The reputation of private equity and hedge funds is that they are all about the money, a stark contrast to the sustainable and socially responsible investing space, which is all about the values. But there are a growing number of alternative investors who think both things are important. 

At the beginning of 2011, $80.9 billion was invested in 375 alternative investment funds incorporating environmental, social and governance (ESG) criteria, up from $69.8 billion in 346 funds the year before, according to a recent report, Sustainability Trends in U.S. Alternative Investments, from US SIF, the Forum for Sustainable and Responsible Investment. 

Of that $80.9 billion, the report identified 233 distinct private equity and venture capital funds with a combined $33.9 billion. Some $44.3 billion was held by 95 property and real estate investment funds. There were also 47 hedge funds identified with a total of $2.6 billion.

Since alternative investment fund managers won't always disclose assets under management, "my hunch is this is a bigger space than we realize," said Joshua Humphreys, the report's lead author and the director of the Center for Social Philanthropy at the Tellus Institute, during a session at the annual SRI in the Rockies conference last fall. 

Nearly three-quarters (73%) of the funds in the study incorporate multiple ESG components into their management strategies. The biggest emphasis is on environmental criteria (represented by $68.9 billion of total assets under management), followed by social mandates ($48.8 billion) and governance criteria ($37.5 billion).

Previous studies also reinforce the idea that the sector is growing and gaining interest, says Meg Voorhes, the deputy director and research director for US SIF. Alternative investments have also gained share in Europe's SRI market, according to research from Eurosif, the European Sustainable Investment Forum.

"Institutional investors have been a large part of the story," says Voorhes, who notes that these institutions have been diversifying more into different asset classes for the past few years and taking their growing interest in ESG with them.

Public pension giant CalPERS has approximately $1.2 billion of exposure to clean technology in its alternative investment management program. The CalPERS Clean Energy and Technology Fund has capital commitments to 14 private equity funds focused on clean tech and energy.

Not surprisingly, however, troubles in the clean energy sector have chased away some investors and funds. The WilderHill New Energy Global Innovation Index (NEX), a commonly used industry benchmark, plummeted 40.2% in 2011.

But alternative investors who remain committed to carbon reduction say they're in it for the long haul, not quick profits. And they share a strong sense of optimism.

Environmental Enthusiasm

"We think tremendous opportunities exist for at least the next couple of decades," says Richard Bookbinder, managing member of New York-based Bookbinder Capital Management LLC and its affiliate TerraVerde Capital Management LLC. The latter manages TerraVerde Capital Partners LP, a fund of funds that invests solely in green hedge funds. 

Bookbinder admits it's gotten very challenging to be invested in this area at a time of global economic slowdown, Washington gridlock and cutbacks in environmental financing by the U.S. and European governments. But capital setbacks notwithstanding, a fast-growing global population will have no choice but to address shortages in energy, food and water, he says. 

"The good news is companies around the globe are really picking up the slack," says Bookbinder. Even without government funding, he expects to see much more entrepreneur activity. What's more, sustainable clean tech is still in its infancy in the U.S., he says.

The TerraVerde fund, launched in 2009, has roughly 20% of its assets in water-related investments, says Bookbinder. Its underlying hedge funds also have exposure to wind and solar power, agriculture, fuel cells, biodiesel fuel and other sectors related to reducing the carbon footprint. 

Bookbinder can't mention specific funds that TerraVerde is invested in but says these funds have held positions in leading alternative-energy companies such as Johnson Controls (a maker of energy-efficiency components for buildings and autos); First Solar (which makes low-cost solar panels and photovoltaic systems) and Cree (which produces energy-efficient LED lighting). He stresses these are not recommendations. 

Bookbinder says the TerraVerde fund was in positive territory in 2011 while there was a 50.5% decline in its peer index, the WilderHill Clean Energy Index (ECO). "We're happy to have preserved partner capital and to have delivered some alpha at the same time," he says.

One factor that he says helped was the use of a long/short equity strategy, which is well suited to the clean energy sector. "There are going to be lots of winners and losers," says Bookbinder, who notes consolidation has already begun in the solar industry. The firm also puts much effort into research, quantitative analysis and the ongoing oversight of the underlying funds.

Bookbinder is spending a lot of time researching hydraulic fracturing, or "fracking." "The issue is far from being clear," he says. "It could be the greatest thing since sliced bread or the next environmental nightmare." He's visited wells in Pennsylvania and recently attended a class there on water testing. "Ten people were there-nine water engineers for CE credits and me," he says.

TerraVerde's underlying funds may also use arbitrage with hydroelectric power, electricity and carbon emission trading, predominantly with European carbon credits.

Carbon Up Close

Meanwhile, weakness in the European carbon market, triggered by the economic situation and decreased demand for carbon credits, has boded poorly for carbon finance funds.

No one knows this better than Climate Change Capital Ltd. (CCC), a London-based investment manager and advisory group specializing in opportunities created by transition to a low carbon world. CCC manages the world's largest private sector fund committing money to companies and projects generating emission-reduction credits.

Ben Caldecott, head of policy for the firm's advisory team and the director of the group's think tank, says that to generate significant interest in carbon credits we'll need a deep, liquid international carbon market supported by plenty of demand-something he doesn't expect in the near term. Even so, "I think the future is very bright, very exciting," he says.

One reason for his optimism, he says, is that low-carbon technologies are expected to be an important factor in meeting increasing demand for energy and other resources from the rapidly growing global middle class. According to the Organisation for Economic Co-operation and Development, this population could swell from 1.8 billion people to 3.2 billion by 2020 and 4.9 billion by 2030. (Most of the growth, 85%, is expected in Asia.) 

"The fact that we need to become dramatically more resource efficient will help drive investment into clean technology, regardless of other factors," he says.

Caldecott is also optimistic because solar and wind are becoming cost competitive with coal and gas, more governments and regions are encouraging policies and frameworks to reduce carbon, and more mainstream investors are coming aboard. 

Cumulative investments in clean tech and energy efficiency topped $1 trillion last year. In 2011 alone, $260 billion was invested, almost five times the $53.6 billion total in 2004, according to Bloomberg New Energy Finance. "The scale-up has been staggering," he says. 

Caldecott expects many investment opportunities in sustainable property, particularly with commercial properties that retrofit existing buildings for energy efficiency. That's the focus of CCC's sustainable commercial property fund. "I think the market is massive," he says

As for clean tech, Caldecott says the safer bets are those companies that offer strong energy efficiency solutions without having to rely on subsidies or government policies.

Double Benefits

Venture capital is the focus of San Francisco-based DBL Investors. Nancy Pfund, a managing partner at the firm, says its mission is to help young companies achieve financial success and bring positive social, environmental and economic improvements to their communities.

DBL Investors, which stands for "double bottom line," has two funds. The first, spun out from JPMorgan in 2008, is ranked in the top quartile of venture capital funds by Cambridge Associates LLC, says Pfund. The second was launched last March. Each fund has a ten-year life.

The firm's combined assets under management total some $225 million, with more than half of that in clean tech, she says. The rest is divided among different industries including health care, information technology and sustainability-oriented products and services.

DBL, which invests in local companies and sits on their boards, develops a unique set of double-bottom-line practices for each company based on its needs and goals. The firm encourages its companies to hire locally, for example, as well as focus on employee development and energy conservation.

"It's an asset class that really is unique," Pfund says. "We help create their culture; it's harder to penetrate when you're a shareholder in a public company." Since the companies are not tied to the public markets, there is also less volatility.

One DBL holding is SolarCity, the nation's largest solar service provider by project volume. It's helped thousands of homeowners adopt solar power, and it also offers services to schools and universities, government agencies and corporations. SolarCity was the first company to develop a solar lease program for middle-class customers with no up-front costs, says Pfund. It's also helping local community colleges develop training programs for solar installers, she says. 

DBL first invested in Revolution Foods when it started serving meals to low-income schoolchildren at several schools in the Bay Area. The nearly 6-year-old company now provides hot and healthy meals to children in eight states and Washington, D.C. 

"It's a good business and it's addressing urgent social needs," says Pfund, who notes that the company has created hundreds of entry-level jobs. It has good supplier relationships, is expanding some products through Whole Foods Market and is benefiting from increased government reimbursements set last year by the Child Nutrition Act, she says.  

A success story Pfund says she's very proud of is electric car manufacturer Tesla Motors. DBL helped Tesla gain access to state grant programs and identify manufacturing sites where it could optimize growth, she says. DBL exited Tesla after it went public in June 2010 but keeps in close contact. "We don't stay in our companies too long after they go public. That's not really our job," she says.

Final Words

A high-net-worth individual considering alternative investments should pay close attention to such things as their fees, liquidity and transparency, which can be much different than they are in traditional investments.

Although most ESG alternative investments are restricted to accredited high-net-worth and institutional investors, more green options are cropping up for retail investors interested in alternative asset classes. The Slow Money Alliance provides investment opportunities in a variety of professionally managed funds, many related to food and agriculture. Other options include pooled investments and angel investments.