An Interview with Dave Chen: Sustainable Finance amid Climate Change, the Transition of Human Behavioral Habits and Societal Shifts

I drive to teach the creative use of financial instruments, the creative use of capital, and the alignment of interests to create sustainable business models that are beneficial and intentionally beneficial to the environment and society.

Can you tell us a bit about your background and how you started doing impact investment?

I started my career in the tech industry and was in that industry for about 25 years. My last ten years in the tech industry were in venture capital as a partner in a large regional investment management firm.

Around 2006, I started to ask whether capital can be a driver of positive change in and of itself. At that time, we began seeing the growth of microfinance as an industry, cleantech, and the first waves of water investments. As a Professor of Finance, when I looked at microfinance, I said: “This is a classic debt instrument, which is being used for a very intentional positive outcome. What other financial tools can be used to create a market rate of return, creatively address market failures, and intentionally drive a positive outcome?”

We had the good fortune of meeting many CEOs who built successful businesses around sustainability-driven thematics and organic agriculture. We also met people making successful companies in high-performance, green, and sustainable buildings. So we started to ask: “What are the common aspects of these businesses where they do not define sustainability as being responsible, a good guy, or more ethical? Why is a green building a more productive one, a better place to live with happier tenants, and inherently performing better as a piece of an asset?” These were fundamentally business, competitive, and performance conversations, as opposed to deep philosophical discussions. 

We continued to ask, “What financial instruments and techniques can be deployed differently? How could financial instruments be used to address market failures by aligning incentives? Why are these significant multi-hundred-million-dollar businesses being created on sustainability-driven thematics, competitive advantage, or end-user markets performing at the upper decile of their sector?”
The last thing that we looked at around 2006 was: “Why is wind energy starting to take off? Is it because of the technological efficiency of the turbine or government incentives? What got the wind market to take off?”

What did the rise of the wind industry tell us?

Since years of the Jimmy Carter presidency, the wind and the solar industry have been on a relatively slow, small, flat curve. But from 2001 to 2003, wind and solar started doubling every year. There was a moment of inflection on the growth curve when the wind industry in the U.S. took off effectively. 

What drove this inflection? It was not because of government incentives: They have been in place for a long time. It wasn’t technology or efficiency, either. It was the fact that the incentives could not be properly used in the U.S. as they used mostly the Investment Tax Credits (federal tax incentives for certain types of renewable and clean energy investments). Yet most of these wind projects had no gains or profits. Between 2002 and 2004, a bunch of finance guys got together and started asking: 

“How can we flip the whole tax issue? Who is incentivized to put money to work if they get tax benefits and a financial structure that allows highly taxable companies with tax shelters to become investors in wind projects and take advantage of that?”  

Ultimately, a bit of financial structuring and engineering unlocked the U.S. market. When I stepped back and thought about these things, it became very clear that there was a huge market opportunity in applying the capital markets to catalyze sustainability opportunities.

Many of these things were about the creative use of financial instruments, the creative use of capital, and the alignment of interests to create business models. And that was beneficial and intentionally beneficial to the environment and society.

How is impact investing different from other investment strategies?

I believe that intentionally impactful investing incorporates three words that originated with the carbon markets: Is it intentional? Is it additional? Is it permanent? And as you think about impactful investing, you should think about whether you are intentionally trying to make a positive impact; whether what you’re doing is actually creating additionality; and if the changes you make and the benefits you create have some level of endurance or permanence. Impacted investing started around 2007 to 2009. Was impact investing an asset class or a strategy? We believed it was a way of thinking because every asset class can be made impactful: Equities, debt, private equity, tangible assets, and real estate can all be made impactful. As we learn in business school, if you can define a market segment that wants to buy your product, then you have a right to exist; the same can be applied in the finance industry and investment products.

Can you call your company an impact investment company? Introduce what Equilibrium does. 

You will never find the words “impact investing” on our website. We focus on sustainability-driven investment strategies. We believe sustainability drives both economic and environmentally advantaged outcomes. Our main portfolios are in agriculture and carbon transition infrastructure. We believe our portfolios have probably reduced as much carbon as some of the most significant impact investment funds, but we would not call ourselves an impact investor. 

Equilibrium is an investment management firm. We currently manage about two billion USD, and almost all of our clients are institutional clients, primarily pensions, life insurance, or sovereign wealth funds. Many of them historically have never thought of themselves as sustainable investors, let alone impact investors. We create highly sustainable portfolios that derive their returns from sustainability.

Do you have any specific approaches or techniques in your selection of funds?

We build portfolios in two primary areas. One of our strategies is waste to energy, which we call carbon transition infrastructure. We invest in assets that convert animal waste, farm waste, and food waste into renewable natural gas. Our second strategy and portfolio is in sustainable agriculture with a specialty in controlled-environment agriculture (CEA). Our CEA strategy and portfolio is trying to use less water, energy, and human resources to produce each kilogram of food. One of humankind’s greatest issues on a global scale is agriculture. Agriculture is Ground Zero for climate change. If the weather changes, you better figure out where to grow your food because CEA addresses the threat of climate change in our food system. In that way, CEA is climate adaptation. 

Our strategies are architected to target sustainability.

Are there any specific social problems that your company aims to address? Do they relate to any SDGs?

Our strategies address the SDGs related to communities, quality of life, human equality, water, energy consumption, and CO2: SDGs 2, 6, 8, 9, 11, 12, and 13. 

What have been the main challenges faced by your company in its endeavors toward sustainability?

Between 2008 and 2017, what we did was a very lonely place. Raising money took work. It’s not easy to raise two billion dollars from institutional capital. Every step of the way was a hard-fought battle. It was not unusual for us to walk into the chief investment officer of a large pension or of large life insurance and say: “We’re here to talk about making money and growing portfolios that are market-beating by sustainability thematics.” It’s common today, but at that time, a frequent response was, “Dave, that’s nice, but we do real investing here.” 

Today, “investing in sustainable themes” has become increasingly mainstream. And today, if you were to say, we’re investing behind the implications of climate change and building portfolios that are resilient to climate risk, you are speaking to the mainstream. It’s now a very cool trend and a very different time.

You said that now it’s easier, what is the biggest challenge faced by your company at the moment?

The main challenge is that every major investment platform is now our competitor. 

What is Equilibrium’s competitive advantage compared to other companies? 

Competition forces us to use the time advantage we have, to ensure we’re building the strongest portfolios possible, and that we exercise our early lead to lock up key assets. We use our advantage of speed and research to our advantage. But at the end of the day, the investment management world is among the most competitive markets. It’s populated by smart guys who are thinking about what you do, learning from what you do, and copying what you do.

Can you share 2 or 3 common mistakes you have seen other impact investment companies make? What to keep in mind to avoid that?

We have a saying in our company: “Come for the returns, stay for the impact.” Most impact investors historically have made the mistake of reversing that. Oftentimes they talk about responsibility and the imperative more than the economics of the problem and solution. They usually don’t speak the vocabulary of their investors. Spend time understanding the market failure and ask — “Can the capital market or a market-making mechanism address that?” 

At the end of the day, whether it’s a value chain, the cost of production, the use of the capital, and the efficiency of the capital, many of these things that have to do with sustainability come down to commodity markets, and math counts. Most of the sustainability themes are food, water, shelter, clothing, electricity, and power. These are basic Maslow’s Hierarchy of Needs and basic societal foundational infrastructure, which almost by definition say that they are commodities, and math matters a lot. 

Do you provide such training in Kellogg?

Yes, we do. The class that I began 13 years ago did not focus on social venture capital or microfinance. It focused on the fact that you can be intentionally impactful across every asset class and that behind every successful impactful investment strategy you’ll find a finance fundamental. 

Every strategy in the investment portfolio allocation can be made impactful, but you’d better understand how the math works. People like to talk about things in high-level ways: “This is a planetary problem. Greenland’s going to melt.” What if you talk about a big problem, but your solution is small? How is that making a difference?

Back to the first analogy I gave you about the financiers who figured out how to align the tax credit incentive program in the U.S. that unlocked the U.S. renewables markets. In the 15 years that followed that financial innovation, the U.S. built about a quarter of its energy profile in renewables. The largest economy in the world in 15 years changed its energy profile — that’s a meaningful scale. I ask the students, can you harness your creativity in finance to do something that catalyzes meaningful scale?

Are you planning any new courses at Kellogg?

At Kellogg, we have continued to expand the sustainable finance and impact curriculum, in specific areas like metrics, venture capital models, social innovations, and energy economics. One of the hottest classes for students in the near future will be carbon accounting. 

What is the current state of the impact investing market? What trends are emerging? 

If you expand the conversation of impact investing to think about the broader context of sustainable finance, climate finance, and ESG, you’ll see the expansive opportunities in the impact trends. You’ll come to grips with the fact that we’re transitioning industries and human behavioral habits. We’re just at the beginning of shifting human behavioral habits because humans are selfish, aren’t we? We like our cars and freedom. Consider the transition of entire industries like automotive and transportation as we transition to low-carbon transportation models, from EVs to all forms of mass and sharing, to small forms of mobility. Consider that fleets from trucking to shipping to planes will all be affected by looking at low-carbon or non-fossil alternatives. It’s no longer over the horizon, it is happening, now. 

Once, I met a Taiwanese young man at a wedding whose family owned a large automotive parts company. They are very proud of what they do. I asked them a question,  “You guys make incredibly important transmission components for some of the most expensive cars in the world, like Porsches and high-end BMWs. What happens when BMW announces that the last gasoline engine, which needs your transmission and your paddle shifters, will be made in 2030? What does your company do? And then, the next day, Audi, Mercedes Benz, and General Motors all announce 2030. This becomes a classic business problem, right?” What happens when the stock analyst calls and says, “If I do the math, you have zero percent of your customers buying anything from you in 2030.” There must be a strategic planning session that asks, “What do we do when our customers evaporate?”

As a Business School Professor, this question is a case study in organizational change, strategic change, and strategic direction. It is the classic BCG four-box problem. We have a cash cow which is a diminishing cash cow. How do we use the cash cow with its cash flows to either dividend the company back to the shareholders or buy a future? But if we buy a future line of business, we have to buy a future fast enough to compensate for the decline in the current business revenue. In reframing the “climate” problem this way, this becomes a common topic for many sectors and many businesses. It is no longer about impact investing or whether you are a do-gooder.

That was a fascinating story. I think it’s something we can share with students.

But you can see this happening. If the world is going to transition to resiliency and non-fossil dependency, what are the implications for industries? What do we do if the weather changes and climate impacts the number of times bees can pollinate? You don’t get this much in Taiwan, but across many parts of the world where the snowpack melts through the mountains and becomes fresh water in rivers. The rivers then become the irrigation source for agriculture. If there’s less snow, there’s less irrigation. If the second phenomenon occurs, where the snow melts quickly because we’re getting hotter in Spring, it melts at a time when farms don’t need the water, and they would be gone. Additionally, these rivers are used for hydroelectricity; less water is less power. 

When these conditions take place, the conversation becomes, less about “being a do-gooder” and more about how we survive when the water is not there, or that it is there at the wrong time, while I have to grow my crops.

Risk evaluation is now very important because of the climate change quality affecting the whole world. Has the pandemic changed the climate of impact investment? What is that like?

There was a trajectory for the interest in investing in climatic themes before the pandemic, and in many ways, the pandemic did not take us off that course. In the years 2020 to 2022, you saw even more momentum in climate-driven risk management, analysis, and risk pricing. There was an awareness that climate shifts and decarbonization affect entire industries. Maybe it was because we were stuck at home, and we had nothing to do but work. The pandemic actually accelerated the interest and the realities of these investment strategies.

Net Zero is actually part of continuous improvement and re-engineering of your processes and your company. We forget that we have gotten used to 100 years of cheap energy

Can you share more about your recent investment story? How do you select an investment target? And how do you measure your impact?

The sustainability metrics we use depends on the portfolio we are managing, whether it’s our energy portfolio or the agricultural portfolio. We tend to measure very basic things, like the dollars of output per liter of water, the dollars of economic output per BTU, and the number of fair family-wage jobs we create through our investments. We tend to measure the amount of carbon we reduce or produce. We are just now starting to grasp that net zero is actually part of the continuous improvement and re-engineering of your processes and your company. We forget that we have gotten used to 100 years of cheap energy, so our basic assumptions and processes are based on the assumption of cheap energy.  If you’re going to reduce emissions by so much, you have to step up to the fact that we’re re-engineering.

The closest analogy is the Quality Movement that started in Japan in the 1980s. Europe and the U.S. manufacturers reacted by saying: “We’ll just inspect more.” The fact is you cannot get to perfect quality by inspecting more. How can you fix your product quality, if you didn’t re-engineer the design and manufacturability of your engine, the way it was then assembled, and rethink the entire manufacturing process? 

The net-zero processes will likely evolve the same way, and our net-zero metrics are going to be those that allow us to spot and operationalize the improvements over time.

How do you collect the data? And how can you count the impact?

Before I answer that question, the other major form of metrics that we use is the TCFD 2-degree and 4-degree scenarios. We think that’s probably one of the most important metrics. By defining the risk of 2 degrees and 4 degrees, you’re asking the question, what’s the risk resilience and risk exposure of my assets? It very directly quantifies the value, productivity, as well as risk to my assets in a changing world. TCFD risk analysis becomes a fundamental part of impact metrics.

Back to your question, how do we get this data? I’ll tell you the hardest ones to measure, and I’ll tell you the easy ones. In many ways, if you’re running a good manufacturing or operational information system, much of that information for productivity per BTU, productivity per liter of water is actually buried in the current data that you’re collecting. The hardest one is measuring your carbon footprint because most of the carbon footprinting is still done by proxy and estimations. It begs the definition of the “scope” of scope one, two, and three issues. Scope one, two, and three sound very easy.  How do you actually draw the rings around the system’s definition, and it becomes very, very difficult to make comparisons. How I define the ring around the system in “my” scope three can be very different from the way you draw the ring around your systems and supply chain. We’re in the early days of being able to truly grasp the carbon footprint. 

When you make the decisions about your investment, do you involve stakeholders and people who will be impacted by your investment?

We generally do make sure the most immediate stakeholders in our agricultural community, supply chain, or in our waste shed understand what we do and how we create impact and economic advantage for them. We try to include as much as possible, the “benefit corporation” thinking about serving multiple stakeholders that affect the outcome and output of what you do. As investment managers, we try to expose and incorporate the sustainability objectives of our investors into our thinking. Since we were so early on in the execution of these investment strategies, we got the benefit of early learning. One of the early learnings that we had about things as seemingly simple as ESG, sustainability protocols or climate protocols is that almost every one of these protocols from our investors will be different. There is no universal definition of “goodness.”  As an investment manager, one of the things we work on is how to build resolution paths between very different ESG and sustainability protocols that our investors are executing.

Do you have any investments in Asia so far?

We have opened our office in Singapore and staffed it with two investment professionals, signaling our expansion into the ASEAN region, and possibly into non-China Northern Asia. We have one investment right now, a fairly sizable one in Australia.

Do you have a different strategy or approach for Asian region investments?

I think that the approach will reflect that some of these ESG, impact, and sustainability themes are still less accepted and nascent. Our belief is that they will accelerate in the next three to five years. We can see that kind of momentum taking place. One of those themes is the conversion of waste streams into energy and other valuable commodities. We also see controlled-environment agriculture increasing in importance across Asia. We’re very excited by our opportunities there. 

As for the last question, please give some advice to our readers who want to get into the impact investing area.

In today’s world, almost every major investment platform has entered this field or is entering this field with a breadth of products. It is not just Black Rock, it’s TPG, KKR, Goldman Sachs, Morgan Stanley, Nomura, and the major insurance firms. They’re all entering with major portfolios. The biggest change taking place is the recognition that these themes and strategies are no longer about “feel good” or “do good”. They are about the investment and asset value implications of major economic, industrial, and societal shifts taking place.

Hiro Mizuno had a profound impact on Japan.  At the beginning of his journey, he famously said something at the Milken Conference 2016 by answering the question, “What do you think about climate change?” He hadn’t been prepared for the question, but gave a profound answer, “What good is a pension check if it’s 120 degrees Fahrenheit outside?”

And I think he encapsulated a tremendous number of nuances into that answer. Oftentimes when I’m in conversations in Asia, the conversation is still: “Why should I care? Is this about do-gooding?” Certainly, if you’re in the automotive industry, it won’t be about do-gooding anymore. I love the cycle of history and how motherhood and apple pie become incredibly relevant. We joke in our business school strategy classes, “You never want to be the buggy whip manufacturer.”  In our lifetime, we will see automotive industries that make gasoline engines relegated to the buggy whip. “What do you do to transition to the new economy, especially if you see it coming?”

Thank you very much for the interview.

You can be intentionally impactful across every asset class if you can think about the problem you’re trying to solve.