California Carbon Allowances (CCAs) Should Retrace 2024 Losses in 2025

Celia Dallas, Chief Investment Strategist

CCAs fell from their $44 high at the start of 2024 to bottom out at $31 in August after news of program changes being delayed to 2026. Once the California Air Resources Board (CARB) finalizes the timing and path of CCA supply reductions, prices should retrace losses. Investors and covered entities are likely to purchase CCAs before program tightening pushes up prices more meaningfully.

Companies covered under California’s cap and trade program must purchase CCAs. Each allowance permits emission of one metric ton of carbon dioxide equivalent. Such programs initially provide excess allowance supply to give covered entities time to reduce emissions. Consequently, carbon prices were relatively flat in the program’s early years. CCA prices began rising as supply/demand balance improved. Following recovery from the COVID-related demand shock, CCA prices have been trending upward, especially as expectations grew that CARB would tighten supply to meet environmental targets. Prices fell in 2022 amid concerns that CCA demand would fall after California extended the Diablo Canyon nuclear plant’s life. However, these concerns faded as expectations for program tightening emerged in 2023.

We anticipate that final clarity on the program’s tightening path and timing of supply reductions will enable the market to recover lost ground in 2025. CARB proposed two potential supply reductions paths, resulting in a 10% to 14% annual decline in allowances, up from the current 4% annual decline, from 2026 to 2030. Even the slower decline path would see a 180 million reduction in CCAs between 2026 and 2030, equivalent to more than 50% of the current inventory surplus. Such a cut would push the program into a cumulative deficit as early as 2030, requiring covered entities to purchase CCAs held in reserve at prices indexed to increase at 5% plus inflation annually. The first tier of reserved allowances is expected to price at $86 in 2030 based on current inflation expectations. As details are finalized, CCA prices should recover in 2025, with significant upside potential into 2030 as the program moves into deficit.

Impact Flows Should Favor Strategies With Faster Distributions and Commercial Validation in 2025

Liqian Ma, Head of Sustainable and Impact Investing Research

Investors will enter 2025 marked by slower exits and distributions. While “patience is a virtue” still applies, private market investors focused on sustainability and impact also need to balance interim liquidity considerations and demonstrate validating proof points to achieve long-term success. Therefore, flows in 2025 should favor strategies that orient toward faster distributions. Managers that have both the intention and the skill to urgently drive commercial progress and liquidity for investors should benefit. Fortunately, an emerging set of tools should help investors achieve these goals even in a muted exit environment.

Impact strategies in areas such as climate tech and sustainable real assets can take years to prove out and generate liquidity. While climate-oriented strategies have seen hold periods comparable to those of the broader PE/VC market, the current environment is particularly challenging: follow-on capital is scarce and exit conditions remain subdued. As a result, allocators will likely prioritize new commitments to growth-stage, buyout, credit, and real assets strategies with inherently quicker-to-validate-and-exit models. Allocators will also increasingly hold all managers accountable for distributions in a more reasonable timeframe.

How can this be achieved? First, in the manager diligence and selection process, allocators will increasingly focus on managers’ competence in positioning companies for early validation and eventual exit. Some managers develop a differentiated understanding of what makes companies attractive to both strategic and financial acquirers, then position their portfolios accordingly. Others might sell shares as part of a follow-on or pre-IPO round or monetize parts of businesses, while developing others for upside optionality and impact. Finally, more impact managers are prudently using non-dilutive sources of financing and blended finance ¹ to reduce both the cost basis and risk of an investment. With the right strategies, managers, and toolkits, sustainable investors can effectively shorten distribution cycles in 2025 to navigate a challenging liquidity environment.

Headwinds for Private Diverse Manager Allocations Moderate in 2025

Jasmine Richards, Head of Diverse Manager Investing, and Carolina Gómez, Investment Director, Diverse Manager Investing

Until 2022, PE/VC firms experienced significant growth in fundraising due to low interest rates and increased risk appetite. Underrepresented fund managers also benefited, with diverse fund managers raising a decade high amount in 2021. However, fundraising declined sharply in 2023 and continued to decline in 2024. In 2025, ebullient markets may offer some relief, but the sizeable overhang of emerging funds could lead to consolidation or shutdowns.

Investments with diverse managers require both willingness and ability. Recent years have seen a decline in commitments, often attributed to decreased willingness. However, in a recent survey, more than half of LP respondents expressed that, despite recent US legislative resistance to DEI programs, these initiatives remain essential and will continue to be implemented and supported across their organizational portfolios. The pullback is more attributable to reduced ability. As US capital markets open, asset owners’ ability to commit to new funds should improve.

While investments in diverse funds are expected to increase, we do not anticipate the record levels seen in 2019–22. From 2019–22, diverse managers raised $127 billion across 198 PE and VC funds, with growth accelerating in 2020 after George Floyd’s murder, according to our data. Initiatives focused on increasing representation of women and people of color often favored new firms. Emerging managers (Funds I or II) accounted for 27% of capital, 51% of funds. Developing managers (Funds III and IV) represented 36% of capital, 31% of funds. By September 2024, these funds were about 75% called and may need to return to market in 2025, posing fundraising challenges. Established managers might withstand slower fundraising, but emerging and developing firms may face financial instability, leading to more consolidations or closures.

With $28 billion across 45 emerging and developing diverse-owned funds potentially returning to market, manager selection will be challenging for LPs with limited budgets. Fundraising momentum will become a key evaluation factor. Early commitments will be crucial in a slow fundraising market. LPs can use creative commitment structuring to support emerging diverse fund managers while mitigating risks from fundraising challenges.

Figure Notes

CCAs Have Recovered Rapidly From Previous Sell-Offs
Data are daily.

Hold Periods for Private Cleantech/Climate Companies Are in Line With Market
Number of companies from the initial investment to complete realization are indicated in parentheses.

New Managers Have Driven Peak Commitments in Recent Years
Private equity includes buyout and growth private equity. An emerging fund is defined as the first or second fund, a developing fund is the third or fourth fund, and an established fund is the fifth fund and beyond. Manager data include US and non-US managers. Data for 2024 are through September 30. Historical data are subject to revisions.

Footnotes

1. Blended finance is the use of concessional or catalytic capital to “crowd-in” private capital investment, while optimizing returns and impact. By leveraging concessional funding from philanthropic, governmental, and other sources, blended finance structures are able to “readjust” the risk/return profile of an investment strategy, making terms favorable for institutional investors.

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We believe in the power of diverse voices to drive performance, recognizing that we create the best opportunity to deliver for our clients, our firm, and our community when every voice is engaged and empowered. Only then can we work together to make decisions and seek the best solutions.

—Melinda Wright, Head of Diversity, Equity, and Inclusion

Footnotes

1. Blended finance is the use of concessional or catalytic capital to “crowd-in” private capital investment, while optimizing returns and impact. By leveraging concessional funding from philanthropic, governmental, and other sources, blended finance structures are able to “readjust” the risk/return profile of an investment strategy, making terms favorable for institutional investors.

The post 2023 Diversity, Equity, and Inclusion (DEI) Report appeared first on Cambridge Associates.

According to new research from BCG and Cambridge Associates, private equity and venture capital firms whose ownership is predominantly women or people of color may unlock access to differentiated deal flow (i.e., an increase in the variety of investments in a portfolio) for their limited partners (LPs) and other investors.

Key Findings:

Of the deals analyzed, 76% were financed exclusively by nondiverse private equity and venture capital firms, 17% of the transactions had deal syndicates with a mix of nondiverse and diverse firms, and 7% were investment rounds completed exclusively by diverse-owned firms. Here is what we found:

• Diverse asset managers are more likely to invest in early-stage deals than nondiverse firms as well as in historically overlooked companies.
• Because they tend to work within networks they are familiar with, many nondiverse private equity and venture capital firms (35%, according to our research) have not coinvested with diverse asset managers. As a result, they risk facing reduced exposure to differentiated deal flow and reduced engagement with diverse private fund managers in later rounds.
• Diverse asset managers are increasing their share of private market deals. From 2018 to 2022, the value of the deals led by diverse private equity and venture capital firms grew at 25% annually from a starting point starting of $33 billion. This is nearly twice the growth rate of deals completed by nondiverse firms. The number of private market deals led by diverse firms also grew by 14% annually, in the same period.

Read the full report here.

Footnotes

1. Blended finance is the use of concessional or catalytic capital to “crowd-in” private capital investment, while optimizing returns and impact. By leveraging concessional funding from philanthropic, governmental, and other sources, blended finance structures are able to “readjust” the risk/return profile of an investment strategy, making terms favorable for institutional investors.

The post In Private Investment, Diverse Fund Management Teams Have Opened Doors appeared first on Cambridge Associates.

As a leader in providing portfolio management services to institutions and families across the globe, Cambridge Associates aims to lead by example and believes that the firm’s actions can lead to greater impact on society and in the communities in which it operates. Through hard work and commitment to inclusion via its LGBTQ+ employee resource group, CA Pride, Cambridge Associates is proud of implementing inspiring changes to the firm’s policies and creating environments tailored to each region around the globe that results in a true sense of belonging for all. Progress on this work is not linear, nor is it ever complete. The firm’s dedication to DEI is an ongoing commitment and a global effort.

“We know employees who feel valued for their differences stay at their jobs longer and are nearly five times more likely to perform at their best. Stonewall’s designation has significant meaning, not only because it reflects the work we have done to create a safe, inclusive and supportive space for our LGBTQ+ colleagues, but because it says to the global communities where we work that we want the best and most diverse talent to make their home here at Cambridge Associates,” said Melinda Wright, Global Head of Diversity, Equity, and Inclusion (DEI).

For the last twenty years, Stonewall, the world’s second-largest LGBTQ+ charity, has been supporting employers to create welcoming workplaces for lesbian, gay, bi, trans people. Stonewall’s Global Workplace Equality Index provides organisations the opportunity to examine their policies and practices, celebrate successful initiatives, and share their important inclusion work as they lead the way. The full list this year can be found on the Stonewall website.

“We heartily congratulate Cambridge Associates. This award reflects the incredible work done to advance LGBT+ inclusion in the workplace and advocate for the rights of LGBT people across the world,” said Leanne MacMillan, Director of Global at Stonewall (she/her). “As a global employer Cambridge achieved vital change by ensuring its workplaces are safe, supportive, and free of discrimination, and that LGBT+ staff are able to thrive at work.”

You can learn more about Cambridge Associates’ commitment to diversity, equity and inclusion here. 

About Cambridge Associates

Cambridge Associates is a global investment firm. The firm aims to help pension plans, endowments & foundations, healthcare systems, and private clients implement and manage custom investment portfolios that generate outperformance so they can maximise their impact on the world. With 50 years of institutional investing experience, the firm has helped to shape and implement investment best practices and built strong global investment networks with the purpose of driving outperformance for clients. Cambridge Associates delivers a range of services, including outsourced CIO, non-discretionary portfolio management, staff extension and alternative asset class mandates.

Cambridge Associates currently maintains offices in Boston; Arlington, VA; Beijing; Dallas; Hong Kong; London; Munich; New York; San Francisco; Singapore; and Sydney. Cambridge Associates consists of six global investment affiliates that are all under common ownership and control. For more information, please visit www.cambridgeassociates.com.

Media Contact
Prosek Partners on behalf of Cambridge Associates
pro-cambridgeuk@prosek.com

Footnotes

1. Blended finance is the use of concessional or catalytic capital to “crowd-in” private capital investment, while optimizing returns and impact. By leveraging concessional funding from philanthropic, governmental, and other sources, blended finance structures are able to “readjust” the risk/return profile of an investment strategy, making terms favorable for institutional investors.

The post Cambridge Associates Awarded Bronze Among Stonewall’s Top LGBTQ+ Global Employers appeared first on Cambridge Associates.

Today, diversity, equity and inclusion remains a core part of our culture. Currently, women represent more than 60% of our executive leadership team and more than 40% of our partners.

Watch the video to learn more.

Footnotes

1. Blended finance is the use of concessional or catalytic capital to “crowd-in” private capital investment, while optimizing returns and impact. By leveraging concessional funding from philanthropic, governmental, and other sources, blended finance structures are able to “readjust” the risk/return profile of an investment strategy, making terms favorable for institutional investors.

The post Video: Women in Leadership at CA appeared first on Cambridge Associates.

Footnotes

1. Blended finance is the use of concessional or catalytic capital to “crowd-in” private capital investment, while optimizing returns and impact. By leveraging concessional funding from philanthropic, governmental, and other sources, blended finance structures are able to “readjust” the risk/return profile of an investment strategy, making terms favorable for institutional investors.

The post 2022 Diversity, Equity, and Inclusion (DEI) Report appeared first on Cambridge Associates.

Whether we crash into a recession remains to be seen, but if history is prologue, market downturns would disproportionately harm communities already struggling to stay afloat. Now is not the time to turn back. Adopting a more disciplined approach to investing for social and environmental equity (SEE) can help investors minimize portfolio risk and maximize impact, even during flagging markets. In this paper, we review the momentum experienced in sustainable and impact investing (SII) and the historical relationship between global recessions and inequality. We then explain the rationale for staying the course during turbulent times, and introduce a framework designed to help investors produce better financial and impact outcomes in any market cycle.

Part I: Risk-Off Sentiment Threatens Momentum in Social & Environmental Equity

According to our 2022 biannual client survey, 65% of institutions had actively engaged in SII and environmental, social, and governance practices, a 29-percentage point increase relative to the 2018 response. The primary drivers of increased uptake are better education around the opportunities and risks of sustainable investing, increased clarity around clients’ mission priorities (and ways to express those views in portfolios), as well as growth of strong performing and aligned investment options. Additionally, social and/or environmental equity were among the top priorities for sustainable and impact investors surveyed, with one-third of respondents making impact investments across three or more impact themes. These results draw in sentiment from 2020, which shined a spotlight on widespread social and economic disparities impacting marginalized communities and compelled investors to focus more on the interconnectedness of social and environmental themes.

Despite this evolution and recent momentum, there’s still risk of investors pausing or even reversing course on investing for SEE amid a critical time for marginalized communities. During heightened market volatility and falling market returns, availability and recency biases tend to lead to decreased risk tolerance and a race to implied safety. Some investors might consider investing in sustainable and/or impact themes to be too risky. Worse yet, sustainable investing initiatives can be labeled as “idealistic” or “ancillary” despite the materiality of SII factors.

Economic downturns accelerate the pace of economic and social inequality, according to a recent study conducted by the Bank of International Standards (BIS), ² which found that, on average, income inequality grew twice as fast during recessions. Contractionary periods exacerbate a wide variety of social indicators—from job insecurity and health outcomes to generational wealth distribution—while stoking uneasiness among the very investors that want to effect positive change at the same time. This perfect storm of macroeconomic factors and investor sentiment threatens progress made on SEE over the past several years. Still, turbulent markets are not the time to steer away, but to forge ahead.

Part II: A More Disciplined, Intersectional Approach Can Help Minimize Risk and Maximize Positive Impact

A Framework for Stable and Volatile Times

In Social Equity Investing: Righting Institutional Wrongs (2018), we define social equity investing as “investments to promote equal opportunity and access for all, regardless of background.” The SEE framework is a natural evolution of our investment approach, overlaying the following three-step process:

1. Rigorously assessing each investment manager’s alignment with SEE themes and categorizing them on a spectrum of SEE alignment; ³
2. Mapping managers based on their investment strategies against a five-stage thematic pyramid; and
3. Executing an engagement program designed to improve alignment of managers that are weakly aligned with SEE and explore new opportunities.

This approach addresses myriad pain points we have uncovered. These include the association of social equity investing with lower or concessionary returns, a failure to acknowledge the intersectionality ⁴ and interconnectedness of sustainability and impact issues that result in siloed portfolio approaches, and inaccurate language used to describe and define social equity—particularly the conflation of broad social and racial equity with diverse manager investing.

The SEE framework’s five-stage pyramid (Figure 1) is inspired by a well-established theory in psychology, Maslow’s Hierarchy of Needs, and offers a more disciplined, clearer, human-centered approach to investing for SEE.

Investable social and environmental themes—which we view as core to creating an equitable society—are mapped to a hierarchy of needs, rather than a primarily demographic or social lens (e.g., race and gender). The hierarchy provides a visual representation of the relative weight or impact of investing in a particular theme. For example, the base of the pyramid addresses physiological or basic existential needs of all people, regardless of race, gender, or geographic region. We all need clean water, air, food, safety, infrastructure, and affordable and reliable means of getting around to survive. It is important to note that while civil rights and justice themes are also represented at the base of the pyramid—a reflection of their fundamental importance—they are not easily actionable through market rate investable instruments. Instead, we currently see grants and program-related investments (PRIs) as the primary capital source for these themes.

Progressing up the pyramid, we approach more “psychological” or “esteem” needs, which are defined as those that foster greater feelings of acceptance, status, and independence, and go beyond the very basics of subsistence. The apex of the pyramid represents “self-fulfillment” needs that refer to the realization of a person’s highest potential and ability to seek personal growth. Its relative size on the pyramid reflects the limited, albeit growing, grant or PRI opportunities we currently see in arts and culture. Lastly, as illustrated by the arrow ascending the right flank of the pyramid, the framework fully integrates racial and gender equity into every theme and reinforces them—and myriad other forms of equity—at every step. Therefore, racial and gender themes do not lose, but instead, gain prominence in SEE investing.

All told, the approach leaves investors with a clearer way to express their values in portfolios and to visualize alignment of investment managers with portfolio goals and objectives without prescribing the order in which to invest.

Maximize Impact and Enhance Returns With a Systems Lens, Improved Investment Processes and Manager Selection

The framework is designed to help accelerate investment in SEE themes in three important ways:

First, it acknowledges the role of systems in exacerbating inequities and therefore leans into a systems approach ⁵ to support investors in reversing those inequities. It does so by purposefully building in the interconnectedness of myriad sustainability and impact issues and, critically, weaving in environmental equity and climate change as core tenets in our discussion of social equity. A more holistic portfolio approach benefits a wider group of global stakeholders and, if done well, will help to enhance long-term climate, social, and financial resilience of portfolios.

Second, in keeping with our approach to debias the investment decision-making process, the framework explicitly seeks to reframe SEE themes in terms of the universality of human needs. Mapping themes in this way, rather than social constructs (e.g., race or gender), works to reduce the cognitive barriers that trigger implicit biases, restrict fruitful discussion about the intersectionality of themes, and ultimately limit investment uptake. For example, too keen a focus on a specific “gender lens” or “racial lens” can potentially compromise investment processes. This could result in unnecessarily siloed portfolios, which threaten the overall scalability of global impact.

Finally, strong manager selection and diversification are hallmarks of this intersectional approach. Improving the classification of managers that have closer alignment with SEE and enhancing engagement practices with those that are not quite there are pivotal to better outcomes. Sample engagement questions might include:

• How does the firm consider equity and inclusion in the evaluation of prospective investment opportunities and pipeline generation?
• How specifically does your strategy incorporate and promote equitable access for women and marginalized communities within each portfolio company’s long-term strategic plan and operations?

These are challenging questions, but all responses from all managers across all strategies, regardless of an explicit SII focus, are data points that enhance our ability to better classify managers that meet our clients’ needs. The framework defines an SEE investment manager as one that intentionally targets social or environmental equity themes at the strategy level (e.g., supporting diverse entrepreneurs, thus targeting the financial inclusion theme) or through the products and services offered by their portfolio companies.

Leaning into SEE thematic investing may help buffer portfolio performance and mitigate risk, particularly in market downturns, as we believe many industries that align with high-impact SEE themes tend to be less prone to the negative effects of recession. In fact, while recession-era vintages have historically performed well (Figure 2), a deeper look at SEE-aligned sectors exposes resilience (Figure 3). We recognize that many SEE themes overlap with historically defensive sectors, but these are also areas that address fundamental human needs and are ripe for innovation. Managers with high SEE integration are intentionally focused on making better and more accessible products within these industries to address those needs.

Applying the Framework: A Foundation’s Impact Portfolio

A hypothetical scenario brings this approach to life and illustrates how the SEE framework can help improve the ability to select the most aligned managers for long-term portfolio sustainability. This case study consists of only private investments managers, given their unique ability to effect impact more directly through control and influence of underlying portfolio companies.

Applying the three-step SEE approach, each manager in the impact portfolio is initially analyzed to gauge the level of authenticity, intentionality, and materiality of focus on SEE themes. This assessment begins with a rigorous due diligence and manager landscaping process. Next, managers are classified in an easy-to-use stoplight format (red illustrating no material SEE integration and green representing the highest SEE integration) before being mapped to the thematic area in the SEE pyramid that best aligns with their primary investment strategy (Figure 4). The final step is to develop an engagement strategy in partnership with the investor. While all managers are eligible for engagement, those with less than a green classification present the greatest opportunity for engagement around these issues.

The analysis reveals an impact portfolio that is less aligned than intended with their stated racial justice/equity mission. For example, there is a dearth of managers with strong SEE integration (green), presenting an opportunity for further engagement and discussion among investment committee members around their managers’ intentions and true fit in a social equity mandate. Additionally, a concentration in sustainable real assets and climate tech venture capital managers that have minimal SEE integration (orange) is exposed. Finally, the portfolio has strong diverse manager representation, which suggests a keen focus on diversifying managers, but also a potential confluence of diverse manager investing with SEE investing (e.g., red sphere, a diverse manager with no material SEE integration). Overall, this process creates an opportunity to dig deeper into what the investor owns and to find ways to improve the portfolio’s mission alignment through improved engagement and future manager selection.

There is no “one size fits all” approach to building a resilient and impact-forward portfolio. However, leveraging the SEE framework can support discipline, rigor, and more thoughtful implementation strategies across market cycles. We believe there is an existing and growing universe of SEE-aligned managers that have the potential to outperform broad equity benchmarks and to reduce risk because of their integrated focus on improving social and environmental equity (Figure 5).

Conclusion

The SEE framework is designed to induce investment in SEE themes through an intersectional human-centered approach. While we introduce it in the context of economic downturns, it is a useful tool that is applicable in all market cycles and can help investors to reduce bias in the investment process, enhance portfolio construction and unearth new sources of alpha, and mitigate portfolio risk. Risk-averse behavior is characteristically human. Whether in calm or stormy waters, we should batten down the hatches and sail with resolve toward sustainable solutions that address and advance the fundamental needs of all human beings.

Drew Carneal and Caryn Slotsky also contributed to this publication.

Footnotes

1. Blended finance is the use of concessional or catalytic capital to “crowd-in” private capital investment, while optimizing returns and impact. By leveraging concessional funding from philanthropic, governmental, and other sources, blended finance structures are able to “readjust” the risk/return profile of an investment strategy, making terms favorable for institutional investors.
2. Luiz Awazu Pereira da Silva et al., “Inequality Hysteresis and the Effectiveness of Macroeconomic Stabilisation Policies,” Bank for International Settlements (BIS), May 2022.
3. A manager with high SEE integration is one that intentionally targets one or more investable social or environmental equity areas: health/wellness, environmental equity/climate justice, education/workforce preparedness, affordability/physical security, and transportation/sustainable infrastructure.
4. Intersectionality describes the interconnected and overlapping systems of discrimination across social categorizations. The term intersectionality was coined by Kimberlé Williams Crenshaw in 1989. An intersectional approach to investing, similarly, acknowledges that certain risks and opportunities are interconnected and cannot be separated. Investors that pursue an intersectional approach within their portfolios may enhance the long-term climate, social, and financial resilience of their portfolios, benefiting stakeholders.
5. Systems thinking/lens or approach in the context of this discussion acknowledges the linkages of material sustainability and impact factors to one another and to portfolios. It is a way to make sense of complex systems by exploring the interrelatedness of the parts, boundaries, and perspectives within that system. It recognizes that complex systems cannot be fully understood from only one perspective, and complex problems cannot be solved by any single actor.

The post A Social & Environmental Equity Investing Framework for Better Real-World Outcomes appeared first on Cambridge Associates.

Approaches to Climate & Net Zero Shift from Window Dressing to Real Change in 2023

Simon Hallett, Head of Climate Strategy

Since the 2015 Paris Agreement, global attention has increased on limiting the global temperature rise to 1.5 degrees Celsius by achieving “net-zero” greenhouse gas emissions by 2050. Glasgow’s COP26 climate conference triggered greater scrutiny of targets set by the increasing number of investors making net-zero commitments. This has focused attention on what net zero should mean for an investment portfolio.

At first, the common interpretation was to reduce “portfolio emissions” by selling high emission companies. This is called portfolio decarbonization. Since most emissions are concentrated among a small number of companies and sectors, it proved surprisingly easy. But it led to accusations of window dressing and greenwashing. While selling high carbon companies does tend to increase those companies’ costs of capital, it made little difference in the emissions those companies contributed.

The focus is now shifting toward driving “real world change” rather than portfolio optics. The main lever is to encourage more portfolio companies—especially the high emission ones—to adopt “Paris-aligned” decarbonization plans with third-party verification. This can be achieved through active ownership—voting and engagement. It needn’t imply portfolio changes, but it must have genuine bite, with investors and their managers prepared to challenge and vote against company management if necessary. It can even be followed by passive investors, though the sanction of divestment adds teeth to any engagement. Private fund general partners can often directly drive better climate performance than small public shareholders, as large or even controlling owners, so they should be held especially accountable.

Voting and engagement works with established self-funding businesses that are hard to influence by public equity capital allocation. Elsewhere, credit strategies and private investments are more likely to provide net new financing to business; in this case, capital allocation does matter since it could fund new climate positive or negative activity. As an extension of this idea, investors increasingly seek opportunities among climate solutions—businesses that are rapidly decarbonizing or enabling others to do so.

Sustainable and Impact Investors Will Prune the Weeds in 2023

Chavon Sutton, Senior Investment Director, Sustainable & Impact Investing

If there was a season of abundance in sustainable and impact investments (SII), it was the past three years. The letters “ESG” (environmental, social, and governance) became a calling cry, sprouting up on earnings calls in what appeared to be a seismic shift in companies wanting to approach business more sustainably. ESG and sustainable exchange-traded fund inflows exploded, reflecting a heightened desire to use capital to right environmental and societal wrongs. The first net outflows since 2017 from the SII investment universe were seen in 2022, as investors began pruning the weeds in their portfolios. In other words, they trimmed sustainable investment allocations that suffered relative underperformance or missed the mark on alignment with sustainability goals.

Investors turned their backs against a swell of so-called green-, blue-, and social-washed products—designed to attract assets rather than achieving genuine social and financial returns. And Russia’s invasion of Ukraine exacerbated this trend by amplifying an already extraordinary run-up in energy prices that hampered the relative performance of sustainability funds that often exclude such companies.

As risk assets struggle with elevated inflation and below-trend economic growth, 2023 will usher in a new—more cautious and demanding—era of SII. A rebound in the pace of SII investing will be propelled by the application of more robust frameworks, ⁶ which refocus values, reframe risk, widen the investment opportunity set, and produce positive real-world outcomes. Global reporting and measurement standards should continue to converge, giving investors greater clarity around how best to set, measure, and track ESG and impact metrics. Investors will be more discerning in their manager selection, seeking those with greater intentionality around sustainability and impact themes, traceable through lines between intent and execution in their portfolios, and a penchant for risk management.

A turbulent year will compel rigor, which we think is the right kind of fertilizer for newly planted SII seeds.

Diverse Manager Net Flows Will Remain Positive, Supported by Governance Structures in 2023

Jasmine Richards, Head of Diverse Manager Research, and Carolina Gómez, Associate Investment Director, Diverse Manager Research

US public pension plans have long been investors with diverse fund managers. In recent years, this focus has expanded to family offices, corporate pensions, endowments, and foundations. While allocators’ journeys have varied, many have created diverse investing objectives, codified these in investment policies, and begun implementation. With structural changes in place, we expect allocators to continue driving capital to diverse managers in 2023.

In the wake of increased social unrest due to global inequality, many asset owners have begun to examine diversity within their portfolios. Understanding that less than 2% of global assets are invested with women or people of color, ⁷ many asset owners are seeking to be more intentional about their investment with diverse managers. With this interest, diverse fund managers are on pace to raise historic levels of assets in 2022, which is even more notable given the challenging fundraising environment.

Historically, allocations to diverse managers have waned during periods of market stress. During these periods, new manager relationships can be perceived as risky particularly with firms that are younger or have lower assets under management (AUM). Given that many asset owners are currently over-allocated to private investments—the area of highest new fund starts for diverse managers—the market could pose specific challenges for sustained AUM growth for diverse fund managers. Despite these headwinds, data indicates that governance revisions instituted in recent years will support continued commitment to increasing diversity among manager lineups of asset owners.

Data from a recent CA client survey show that 15% of survey respondents have codified their diversity, equity, and inclusion objectives in investment policy statements, an increase of more than 10 times since 2020. Of the respondents who have implemented diverse manager strategies, 95% indicated that they have increased allocations over the last five years. Additionally, 92% anticipate increasing their allocations even further over the next five years. While market headwinds create higher bars for new commitments, the structural policies and programs that have been implemented in the recent past will support continued commitment to investments in diverse fund managers.

Footnotes

1. Blended finance is the use of concessional or catalytic capital to “crowd-in” private capital investment, while optimizing returns and impact. By leveraging concessional funding from philanthropic, governmental, and other sources, blended finance structures are able to “readjust” the risk/return profile of an investment strategy, making terms favorable for institutional investors.
2. Luiz Awazu Pereira da Silva et al., “Inequality Hysteresis and the Effectiveness of Macroeconomic Stabilisation Policies,” Bank for International Settlements (BIS), May 2022.
3. A manager with high SEE integration is one that intentionally targets one or more investable social or environmental equity areas: health/wellness, environmental equity/climate justice, education/workforce preparedness, affordability/physical security, and transportation/sustainable infrastructure.
4. Intersectionality describes the interconnected and overlapping systems of discrimination across social categorizations. The term intersectionality was coined by Kimberlé Williams Crenshaw in 1989. An intersectional approach to investing, similarly, acknowledges that certain risks and opportunities are interconnected and cannot be separated. Investors that pursue an intersectional approach within their portfolios may enhance the long-term climate, social, and financial resilience of their portfolios, benefiting stakeholders.
5. Systems thinking/lens or approach in the context of this discussion acknowledges the linkages of material sustainability and impact factors to one another and to portfolios. It is a way to make sense of complex systems by exploring the interrelatedness of the parts, boundaries, and perspectives within that system. It recognizes that complex systems cannot be fully understood from only one perspective, and complex problems cannot be solved by any single actor.
6. Cambridge Associates’ Social and Environmental Equity investing framework seeks to induce investment in SII themes through the application of a more systems-focused lens, breaking down cognitive bias in investment processes and reclassifying investment managers with stronger alignment to investable social and environmental equity themes.
7. Diverse-owned firms are defined as those that are over 50% women- or minority-owned.

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