The Sugar Daddy Effect? Assessing Corporate venture capital, Sovereign funds and Green Energy!

Performance

    The research on active investing suggests that active investing collectively has trouble matching the passive investing returns (from owning index funds), especially after the costs of active investing have been brought into the equation. But how does sovereign wealth fund investing do, relative to passive and other active investing? The answer, at least in the aggregate, is not so well, with equity in the companies targeted by SWFs underperforming the market significantly, with the caveat that performance is much better at transparent SWFs than at opaque ones. Looking at the impact on corporate performance, the results are mixed, with increases in profitability, when the SWF’s holdings are less than 2% of outstanding shares, but decreases in profitability and worsening operating performance for larger holdings. In short, if the core mission for sovereign wealth funds is preserving and growing a nation’s wealth for its citizens, many of them are falling short, and if it is activism at the investing companies, it is not working.

    That said, there are outliers, and looking at them may provide us some insight into why sovereign wealth funds under or out perform. While many sovereign funds are opaque on performance evaluation, offering little in public on historical performance relative to benchmarks, Norges provides exhaustive documentation of how their active investing has measured up to passive alternatives. Since the fund is invested in different asset classes, let us focus on just the equity investments made by the fund and the comparison that they provide with a benchmark (admittedly of their creation):

As you can see, the fund has outperformed the benchmark, albeit by a very small amount, but given the troubles of active investing, the fact that the alphas are positive is a substantial win. At the other extreme, consider the story of 1MDB, the Malaysian sovereign wealth fund, set up in 2009 with money from an oil joint venture (with PetroSaudi), with the intent of encouraging investment in Malaysia. In the years that followed, hundreds of millions of dollars from the fund was used to fund Hollywood movies and bankroll the lavish lifestyles of connected financiers and politicians, before leading to the jailing of Najib Rezak, Malaysia’s prime minister, and a $3.9 billion charge against Goldman Sachs, for the bank’s role in the scandal. 

Green Investing

    It is undeniable that climate change has moved up the list of global concerns, and if like me, you followed COP28, the climate change conference, this year, or even read news stories about the weather in your part of the world, the need to reduce our carbon footprint does seem urgent, and there are laws, rules and resources that are being directed towards that end. In fact, if investing were measured on the virtue scale, there is perhaps no more virtuous version than green energy investing, and hundreds of billions have been directed towards it. 

Motives

    Of the three groups that we look at in this post, green investing’s motives should be the simplest to disentangle. It is to push the world away from fossil fuels to alternative energies, but that is where the consensus ends. For some players in this space, reducing the carbon footprint and fighting climate change is the core mission, with returns being a constraint rather than an objective. Thus, for foundations and perhaps even some endowment funds, investing green with as little loss in returns as possible becomes the mission statement. Unfortunately, the bulk of green investors want to have their cake and eat it too. Among impact investors, a prime source of funding for green investors, a significant majority of impact investors (close to 64%) want to have their cake (at or above-market returns, given risk) and eat it too (by making an impact). 

With equity investors in the green space, this hoped for payoff takes the form of positive alphas, while directing their money to solar, hydro and wind energy investments, and with green loans and green bonds, the higher returns come from being able to earn higher interest on their lending, given default risk.

Magnitude of Investment

    While the speakers at COP28 have lots of legitimate grievances against governments and markets, including the subsidies that fossil fuel companies have received over their lifetime and the laws that enable fossil fuel energy consumption, one grievance that they cannot have is that not enough money has been spent on developing alternative energy, i.e., energy from everything but fossil fuels. Consider the following graph, that reports investments made in billions of US dollars in fossil fuel and alternative energy sources each year.

Performance – Financial and Carbon Footprint

    For defenders of green investing, it is good news that that so much money has been directed towards green investing, but that is unfortunately where the good news seems to stop. For the most part,  the payoff from green investing has been surprisingly small, on both the financial and the social dimensions, especially given how much money has gone into it. 

    Let’s start with the financial payoff from all of the trillions of dollars that have gone towards making the world greener:

1. Business building: When trillions of dollars are invested in a space, you would expect, at some point in time, that this will lead to companies emerging from the space with business models that can deliver sustained profitability and command large market capitalization. In the green investing space, that has not happened (yet). For instance, the 273 publicly traded companies in the alternative energy space (including almost every aspect of that space), in October 2024, had a collective market capitalization of $506 billion, and they reported aggregated revenues of $117 billion in the most recent twelve months. In contrast, just one fossil fuel company, Exxon Mobil alone had a market capitalization of $532 billion, and revenues of $479 billion. Green investing defenders will argue that it will take time for these companies to mature and deliver profitability, but the clock is ticking and the trend lines do not look promising. 
2. Investor returns: On the other side of the equation, what type of returns are investors in green energy getting from their investments? The answer will depend  on whether you are looking venture capital investors in green energy or public market investors, and also on the time period that you examine. While returns for both groups were robust during portions of the last decade, when investor demand for green investing was high, they have come back to earth, and especially so in the last few years. Here again, your response may be two-fold. The first is that you need patience, for these green energy investments to pay off and deliver profits and returns. The second is that green investing is not about delivering excess returns, but about saving humanity from global warming. I have absolutely no problems with the latter rationale, as long as green funds (both equity and bond) make it clear that they expect to under perform markets, when they seek out capital.

In fact, if your response to the financial impact of green investing being unimpressive is that these investment are saving us from global warming, the numbers are not supportive of the virtue thesis. In the graph below, I look at energy consumption, based on source: 

It is stunning how small an effect  the trillions invested in the space have had on where we get our energy, with fossil fuels accounting for about 81.5% of total energy consumption in 2024, about 5% lower than it was twenty years ago . In fact, much of the gains from solar, hydro and wind energy have been offset by a loss in energy product from nuclear energy, the one alternative energy source where almost no money was invested over the period. It is true that there are parts of the world (Latin America and Europe, for instance) where green energy has made significant inroads, but if global warming is an existential crisis, that is small consolation. For those who argue that shifting to green energy takes time, I have two questions. The first is, unless I misheard what climate change advocates are telling me, time is not an ally and we don’t have a luxury of moving slowly. The second relates to economics: if it has cost us five trillion dollars (or more) to reduce our dependence on fossil fuels by 5%, will we go bankrupt trying to reduce it by another 35%?

    There are some who will argue that the money spent on green investing has given rise to innovation and new technologies, but I wonder whether that innovation and those technologies are the ones that we would have invested and developed, without a firehose of capital raining down on green enterprises. There is research starting to percolate through the system that we could have made a much bigger impact on greenhouse emissions by spending our R&D on brown innovations, i.e., innovations that make fossil fuels cleaner-burning and less damaging, than on green innovations, i.e., innovations that explicitly focus on just green energy. More importantly, and as noted earlier, it can be argued that the impact investing definition of alternative energy excluded the one source of energy that has had a track record of making a significant impact on energy consumption, i.e., nuclear energy, and spending a fraction of what was spent on nature’s energy sources (solar, wind and hydro) on developing safer ways of delivering nuclear power would have moved the fossil fuel dependence needle by far more. 

    In short, green investing, in the aggregate, has failed in terms of delivering financially (both in terms of business building and delivering returns for investors) and socially (in terms of reducing dependence on fossil fuels).. It is the point that I made in my post on impact investing, where I argued that the prime beneficiaries of the movement have been the consultants, green fund managers, advisors and academics who live in its backwaters.

The Sugar Daddy Syndrome

    Clearly, corporate venture capital, sovereign wealth funds and green investing have very different roots and motives, and have evolved differently, but they do share a common feature. Given how much has been invested in each, they have under delivered, at least collectively, and the vaunted side benefits have been slow to manifest, again with exceptions. I am perhaps overreaching, but here are the reasons as I see them:

1. Assured funding: Each of the three groupings has assured funding, though the degree of assurance and magnitude can vary across individual players. With corporate venture capital, it is the parent company, with sovereign wealth fund, it is the government, and with green investing, it has been impact investors, at least for the last two decades. That assured funding may give them an advantage over their counterparts – VC for CVC, traditional funds for sovereign funds and conventional energy companies for green energy investments- but it does come with a downside. Looking at start-ups and very young companies that manage to make the transition to businesses, one factor that plays a role in focusing attention on building business models is desperation, i.e., the fear that if you do not, you will go out of business. That desperation is lacking in all three groupings highlighted in this post, in many cases. Start-ups and young businesses founded by corporate venture capital may not feel the urgency to create and build business models, if they perceive the capital window at the parent company will stay open. In active money management, a big investing mistake can lead to client flight, but for a sovereign fund, that mistake may quickly be covered by government largesse. Finally, with green investing, one reason that there are so many bad companies and investment funds continue to survive is that they use their virtue at least on the climate change front to attract more capital.
2. Mixed Mission: I noted that for each of the three groups, there is a mixed mission, where, in addition to, and sometimes, instead of, their core missions (start-up to success for CVC, investing alpha for SWF and producing non-fossil-fuel energy at a reasonable price for green investing), they are given other missions. Running any entity, when you have more than one core objective, is always tricky, and it becomes doubly so, when you have two or more objectives, pulling in different directions. 
3. Stakeholder distractions: Every entity has multiple stakeholders, and navigating the conflicting interests to deliver success is difficult to do. With the three groupings highlighted in this section, there is at a stakeholder that is the equivalent of a 600-pound gorilla, and what it wants can often overwhelm every other interest. With CVC, that gorilla is the parent company, and the CVC’s performance can reflect decisions made at the parent company level that are too big of a handicap to overcome. With sovereign funds, it is the government, and the people who have oversight of the funds, and to the extent that they call the shots, sometimes with other national interests (protect bad banks from failing by investing in them), sometimes with political end games (hire more workers or not fire workers, just ahead of elections) and sometimes for personal reasons (corruption), the SWF can be left with the residue. With green investing, it may be impact investor skews and biases, and governments, that provide the tax benefits and subsidies, pushing companies into technologies and investments that they would not have otherwise.
4. Non-accountability: As you can see, in our discussion of performance for CVCs, sovereign funds and green investing, under performance can always be excused or explained away by either pointing to other mission objectives or arguing that in the long term, success will show up. Thus, a CVC that underperforms a VC will argue that while its corporate ventures did not meet the mark, the side benefits that accrued to the parent company make up for the underperformance. With sovereign funds, it is convenient to point to the other roles – nation building, sector fixing or social safety net – that they play that may excuse the negative alpha. With green investing, the cloak of planet defender comes in handy, whenever the absence of results (either in financial or social terms) is brought up.

1. Independence: With CVCs, we reported that very few are set up as stand alone entities, with control, over funding and investing choices. If you are investing significant amounts of money through a corporate venture capital, it may make sense to not only separate the CVC from the rest of the business, but also to let the individuals that you pick to run the CVC make decisions that are not second guessed. In the context of SWF, one reason that Norges has been able to deliver above-benchmark returns is because its executive board  is insulated from government interference. 
2. Transparency: In a related point, many CVCs and SWFs are opaque about their working and holdings, with no good business reasons for secrecy. That makes it easier for them to not only hide inefficiencies but almost impossible to assess performance. That opacity is particularly present with the side-missions that these entities are called on to perform – the actions that protect national interests or strengthen financial institutions, for instance, are open for interpretation. At the best performers, though, transparency is more the norm than the exception, and that transparency extends to almost every aspect of how they operate.
3. Separation of motives: I think it was Marc Andreessen who described a house boat, as neither a very good house nor a very good boat. When entities are asked to deliver different missions, intermingling them in decision making will create bad choices. If the Saudi government does want PIF to deliver both solid risk-adjusted returns on its investments and diversify the Saudi economy, it will be better served to separate PIF into two entities – a fund management entity that invests in the best investments it can find and nation-building arm, whose job it is to make the investments or provide the subsidies that work in delivering that mission. Again, at the best performers, there is more of an an attempt to separate core missions from side missions, with clear guardrails on the latter.
4. Accountability: As things stand, it is difficult to hold the entities that make up each of these groups accountable, and the mixed mission is the primary culprit. By separating the missions, accountability becomes easier, since the core mission part of the company can be assessed using the performance metrics of that core mission, and the side mission on how much the money spent advances movement to the social or side goal. That accountability should be followed up with actions, i.e., a greater willingness to shut down corporate venture capital arms that do not deliver and to convert  under-performing sovereign wealth funds from active to passive. 

1. Funding always has to have contingencies: When companies, governments or institutions create entities that they commit to fund, that fund commitment has to come with contingencies, where if the entity does not deliver on its promise, the funding will be reduced or even shut off. To the pushback that this will make these entities short term, note that the contingencies that you put in can allow for long time horizons and long term payoffs, but the option of cutting off funding has to be on the table. After all, it is entirely possible that the funder can accomplish what they hoped to, with their under performing entity, with a different pathway.
2. Have a core mission: I sympathize with those who head CVCs and SWFs, when they are faced with a laundry list of what they are expected to deliver, with their funding. Since it is impossible to run an entity, or at least run it well, with multiple missions, you have to prioritize and decide on your core mission. Thus, if you are a sovereign wealth fund, is it your core mission to invest your funding wisely to deliver market-matching or market-beating returns or is it to build a nation’s infrastructure? 
3. Social purpose, but with reality checks: In many cases, entities that have a business purpose are also given a social purpose, and while that is understandable, it can give rise to incentives and actions that lead these entities to fail at both. If there is a social purpose component, as there is in green investing and sovereign wealth funds, it has to be made explicit, with clear measures on how much in economic profits the entity is willing to sacrifice to deliver them. In short, claiming that you can deliver good without sacrifice is delusional, and as I have noted in my posts on ESG and sustainability, it is at the heart of the internal inconsistencies and incoherence that bedevil them.
4. Failure can be a strength: In my writing on corporate life cycle, I noted that survival for the sake of survival or growth for the sake of growth will lead to outcomes that make us all worse off. As noted in the last section, the biggest weakness in the three groups is the unwillingness to euthanize underperforming entities, ensuring that good money will be thrown after bad.