Full transcript below:
Brad: Welcome to the "Climate Risk" podcast. I'm your host, Brad Hurley from the consulting firm ICF. In this episode, we'll look at climate risk and investment, focusing on opportunities to unlock the power of the private sector to scale up technologies and services that facilitate climate resilience and adaptation. To learn what's happening in this area, we talked with Jay Koh, who's the co-founder and managing director of The Lightsmith Group, a sustainable private equity firm in New York City. Jay is also the founder and chair of the Global Adaptation & Resilience Investment Working Group and has more than 20 years of experience in investing and public policy in the public and private sectors. My colleague Peter Schultz and I spoke to Jay by phone during the initial days of the COVID-19 crisis, and we really appreciate his taking time out of a busy and hectic day to talk to us.
Different ways to look at investments and climate resilience
Brad: To set the stage for the discussion, could you explain the differences between investing in climate resilience versus making climate-resilient investments?
Jay: So, we think about investing with regard to physical climate risk in two ways: One is making investments in climate resilience--meaning, where the investments that you're making actually can help further the resilience of parts of the economy or society to the risks and impacts that will be increased by climate change--as opposed to making climate-resilient investments, where the investments that you're making themselves have been designed for--and take into account--the increased potential risk and impact that will be accelerated by the climate change phenomenon.
So an example is, you could invest in a company that does analytics around the supply chain that take into account weather volatility, that can make a multinational corporation supply chain more resilient to interruptions that could potentially happen from extreme weather events. Or you could make it so that your factory--as the manufacturer--has been designed so that it can withstand a higher level of hurricane incidents, or more frequency of flooding, or storms and the like. So on the one hand, you'd be investing in climate resilience--or in companies that have technologies, products, services, or projects that actually themselves support resilience to the effects of climate change. Or you can make sure that your investments are climate resilient. In the long run, we'd hope that investments in the one can help lead to the other. In other words, in the medium to long run, you want all of your investments to be resilient to climate change, or they will be negatively impacted by climate change. And one way of doing that, we think, is by supporting investments in climate resilience, where the companies and activities that you're engaged in support creating resilience in other parts of the economy and society.
Brad: So then tell us about The Lightsmith Group and which of these areas you work on.
Jay: The Lightsmith Group is a sustainable private equity firm. We are focused on making investments that on the one hand generate attractive investment returns for our investors, but also generate impacts that are positive in the social-environmental sense. Our first area of focus is climate resilience and adaptation. So we are looking to make investments in companies at the growth stage that have between $5 million and $100 million of revenue, for example, whose technologies on the one hand and solutions on the other can help to assess--and then help to address--the risks and impacts that are being increased by climate change. That's kind of our focus.
We are looking at a number of different sectors of the economy; six are the initial set of focus. One is agricultural analytics, so data and intelligence around agricultural productivity of all types. Then there's supply chain analytics, where there's weather analytics and volatility incorporated into that analysis. Catastrophe risk modeling and weather analytics from the insurance and reinsurance sector, geospatial imagery and mapping, which is a precursor to doing any kinds of weather analysis. And then two areas where there are some solutions types of companies that we describe broadly as sort of water harvesting and efficiency, including drip irrigation, as well as resilient food systems.
So those are the six initial areas of our focus. Well, we are looking broadly at a whole range of different technologies and products that are out there, that can help to analyze these risks and manage them as those risks become more complex--and more substantial--and move from one place to another. So that could include everything, including medical diagnostics, for example. You might not think that childhood asthma is at the top of your list of impacts of climate change, but it turns out that if you light most of California on fire and most of Australia on fire, you instantly get a lot more childhood asthma. So even the disease vectors being impacted by waterborne and airborne and mosquito-borne vectors moving around--which have been identified by the IPCC and others as a critical component of the impact of climate change on human health--these give rise to the need for investments in resilience in those areas as well.
Brad: And what are some of the kinds of companies that you're investing in? Are these companies that provide services or companies that are developing and implementing technologies, or is it a combination?
Jay: It's a combination. And importantly, most of the companies that we have been identifying as potential investments would not call today most of what they do “climate change anything.” The word adaptation or resilience is probably not at the top of the list of things that they've been thinking about. But they happen to be involved in the assessment, in the management, or addressing of the specific types of impacts and risk that we think will now become much more prevalent, frequent, severe, and less predictable.
So, for example, if you're in the supply chain management business, you may be managing extended supply chains for manufacturing--or for different types of consumer products--and not really think about the fact that, embedded in the assumptions that you have around how to manage that supply chain, are the frequency of storms, weather events, the environmental conditions that you're operating under. And as those increase in risk and complexity, then your need to actually manage them becomes more substantial and your need to view that in a way that actually takes account of a new set of conditions will become more substantial.
What we're looking at is growth stage companies that already have these types of technologies, products, and services--and are serving real companies and other folks in the environment and the economy--because we think we should scale up those sets of technologies, products, and services. It can be, on the one hand, data analytics around how to take digital mapping and overlay it with different types of analytics as the different risks and impacts over those geographies become more complex, or services like managing supply chains in the face of increasing weather volatility or the need for more business continuity.
And we basically think that what we should pursue right now--and where there's a really interesting opportunity that's a very important one--is in tools. So we're investing in data and analytics on the one hand, and products and services on the other that can help to scale up and assess the more complex risks that we're going to see and help address it as the risk gets larger. Our thesis here is that it should be both great for investors because it represents extranormal potential growth as the need for these solutions get larger--and it's a very important target for society. If we have the same conversation that we're having now 5 or 10 years from now, the major difference we can say, with some uncertainty, is that climate will definitely be different. And the question is, will we have invested in the tools to analyze how those changes will affect society and the economy, and products and solutions to help manage and address those impacts, or not?
The value of early adoption ideation and technology
Brad: What exactly do you mean by growth stage companies? What does that mean?
Jay: Growth stage companies are ones that are beyond proving out their technology or getting their initial sets of customers. These are companies that are already proven, in terms of their product development. They're not “if you build it, they will come” kind of companies. And we think this is a good starting point for this kind of investing because they've proven that they understand how a company or a government or an individual or a community actually understands and digest information--or uses their solutions--in a way that actually makes sense for them economically.
One of the challenges that's out there is you're seeing a lot of new technologies being developed in academia, by governments, by some startups, that analyze--for example--a new, more complex set of risk conditions giving rise to the extended fire season in California and new phenomena like fire tornadoes in Australia. And the challenge there is, if those technologies don't find their way into a workflow of a company, or a government, or a community, or an individual, the technology results in data that's not easily digestible and doesn't lead to actual decisions, then it's going to sit in academia or in government as interesting projects, but not have the same kind of effect in a practical sense--as someone who's already figured out how to translate that technology and those solutions into things that people can use right now.
We think a really important test of whether that's happened or not, is whether or not you found folks that can actually value that service or product and pay you for it. Our idea here is, at this moment in time, rather than waiting for those technologies to get adoption--and new technologies are being developed all the time to address the problem of climate change as it gets more substantial--we'd rather start with the technologies that exist now, scale them up, increase their capacity, bring them to the communities and to the companies and individuals and governments that need them. That is the best chance we have right now for scaling up capacity to deal with the problem that we're about to face.
Brad: Could you describe a typical deal that would arise from the use of Lightsmith’s funds?
Jay: We're looking at companies right now, for example, in the catastrophe risk modeling and digital mapping industry that have taken advanced modeling techniques that were developed for the insurance/reinsurance sector, literally to model natural disasters from regulatory purposes and insurance loss projections, and so on. And they've been able, in some cases, to take that basic capability--which is really digital mapping overlaid with different types of risk analytics--and translate and extend the reach of those kinds of technologies to other sectors, like agricultural insurance, or like screening the risk operationally for utilities, whether telecoms or power utilities.
Those kinds of capabilities have led to the application of those technologies to manage extended sets of fixed assets on an operational basis. Those are things we need to manage all the time. So, we've always had, for example, fire risk, since we've discovered fire. It's just a question of how frequent, how severe, how impactful it is. And we manage those risks by modeling those risks to different types of assets like utility assets. And so those kinds of companies are currently helping those utilities and other asset owners manage those risks as a service and as an advancing piece of technology that helps the management of those risks become more efficient.
The interesting thing now is, as you see those risks become much more complex, more frequent, more severe--as we're seeing in the last several years now in California--and the projection is for the next at least 10 years in a row, that those kind of companies can then update their models, help to make them more efficient, have them oriented to a new set of conditions, and extend their reach to support even more potential users of the technology. Our basic idea here is, if we take the way that we analyze these risks today and scale them up, then we have a better chance of analyzing and managing those risks tomorrow.
In other words, climate change is not kind of an “aliens landing on the earth” phenomenon that we've never seen before. It's really taking existing kinds of risks that are already in different sectors of the economy and affect different parts of society, and making them more complex, more frequent, more severe, and moving them around. A starting point to actually assess those risks and to begin to manage them is how we analyze and manage those risks today. We simply need to find companies that are well-positioned for that, and scale them up in partnership with government, with society, with academia, of course, and others, so that we have an extended amount of capacity to actually deal with the scale of the problem when the problem gets increasingly complex.
Investing for a climate that continues to change
Brad: So, what about your own motivations from a mission perspective, maybe even from a personal perspective and a financial perspective for undertaking this?
Jay: I'd say there's two or three ways to answer that question. The first is simply from an investment perspective, my career has been largely in the private equity industry, at the Carlyle Group, and then working for the U.S. government for OPIC [Overseas Private Investment Corporation], the U.S. government's development institution now called the United States Development Finance Corporation, investing in emerging markets and in different sectors around technology transitions or risk transitions, and really thinking about investment in the policy context as a tool for supporting sustainable development. In other words, if you can help people develop their economy and generate employment and generate growth, then that ends up supporting not just your financial returns, but also the overall progress against poverty and towards better society overall.
In that context, when we saw the climate change problem--starting probably around the 2012, 2014 timeframe--as really incorporating not just mitigation or reducing the trajectory of greenhouse gas emissions, but also adaptation or dealing with the effects side of the climate change issue, we realized that with some of the background that we had (having invested around the security sector around the time of 9/11--investing in first, second, third-generation wireless technologies, and each of those technology transitions happened), we could apply a similar approach in finding tools and finding common good intelligence, on the one hand, and solutions on the other to really scale up and meet this challenge as the effects of climate change became clearer and more substantial and more complex.
To an investor, that's one of these few sets of circumstances where you see this unbelievable opportunity, where there's a huge challenge, a giant risk that's going to move its way through the economy and society, that no one else is really doing very much systematically about investing in. So less than 5% to 6% of total climate finance tracked globally has anything to do with the effects of climate change, or adaptation, or climate resilience. Yet you are well-positioned--because of your network, your relationships, and your perspective on other types of transitions and risk and impact--to really focus on it and develop investment strategies against it.
That obviously has the value of creating an interesting investment opportunity that's currently not being focused on by others, which means potential for interesting financial returns. But on the other hand, the strong form of the argument is, without harnessing private sector, entrepreneurial skill and talent--without harnessing innovation and capital--then the chances that we can scale up the tools, the technologies, the services, the product, the capacity to deal with the climate change problem is much, much lower. I think the probability is much higher if we can figure out how to unlock the capability within the private sector to develop technologies, to go after solutions, and to scale it as fast as possible.
And I think one way of doing that is demonstrating that it is a profit-making enterprise, and one that is sustainable and scalable. That's the hope here, which is to say, "Look, without the private sector scaling up its capability in these areas, without demonstrating that capital should flow into these areas, it's much more difficult of a transition."
On a personal note, you know, I have 3 kids and working from home, given the current situation, with my 11, 9, and 4-year-old. And I think about having that conversation 10 years from now, when my 4-year-old daughter is 14, and thinking about the world as it will look at that point. And again, I think it will look pretty different. Beyond this kind of temporary situation, it's clear that the rate of change around the climate is simply accelerating. And the question is, will we have prepared ourselves for that world or not? I'd rather be focused on generating great returns for investors, and aligning that with generating the capacity, the scale of the tools that we need to face the problem over that 10-year period. That's a big motivation as well.
Brad: Another project that you work on is the Global Adaptation & Resilience Investment Working Group. Could you tell us a little bit about that and what it does?
Jay: Sure, The Global Adaptation & Resilience Investment Working Group, or GARI, was launched in partnership with the UN Secretary General at the Paris Global Climate talks in 2015. What it really was designed to do was to bring together investors, asset owners, experts--like ICF and others--rating agencies like S&P and Moody's, governments, companies that were strategic in the space, climate experts, entrepreneurs, and others, just to really kind of have a conversation about two basic topics. One was, what is the practical impact on the value of your investments from the physical risks and impacts increased by climate change? So, what happens to your investments when climate change starts to occur?
And on the other hand, what are the opportunities that are created to invest by the need for climate resilience? That working group has now met about 23 times over the last four years, has released a series of three discussion papers--the last two of which are designed to be kind of plain-language descriptions for the ordinary investor or individual about what the physical risks of climate change really are and how they're relevant to individuals and investors--and it’s broadened out the conversation about different ways being developed or being used right now to analyze these risks and manage them, and useful conversation among a whole range of different parties about the potential practical implications here, financial implications of the effects of climate change, and the opportunities that are created to invest in it.
Aiming for a better future
Brad: Can you think of any or suggest any new frontiers or untapped opportunities in advancing resilience in the private sector?
Jay: Yeah, there are probably two or three ways that you could go from this starting point. So again, we're just trying to pursue what I would describe as sort of a "MacGyver" approach: you take whatever's lying around and try to solve the problem right now. These are existing technologies, products, and solutions that we can scale up to orient at the problem. So fire risk management, supply chain management involving weather analytics, catastrophe risk modeling, these are all technologies that already exist, we need to scale them, we need to orient at the more complex set of conditions that are coming, and deploy them as quickly as we possibly can in different places.
That's kind of today's immediate action. What I think you can see going forward are two or three different other sets of responses. One was exactly what you're talking about before, which is having made investments in climate resilience--the tools and technologies to create the capacity, to create resilience--making sure that all of your investments are climate-resilient, and that's your house, that's your community, that's the bridges and roads that we drive over, those are the airports and seaports that commerce comes through, that the health care system that’s going to be impacted by increasing changes in these vectors, for example, incidents of heat impact on humanity. That's the food and water supply, and so on.
I think the second stage after investing in the tools is making sure that you apply those tools systematically to what's going on. There's obviously then holes that you'll determine exist in the technology required to address those things, and that's where venture capital and new investments and innovation come from as well. But what I think is sort of interesting as another frontier-- and if there are millennials and post millennials out there listening to this conversation--I think the big opportunity really is in thinking about what the world looks like if you focus on what the world looks like through these changes.
In other words, if you think about Impossible Burger today, or Impossible Foods, or Tesla Motors, or IKEA, who says that their fastest-growing product is LED lighting, in each of those cases, what caused part of the acceleration in the transition there, the success of Tesla's electric vehicle sales or LED lighting at IKEA, or people actually eating Impossible Burgers--or whatever else--wasn't that these products and services are designed first for resilience or sustainability, and we're going to give you only a 20% less enjoyable experience as a consumer or user, as existing conventional activity.
In fact, the idea was exactly the opposite. What you designed is a product or a service that was superior because it was cooler, or faster, or quicker, or tastier. If you can actually imagine what that future looks like and create products and services that are better as experiences--that are also designed for a more climate-changed future--then I think you're going to have a lot more transition and a lot more success. So folks are aiming for that better future--even in the context of a more climate changed environment--I think that's where there's a really enormously interesting opportunity for innovation and development beyond this initial set of tools and the application of tools to build resilience.
The other way of saying it is, Naoko Ishii, who was the CEO of the Global Environment Facility of the UN, has said, "Our approach on the transition to low-carbon society has been really aimed at being transformational." We're not looking at simply reducing the carbon output from coal-fired power plants by 5% or 10%, and then gradually, incrementally making that transition. We don't have the time for that. So, we moved to entirely new energy sources like wind, solar, and hydropower. But our approach on the adaptation/resilience side has to date been pretty incremental. You simply think about building the seawall another half a foot or a foot higher, or we think about battening down the hatches a bit more, adding other half a foot to the wall of your data center to make it more proofed against hurricanes.
And she's encouraged a more systematic or transformative thought process with regard to adaptation in climate resilience. Thinking about this from a systems-level or trying to instead of asymptotically approach reality as it changes--kind of doing step changes or solving by algebra and figuring out where you think the world is going to get to and developing systematic approaches to making that transformation happen. That can be everything from incorporating natural capital into the design of cities--where you've got more parks and more green space and more natural landscape features that help with the flooding or reduce inundation or change the way that we actually think about transportation or the supply of water or food in a localized environment. That could be the kind of new products and services I was describing before. These are better experiences that exist in a different environment that we're now going to face.
I think that's where the really interesting set of questions is going to lie. But immediately, least at a minimum, we should start solving for the capacity problem by investing in companies that have the technologies today and have the products and services today--that are being used today in the economy to manage these risks and assess these risks--and scaling them as much as possible. Because we're definitely going need those over the next 5 to 10 years and I think well beyond. And while we use those technologies then to make the rest of our investments more resilient, other work can be done on thinking about this transformation systemically and for a better outcome.
Battling knowledgebase barriers to climate resilience
Brad: Jay, that's really inspiring and very well stated. Peter, do you have any questions?
Peter: Brad, I agree with you that what Jay said is really inspiring about transforming the way that we think about the future and approach the future. Jay, I have a little bit of a down-in-the weeds follow up. You're addressing a barrier to advancement of climate resilience by providing the financing that's necessary to expand the reach of emerging ideas and companies. But what are some of the other barriers that need to be addressed in order for the financing that you're helping to connect people to, to fully take effect? Or is financing the primary barrier and companies are good to go once they have that? The question is, are there other things that are also standing in the way that we should be thinking about addressing?
Jay: Yeah, I think absolutely. If you look back at the UNEP, United Nations Environment Programme Adaptation Gap report in 2014, they would have said the barriers they saw at the time were technology, knowledge, and finance barriers. So, the technology barriers, in some cases, you don't have the technology to design ways of addressing fire tornadoes. I don't even know if anybody's ever figured out how to deal with that because that just started happening this last year in Australia. But there's also knowledge barriers, where the information about how to deal with some of these risks has been developed in places where the risk historically has been and does not yet exist or has not yet been transferred to places where it needs to go.
Brazil has never really had that much of a struggle with drought, and then in the last seven years, they've suddenly had a bunch of drought in northeastern and southeastern Brazil. They never had a need, for example, for drip irrigation technology, because they have the Amazon--they have enormous amounts of water resources. But suddenly, if you start to have much more frequency of drought in places that never had it before, maybe you need to take that technology from India or Israel or someplace else and adapt it for larger-scale agribusiness--which is what you have in Brazil--and different topography and different types of crops, but bring that knowledge someplace else.
The other obvious gap is finance, which is what I mentioned before, which is this challenge of having no more than 5% to 6% of climate finance be oriented to adaptation and climate resilience. Not for want of trying but for want of opportunities, ideation, and so on. Finance is certainly a barrier. But it's not just money per se, but this kind of idea that we need to orient and drive by looking through the windshield and not through the rearview mirror. And we act right now in some ways that the delta is zero, that there's no real difference between past periods and future periods, even though we sort of intellectually accepted that climate change is already underway. And even in a one and a half or two-degree scenario, you're going to have substantial impacts. We just haven't made those concrete yet and thought about them in a systematic way.
I'd say there's kind of two barriers that I would really highlight. One is there's a genuine psychological barrier here. You need to go through a transition and still hold fast to the need to reduce carbon output and transition to a low carbon or net-zero economy as fast as humanly possible--and make as much progress on that--and at the same time, accept that we still need to develop resilience to and adapt to the effects of climate change. Because even if we can achieve a one and a half or two-degree world, it's still going to be pretty substantially different than the world we have right now. And that is a difficult thing to grasp--both of those things--and it's a difficult thing to accept, to some degree, that some of these risks that are now manifesting will increasingly manifest. Because there's a lot of potential for either immobilization, or despair, or fatalism about the fact that we have geoengineered our planet at this point and are going to see the consequences to some degree of that and to prepare for them.
Going through that and trying to translate that into practical actions that you can take—like, you may believe in climate change but your 401(k) doesn't reflect that. And you have no idea of necessarily how climate change might affect the value of your house or your mortgage, even though if you live in Northern California right now it probably is impacting your ability to pay your mortgage if most of your community is on fire. So I think the trick here is trying to make it concrete and translatable, practical to face the risk, to understand the risk, to quantify the risk, and move through that psychological barrier, make that transition happen, and still retain that sense of the need for action and the ability to act, that sense of agency.
The other barrier, I would say, is one of ideation or one of imagination in a way. I am fundamentally a technological optimist. I think we can harness a lot of engineering and innovation and technology and help address some of these challenges, but we need to start turning our attention to it and focusing on it. I'd rather start by saying, "Look, there are tools that we have right now we can scale up and help to understand this problem, which is the first step toward addressing it." And then there are other solutions and services and products that can help us manage and address the problem because we're already addressing it. It's just going to be much bigger than we used to think it was. And then by staging that process and getting people not just to think about this as, "I'm just trying to protect my downside as much as possible. I just don't want things to decay any more than they need to," but also thinking about that better future. You can also shift the narrative and get people to start orienting their energy and innovation and entrepreneurship in that direction as well.
There's a real set of challenges around the psychology of it, and around the narrative, or the ideation, or the focus of it; I think the quicker that we can get through those two sets of transitions in a really practical way--again, not to say that there's any less urgency in trying to reduce the scale of climate change as much as possible--we absolutely should do that. I think most of the technology we're talking about will do that. And the other side of it is--without accounting for the effects of climate change--many of the things we're doing to try to reduce the speed or reverse the effects of climate change will also be at risk. You're going to see hydropower shortfalls and wind power shortfalls because the weather is changing, and you're already seeing to some degree. We need to design everything for a resilient future and a low-carbon future. And to do that, we need to, on the one hand, make the psychological transition and really do that in a way that's practical, and actionable, and concrete. And then also to think through not just how that transition works from protecting the downside, but imagining a better upside.
Brad: Thanks again to Jay Koh for that very informative and inspirational interview. If you're interested in climate risk and would like to learn more, please subscribe to the podcast. You can follow along as we explore this topic in more depth.