Although IPO activities have currently dropped, the environment should clearly brighten again by the time of an exit, i.e. after an expected holding period of five to seven years.

Most importantly, however, with our focus on decarbonisation, we are seizing sustainable investment opportunities that not only enjoy strong financial and legal support from regulators, but also benefit from increasing demand from society. The constant need to become fossil-free creates momentum for new growth opportunities. This way, thematic investing in private equity can set itself apart from the downward trend. I am therefore convinced that innovative companies that offer greenhouse gas-reducing technologies and services and have scalable business models in particular will receive sufficient capital, will be characterised by strong growth in consumer demand and will thus be able to offer opportunities for excess returns.

And why is Zürcher Kantonalbank the right partner for private equity investments?

Private equity is well-established at Zürcher Kantonalbank. With the Swisscanto Private Equity Growth fund, we have many years of experience with direct investments in technologically advanced growth companies. We have made 14 investments in the growth fund since 2018 and carried out three successful exits. The art is to find and refine rough diamonds in the dense jungle of the private equity industry. Our ten-person investment team therefore constantly searches the market for suitable investments. Additional specialist expertise is incorporated through our highly qualified advisory board from the fields of science and entrepreneurship.

How do you go about searching for these rough diamonds?

Identifying high-quality investment opportunities requires expertise and many years of comprehensive relationship management. Our private equity team worked together before joining Zürcher Kantonalbank, particularly in the area of sustainability. We therefore have a direct line to key individuals worldwide who successfully manage funds and companies in the decarbonisation sector. In the case of direct investments in Europe, we can also benefit from the broad and established network of the growth fund team and its expertise.

Due to the fact that Zürcher Kantonalbank is one of the pioneers in the area of sustainable investments, we are also repeatedly presented with investment opportunities. We are also continuously looking for ways to generate deal flow, such as through active participation in industry meetings, specialist seminars and conferences. We are therefore in constant contact with potential collective investment schemes and companies.

According to which criteria are potential funds and companies shortlisted?

We use a multi-stage selection process based on the continuous benchmarking of funds and direct investments. If an investment opportunity meets our strict decarbonisation and return requirements, we analyse the fund or the company in a due diligence phase lasting several weeks, naturally also on location. In practice: from the global universe of companies and funds that we look at in the decarbonisation sector, only around two to three percent of all opportunities lead to an investment. The aim is to invest in 10 to 12 collective investments and 10 to 12 direct investments.

So, the fund invests equally in selected private equity funds and direct investments. Why this hybrid strategy?

Because we create several advantages for our investors. We position ourselves in a diversified manner and intend to invest globally in 10 to 12 of the best funds in the decarbonisation sector, as greater diversification in the investment portfolio means lower risk and lower volatility of returns. However, diversification has its price, because investments in collective contributions incur additional management fees. We therefore intend to invest around 50 percent of the fund volume in direct investments, particularly in Europe. Direct investments offer greater influence and higher potential returns as there is no additional management fee. At the same time, however, they are also associated with higher risks. The combination of fund and direct investments allows us to invest in over 100 portfolio companies, if necessary. This allows us to offer our investors a broadly diversified, risk and cost-optimised portfolio.

How much money has flowed into which funds so far?

Zürcher Kantonalbank is the fund's anchor investor and has therefore already invested CHF 30 million. As a result, we have already made two private equity fund investments of EUR 10 million each in recent months. And this is before other qualified investors provide their contributions in the first close. Thanks to our personal relationships and ZKB's convincing focus on sustainability we were able to, for example, gain access as a strategic investor to a fund in sustainable investing which has been trend-setting in private equity since 2007, even though the fund was absolutely oversubscribed. We are currently in the fundraising period and intend to carry out a first close at the end of October 2022. After that, the fund will remain open for further subscriptions for at least a further 12 months.

What is Ms Jacobs doing personally to emit as little CO2 as possible?

Since I realised that above all animal products contribute a large part to CO2 emissions, I have drastically reduced my consumption of meat and other animal products and have largely switched to plant-based products. I also buy regional products to avoid the impact of transport. Plus, I buy more second-hand clothes and accessories to support the circular economy and, of course, cycle to work.

Disclaimer: This information is intended exclusively for qualified investors, is for information and advertising purposes and does not constitute an offer or a recommendation to acquire, hold or sell financial instruments or to purchase products or services. The sole binding basis for subscribing to shares in the limited partnership for collective capital investments described in this interview is its prospectus with integrated Articles of Association and its subscription certificate (available on request from Swisscanto Private Equity CH II AG or Zürcher Kantonalbank, Bahnhofstrasse 9, 8001 Zurich).