Capital Budgeting Techniques

New paper, "Sustainable Investing: Evidence From the Field" (with Tom Gosling and Dirk Jenter). We survey 509 equity portfolio managers, of both traditional and sustainable funds, on whether, why, and how they incorporate firms’ environmental and social performance into investment decisions. 1. Both traditional and sustainable funds rank ES last out of six drivers of long-term value: below strategy, operational performance, governance, culture, and capital structure in that order. Clients interested in financial returns should not overweight a fund's ES credentials above its ability to assess these other factors. 2. This low relative ranking doesn't mean that ES is immaterial in absolute terms. Indeed, 73% of sustainable and even 45% of traditional investors expect ES leaders to deliver positive alpha. Unexpectedly, the most popular reason is that ES is a signal for other important value drivers rather than mattering directly. As I wrote in "The End of ESG", ES is "extremely important and nothing special". 3. ES performance influences stock selection, engagement, and voting for 77% of investors (66% traditional, 91% sustainable). Calls to "ban ES" make little sense as many traditional investors voluntarily incorporate it. 4. Only 24% of traditional and 30% of sustainable investors would sacrificing even 1bp of annual return for ES, citing fiduciary duty concerns. Policymakers and the public need to have realistic expectations of the asset management industry's likely ES impact. It will incorporate financially material ES factors, but it won't subsidize ES investments that offer below-market returns. That’s not because fund managers are greenwashing, but because they are fund managers. Their fiduciary duty is to their clients, whose goals are often financial. 5. But non-financial goals can be pursued through ES constraints such as fund mandates. 71% (61% traditional, 84% sustainable) report that ES constraints required them to make different investment decisions. These constraints sometimes reduced the very ES impact they aim to achieve, for example by preventing funds from investing in ES laggards whose performance they could have improved. 6. Overall, traditional and sustainable investors are more similar than commonly believed. Sustainable investors recognise fiduciary duty and are unwilling to sacrifice financial returns for ES. Traditional investors view ES as material and face ES constraints (firmwide policies, client wishes) preventing investment in "unsustainable" stocks. While some clients are attracted by sustainability labels, many traditional funds invest sustainably and many sustainable ones don't - and chasing a label can prevent true sustainable investing. Big thanks to the those who filled in the survey, beta-tested it, distributed it, and were interviewed. We hope that by directly involving practitioners, we can increase the relevance of academic research. https://lnkd.in/eGzRzE5t

A visualization of the WACC Formula The Weighted Average Cost of Capital (WACC) is a cornerstone concept in corporate finance. It represents the average rate a company is expected to earn to finance its assets, essentially the “hurdle rate” for investment decisions. The WACC formula blends two main components: Cost of Equity and Cost of Debt. 1. Cost of Equity is derived from the Capital Asset Pricing Model (CAPM): Cost of Equity = (Equity Risk Premium × Beta) + Risk-Free Rate This reflects the returns investors demand for holding a company’s stock, factoring in market risk (beta), expected market returns, and the risk-free baseline. 2. Cost of Debt is based on the company’s borrowing rate: After-Tax Cost of Debt = Average Yield on Debt × (1 – Tax Rate) The tax shield reduces the effective cost, as interest expenses are tax-deductible. Once calculated, these are weighted by their proportion in the firm’s capital structure: WACC = (E/V × Cost of Equity) + (D/V × After-Tax Cost of Debt) Where E = equity, D = debt, and V = total capital. Why it matters: -It’s the benchmark for evaluating investment projects. -A project should ideally generate returns above the WACC to create value. -It reflects both the market’s perception of risk and the company’s financing strategy. -It's used as the discount rate to value the businesses (using DCF analysis) In short, understanding and applying WACC helps ensure capital is deployed where it delivers the most value. Check out Corporate Finance Institute® (CFI) courses to learn more!

Sustainable Investment Framework 🌎 The evolving nature of investment demands a shift from conventional financial metrics to a comprehensive approach that captures real-world impacts. The Sustainable Investment Framework presents a methodology to assess investments across six key themes: Resource Security, Basic Needs, Healthy Ecosystems, Wellbeing, Decent Work, and Climate Stability. Aligned with the UN Sustainable Development Goals (SDGs), it provides a roadmap to measure both financial returns and societal contributions. Resource Security focuses on preserving natural resources through efficient, circular practices. It reduces dependency on virgin materials, promotes recycling, and encourages sustainable resource management. As demand for finite resources rises, investments prioritizing resource efficiency will drive long-term resilience and competitiveness in the shift to a low-carbon economy. Basic Needs and Wellbeing are critical for fostering sustainable societies. Investments in sectors like food, water, healthcare, and housing contribute to poverty alleviation and community development. Wellbeing extends to health, education, and social justice. Metrics tied to these themes show how investments reduce inequality and enhance public services, fostering inclusive growth. Decent Work and Climate Stability ensure investments contribute to secure jobs and climate risk mitigation. Decent Work measures the quality and sustainability of employment, addressing fair wages and working conditions. Climate Stability focuses on aligning portfolios with efforts to limit global temperature rise under 2°C, highlighting the need to reduce emissions across industries. Launched by the University of Cambridge Institute for Sustainability Leadership (CISL) a couple of years ago, this framework remains highly relevant in 2025. Finance will play a defining role in tackling global challenges like climate change and inequality. The framework ensures capital not only generates returns but also contributes to progress toward a sustainable future. Embedding it in financial decision-making will be essential for achieving long-term prosperity for people and the planet. #sustainability #sustainable #business #esg #climatechange #investment

Fund Investing Fees: Thinking About Differences in... Carry 💰 This week on Cape May Wealth Weekly, we're talking about the wonderful topic of fund fees, such as management fee, carry, or feeder fees. Today, let's talk about carry. One key point that the frequently mentioned "2/20" carry model doesn’t highlight is the terms underlying the 20% carry. First of all, GPs eed to repay the management fee and other expenses charged to LPs before the GP receives carry. Assuming 20% fee load, it would mean that a GP needs to generate a 100€/80€=25% return to get the LP to break-even. Then, there's the hurdle rate. The hurdle rate states the required return that a GP needs to generate on invested capital before being eligible for carry. Typically, this hurdle rate is set somewhere between 6-12% IRR. Recently, I’ve also seen more absolute, multiple-based hurdles, i.e. carry being payable after investors receive a 1,3-1,5x cash-on-cash return. Yet some high-flying GPs might not have a hurdle rate at all, meaning that they profit from the moment their fund is ‘in the money’. But even then, carry does not equal carry, especially when it comes to top-tier funds. First, carry may be charged on a deal- or fund-level basis. Typically, we see what is called a European waterfall. Waterfall, in this case, describes the fund flow by which GPs and LPs receive their part of a fund’s proceeds. With a European waterfall, the GP receives carry after LPs have received returns in excess of ALL invested capital and the hurdle rate. With an American waterfall, GPs receive carry on a deal-by-deal-basis, meaning that the GP are eligible to receive carry on individual, return-generating deals even before the LPs have received their money back. Second, the size of the carry. While typically around 20%, it can be higher for top-tier funds (think 25-30%). But there's also extreme cases. I remember meeting a GP who proudly told me that they’d happily take ‘minimum tickets’ (200K€ in Germany), but that at that size, they’d charge 0/75 - so no management fee, but 75% of all upside generated by the fund beyond a modest hurdle rate. Of course, offering such a model is a sign of confidence to LPs, as not generating returns would mean that the GP leaves empty-handed. But it also meant that LPs would essentially grant the GP almost-free, non-recourse leverage. And lastly, so-called ‘supercarry’. With supercarry, GPs receive a step-up in their carry beyond a certain return. For example, they might charge the regular 20% carry to a 3,0x net multiple, which would then step up to 30% for returns in excess of this 3,0x multiple. Besides the obvious increase in fee burden, I find supercarry to be a negative indicator: There’s many incredibly successful firms out there built on the traditional 2/20 models, so raising the fee burden on LPs, especially when it’s done by a young GP, to me, is a sign of arrogance rather than long-term orientation. #privateequity #venturecapital

Many people ask me, 'What is the real impact of #sustainableinvesting?' I am pleased to share an insightful paper that addresses this important question: 'The Impact of Sustainable Investing: A Multidisciplinary Review,' authored by Emilio Marti, Martin Fuchs, Mark DesJardine, Rieneke Slager, and Jean-Pascal Gond, and published in the Journal of Management Studies. Key insights: 💡 Three #Impact Strategies: Sustainable investors utilize three primary strategies to influence corporate #sustainability: portfolio screening, shareholder engagement, and field building. Each strategy plays a distinct role, with portfolio screening and shareholder engagement creating direct impacts on companies, and field building driving change through broader systemic influence. 🏢 Direct Impact on Companies: Portfolio screening and shareholder engagement primarily result in direct impact on companies by reallocating capital to sustainable firms and engaging directly with corporate leadership. This can lead to changes in corporate practices, from reducing carbon emissions to improving supply chain ethics. 🔗 Indirect Impact through Other Shareholders: Sustainable investors also influence other shareholders by shifting their perceptions and encouraging them to adopt sustainable practices. This indirect impact is crucial as it amplifies the efforts of early movers, creating a ripple effect across the investment community. 🏛️ Indirect Impact via the Institutional Context: Field building goes beyond influencing individual companies or shareholders. It reshapes the very institutional contexts in which businesses operate, through activities such as establishing voluntary standards, supporting regulatory changes, or delegitimizing harmful business practices. This broader impact is essential for driving industry-wide change. 🔄 Shareholder Impact as a Distributed Process: Sustainable investing is not a one-time effort. Impact emerges gradually, as different types of shareholders—both mainstream and peripheral—build on each other's efforts. This collaborative and distributed process underscores the importance of diverse investor involvement in achieving meaningful, long-term change. 📈 Implications and Future Research: The authors argue that understanding sustainable investing's impact as a distributed process opens up new avenues for research. Future studies should focus on the interaction between direct and indirect impacts, why shareholders choose different strategies, and the limitations of specific strategies. These insights will help refine our understanding of sustainable investing and its ability to drive systemic change toward a more sustainable economy. In my view, this paper offers a profound and multifaceted understanding of how sustainable investing influences not just companies, but entire industries and the institutional frameworks that shape corporate behaviour. #ESG #ImpactInvesting #CorporateSustainability #FutureofFinance

"The hurdle rate is 9.6%." Real story, not fake LinkedIn AI hype slop. (Managing Partner said this during a deal review). Turns out it was actually 10% 😬. ⸻⸻⸻ I've seen this mistake a few times -- definitely in models, and even fund documents. The LP hurdle is 8% and the sponsor gets a 20% catch-up. So the natural logic is: → 8% × 20% = 1.6% → 8% + 1.6% = 9.6% (what the MP said) Seems reasonable. But sadly, it's wrong. In a true 80/20 split, the 8% needs to be 𝘨𝘳𝘰𝘴𝘴𝘦𝘥 𝘶𝘱 by 20%, not multiplied by it. So the actual math is: 8% ÷ (1 - 20%) = 10% → 8% to LPs (their 80%) → 2% to sponsor as catch-up (their 20%) 8% + 2% = 10%. Not 9.6%. Whoops. ⸻⸻⸻ 0.4% might not sound like much, but on a larger deal it's millions in carry. The image on this post illustrates the point. The sponsor misses out on $1.9mm of carry. (I had AI try to create it twice and it botched it both times 😔🤖) ⸻⸻⸻ If you're interested in PE, this is the kind of thing you can't miss. I teach the LP waterfall, catch-up provision, and every other piece of the LBO model -- step by step, from scratch. 𝗟𝗲𝗮𝗿𝗻 𝗣𝗘 𝗺𝗼𝗱𝗲𝗹𝗶𝗻𝗴 𝗵𝗲𝗿𝗲 › https://bit.ly/FMECourses

How Is Your Investment Strategy Embracing Sustainability? ➤ In today's world, where the call for sustainability is louder than ever, how are you weaving Environmental, Social, and Governance (ESG) factors into your investment strategy? ↳ Sustainable investing is more than a trend—it's a transformative approach reshaping the financial landscape. ↳ The United Nations' Principles for Responsible Investment (PRI) defines responsible investment as integrating ESG factors into investment decisions and active ownership. ↳ While terms like ESG, sustainable, socially responsible, and impact investing may seem interchangeable, they each carry unique nuances. 💡 For instance, Bridges Fund Management's 2015 study highlights a key difference: responsible investment focuses on mitigating risky ESG practices to protect value, while sustainable investment adopts progressive ESG practices to enhance value. ➤ Investment managers today are tasked with a delicate balance. They must consider the interests of shareholders, employees, customers, and communities while delivering both financial returns and social and environmental impact. ➤ There are five primary ESG investment approaches: 📌 Screening: This involves both negative and positive screening to select investments based on specific ESG criteria. 📌 ESG Integration: The most favored approach, as per the Schroeder's Institutional Investor Study 2021, involves incorporating ESG factors directly into the investment process. 📌 Thematic Investing: Focuses on themes such as renewable energy or social equity. 📌 Engagement (Active Ownership): Involves investors actively engaging with companies to influence their ESG practices. 📌 Impact Investing: Aims to generate measurable social and environmental impact alongside financial returns. → As we move toward a more sustainable future, investors are increasingly seeking strategies that balance risk management with the opportunity to generate strong long-term returns. → How is your investment strategy adapting to this evolving landscape? → Are you ready to embrace the potential of sustainable investing to make a meaningful impact?

What happens when investors exclude a part of the universe to create sustainable portfolios? We explore this question in our new paper 𝗧𝗵𝗲 𝗜𝗻𝘃𝗲𝘀𝘁𝗺𝗲𝗻𝘁 𝗜𝗺𝗽𝗹𝗶𝗰𝗮𝘁𝗶𝗼𝗻𝘀 𝗼𝗳 𝗦𝘂𝘀𝘁𝗮𝗶𝗻𝗮𝗯𝗹𝗲 𝗜𝗻𝘃𝗲𝘀𝘁𝗶𝗻𝗴 - which was published in the 𝘑𝘰𝘶𝘳𝘯𝘢𝘭 𝘰𝘧 𝘐𝘯𝘵𝘦𝘳𝘯𝘢𝘵𝘪𝘰𝘯𝘢𝘭 𝘔𝘰𝘯𝘦𝘺 𝘢𝘯𝘥 𝘍𝘪𝘯𝘢𝘯𝘤𝘦. Specifically, we tested how three common sustainable investing approaches - SDG Alignment; ESG Integration; and Carbon Reduction - affect diversification, factor premiums, and factor exposures. What we found: 🌍 Diversification holds up. Efficient frontiers for restricted vs. unrestricted universes are virtually identical over the long run. 🚀 Factor strategies stay intact. Value, Momentum, Quality, and Low-Risk premiums are not meaningfully affected, while factor exposures remain unchanged. 🥬 Sustainability integration can avoid controversies. Yet this applies to SDG alignment, and to a smaller extent Carbon Reduction - ESG Integration doesn't reduce controversies. Why it matters: These results suggest that investors can pursue sustainability objectives without sacrificing diversification or long‑run factor premia. Read the paper here: https://lnkd.in/e6pcAuny or the open access version on SSRN: https://lnkd.in/eBFiFuS5 Thanks to my great co-authors Joop Huij, PhD and Dries Laurs, as well as to Kees Koedijk and XIANG (Sean) GAO, PhD, CFA, FRM, CAIA, FAIQ (CII) for their feedback, and Anni Schleicher for editorial support.

Your investments could be shaping more than just your portfolio. What if every dollar you deploy could create a ripple effect of positive change? The cost of overlooking impact is higher than you think. According to the Global Impact Investing Network (GIIN), over 3,907 organizations currently manage $1.571 trillion USD in impact investing assets under management (AUM) worldwide, representing a 21% compound annual growth rate (CAGR) since 2019. Yet, this still accounts for only about 1% of total global assets under management, indicating a vast potential for growth. By not integrating impact considerations, investors may miss out on opportunities for meaningful change and long-term value creation. 7 Strategies to Align Investments with Purpose: 1. Define Your Impact Objectives ↳ Identify core values: Determine the social or environmental issues that resonate most with your mission. ↳ Set clear goals: Establish specific, measurable outcomes you aim to achieve through your investments. 2. Conduct Thorough Due Diligence ↳ Assess impact potential: Evaluate how prospective investments contribute to your defined objectives. ↳ Analyze track records: Review the historical performance of organizations in delivering both financial returns and positive impact. 3. Diversify Across Asset Classes ↳ Explore various vehicles: Consider equities, bonds, and alternative investments that align with your impact goals. ↳ Balance risk and return: Diversification can help mitigate risks while enhancing potential for impact. 4. Engage with Investee Companies ↳ Active ownership: Use your shareholder influence to advocate for sustainable practices. ↳ Collaborate on initiatives: Work with companies to develop strategies that enhance their social and environmental contributions. 5. Measure and Report Impact ↳ Utilize standard metrics: Adopt frameworks like IRIS+ to track and compare impact performance. ↳ Transparent reporting: Regularly disclose impact outcomes to stakeholders to build trust and accountability. 6. Stay Informed and Adaptable ↳ Monitor industry trends: Keep abreast of developments in impact investing to identify new opportunities. ↳ Be flexible: Adjust your strategies as needed to respond to changing social and environmental landscapes. 7. Collaborate with Like-Minded Investors ↳ Join networks: Participate in groups like the GIIN to share knowledge and resources. ↳ Co-invest: Partner with others to amplify impact and share due diligence efforts. Every investment is an opportunity to shape a better future. What’s one step you can take today to align your portfolio with your purpose? ♻️ Share this story with your network - let's spread inspiration far and wide! 👉 Follow Ben Botes for more insights on Leadership, Entrepreneurship and Impact Investment.

𝐖𝐢𝐭𝐡 𝐜𝐨𝐦𝐩𝐚𝐧𝐢𝐞𝐬 𝐬𝐭𝐚𝐲𝐢𝐧𝐠 𝐩𝐫𝐢𝐯𝐚𝐭𝐞 𝐥𝐨𝐧𝐠𝐞𝐫, 𝐈'𝐯𝐞 𝐬𝐞𝐞𝐧 𝐡𝐮𝐫𝐝𝐥𝐞 𝐫𝐚𝐭𝐞𝐬 𝐪𝐮𝐢𝐞𝐭𝐥𝐲 𝐫𝐞𝐬𝐡𝐚𝐩𝐢𝐧𝐠 𝐆𝐏 𝐢𝐧𝐜𝐞𝐧𝐭𝐢𝐯𝐞𝐬 - 𝐚𝐧𝐝 𝐧𝐨𝐭 𝐚𝐥𝐰𝐚𝐲𝐬 𝐢𝐧 𝐰𝐚𝐲𝐬 𝐭𝐡𝐚𝐭 𝐚𝐥𝐢𝐠𝐧 𝐰𝐢𝐭𝐡 𝐋𝐏𝐬. Preferred returns sound small on paper - 6%, 7%, 8% - but compounded over time, they dramatically reshape how much a GP must return before earning a dollar of carry. The matrix below models 96 venture fund scenarios, showing how 𝐝𝐢𝐬𝐭𝐫𝐢𝐛𝐮𝐭𝐢𝐨𝐧 𝐭𝐢𝐦𝐢𝐧𝐠, 𝐡𝐮𝐫𝐝𝐥𝐞 𝐭𝐲𝐩𝐞, 𝐚𝐧𝐝 𝐟𝐮𝐧𝐝 𝐩𝐞𝐫𝐟𝐨𝐫𝐦𝐚𝐧𝐜𝐞 combine to push breakeven Net DPI far above 1.0x. While many assume a fund “hits carry” once committed capital is returned, a 6 – 8% hurdle - especially compounding - pushes that threshold far higher. In early-stage venture, where companies are staying private longer, these structural nuances matter more than ever. The data shows how preferred returns compound quietly in the background, turning time into a GP’s biggest headwind. A 2.0x fund with distributions between Years 6 – 11 and a 7% annualized hurdle must deliver 𝟏.𝟒𝟎𝐱 𝐍𝐞𝐭 𝐃𝐏𝐈 𝐛𝐞𝐟𝐨𝐫𝐞 𝐞𝐚𝐫𝐧𝐢𝐧𝐠 𝐚𝐧𝐲 𝐜𝐚𝐫𝐫𝐲. Stretch that same fund to Years 8 – 13, and the bar climbs to 𝟏.𝟓𝟔𝐱 𝐍𝐞𝐭. At the top end, faster-returning 4.0x funds clearing between Years 5–10 see minimal drag - just 1.04x – 1.19x to reach carry - leaving meaningful GP upside intact. But as timelines extend and returns compress, the math turns unforgiving: even a 3.0x fund can see half its total value flow to LPs before carry, 𝐰𝐡𝐢𝐥𝐞 𝟏𝟒 𝐨𝐟 𝐭𝐡𝐞 𝟗𝟔 𝐦𝐨𝐝𝐞𝐥𝐥𝐞𝐝 𝐬𝐜𝐞𝐧𝐚𝐫𝐢𝐨𝐬 𝐧𝐞𝐯𝐞𝐫 𝐜𝐥𝐞𝐚𝐫 𝐭𝐡𝐞 𝐡𝐮𝐫𝐝𝐥𝐞 𝐚𝐭 𝐚𝐥𝐥. 🔍 𝐊𝐞𝐲 𝐈𝐧𝐬𝐢𝐠𝐡𝐭𝐬 1️⃣ 𝐓𝐢𝐦𝐞 𝐢𝐬 𝐭𝐡𝐞 𝐡𝐢𝐝𝐝𝐞𝐧 𝐡𝐮𝐫𝐝𝐥𝐞. The longer liquidity takes, the faster preferred returns compound - eating into carry even when absolute performance looks strong. 2️⃣ 𝐍𝐨𝐭 𝐚𝐥𝐥 𝟑.𝟎𝐱 𝐟𝐮𝐧𝐝𝐬 𝐚𝐫𝐞 𝐜𝐫𝐞𝐚𝐭𝐞𝐝 𝐞𝐪𝐮𝐚𝐥. Early, faster-distributing funds can clear hurdles efficiently, while slower ones see nearly 50% of gains flow to LPs before the GP sees a dollar. 3️⃣ 𝐇𝐮𝐫𝐝𝐥𝐞𝐬 𝐜𝐚𝐧 𝐝𝐢𝐬𝐭𝐨𝐫𝐭 𝐢𝐧𝐜𝐞𝐧𝐭𝐢𝐯𝐞𝐬. GPs may feel pressure to sell strong assets early to “stop the clock,” even if doing so hurts long-term performance and LP alignment. 4️⃣ 𝐍𝐨 𝐮𝐩𝐬𝐢𝐝𝐞, 𝐧𝐨 𝐢𝐧𝐜𝐞𝐧𝐭𝐢𝐯𝐞. In many lower-multiple or longer-dated funds, the hurdle stays out of reach. When there’s no path to carry, GPs lose motivation to actively manage the tail end of portfolios - putting residual value and LP outcomes at risk. As venture funds stretch beyond their 10-year lives, 𝐭𝐢𝐦𝐞 𝐡𝐚𝐬 𝐛𝐞𝐜𝐨𝐦𝐞 𝐚 𝐪𝐮𝐢𝐞𝐭 𝐛𝐮𝐭 𝐩𝐨𝐰𝐞𝐫𝐟𝐮𝐥 𝐟𝐨𝐫𝐜𝐞 𝐫𝐞𝐬𝐡𝐚𝐩𝐢𝐧𝐠 𝐫𝐞𝐭𝐮𝐫𝐧𝐬. Designed to protect LPs, preferred returns can, over time, just as easily distort alignment. Knowing how time compounds isn’t academic - it’s essential to preserving trust between GPs and LPs. 𝐒𝐢𝐠𝐧𝐚𝐥𝐬 𝐢𝐧 𝐭𝐡𝐞 𝐍𝐨𝐢𝐬𝐞 🤓