Jun 29, 2020 · 55m · capital-allocators
Sustainable Investing 7: Tony Davis – Hedge Fund Perspective at Inherent Group (Capital Allocators, EP.145)
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In this episode of Capital Allocators, Inherent Group founder Tony Davis shares how his background in distressed credit informed his pioneering hedge fund strategy, which integrates rigorous ESG underwriting, multi-year time horizon arbitrage, and collaborative engagement to generate alpha and accelerate sustainability in public markets.
How this conversation actually went
Every chapter scored 0–10 on four independent dynamics. Hover any point for the reasoning behind the score. Ted holds 20.6% of the talking time here. How this is scored →
Ted as informed peer 3.9 Guest teaching 2.3 Guest disagreement 0.2 Ted pushing back 0.3
speaking balance: gold is Ted, purple is the guest (3 minute bins)
Sharpest disagreement ▶ 19:11 Challenging traditional concessionary thinking
Tony firmly rejects the conventional trade-off assumption between impact capital and financial returns, explaining why blended finance is often more efficient than government or grant programs.
Hardest push from Ted ▶ 19:11 Sacrificing return for missionTed presses Tony on the financial risk of investing endowment assets strictly along mission lines, arguing that sub-par returns diminish long-term grantmaking capacity.
Biggest teaching moment ▶ 31:18 Scope emissions breakdown and Tesla anomalyTony educates Ted on the precise definitions of Scope 1, 2, and 3 emissions, pointing out counterintuitive real-world outcomes where Tesla generates higher Scope 1 and 2 emissions than legacy automakers.
Ted holds their own ▶ 49:07 Distressed credit versus ESG paradoxTed demonstrates keen market insight by challenging the apparent contradiction of pairing distressed debt investing with ESG principles, setting up Tony's explanation of restructuring catalysts.
the scores for every segment, with the reasoning behind each
| Chapter | Topic | Ted as informed peer | Guest teaching | Guest disagreement | Ted pushing back | Why |
|---|---|---|---|---|---|---|
| Nonprofit Spotlight: Alliance for Decision Education | 3 | 1 | 0 | 0 | Ted opens the interview with standard biographical prompts regarding Tony's entry into finance. Tony shares his transition from physics and biomedical engineering to Wharton and Goldman Sachs in an open, friendly narrative. | |
| Distressed Investing Lessons at Goldman Sachs | 4 | 2 | 0 | 0 | Ted prompts Tony on foundational lessons learned at Goldman Sachs and the founding of Anchorage Capital. Tony details his early distressed debt desk experience navigating Enron and utility bankruptcies collaboratively. | |
| Transition from Anchorage to Sustainable Impact | 3 | 1 | 0 | 0 | Ted asks Tony about stepping away from Anchorage and finding a new direction. Tony describes his London sabbatical, meeting early impact pioneers, and realizing investment skills could apply to social problems. | |
| Foundation Strategy and Blended Finance Innovation | 4 | 3 | 1 | 0 | Tony explains the disconnect in typical foundation endowments between the 5 percent grantmaking and 95 percent asset allocation, illustrating innovative blended finance models like income-share coding bootcamps. | |
| Evaluating Social Return on Investment and Capital Trade-Offs | 5 | 3 | 1 | 2 | Ted pushes back with a standard allocator counterargument about concessionary returns reducing future grant capital. Tony walks through the calculus of mission-related investments and the 300 basis point trade-off. | |
| Demonstrating Alpha and Lowering Corporate Cost of Capital | 4 | 2 | 0 | 0 | Tony lays out Inherent Group's core thesis that integrating ESG leads to lower cost of capital and better risk-adjusted alpha rather than concessionary performance. | |
| Investment Sourcing Framework: SDGs and Governance | 4 | 2 | 0 | 0 | Ted asks Tony how Inherent maps long and short sourcing to ESG themes. Tony details their SDG thematic coverage alongside fundamental governance checks like board independence and executive compensation. | |
| Analyzing Climate Transition Risks and Social Dynamics | 3 | 4 | 0 | 0 | Ted asks for clarification on scope 1, 2, and 3 emissions. Tony educates him on how scope emissions function, citing the paradox of Tesla versus legacy automakers, followed by workplace culture analysis. | |
| Quantifying Sustainability and Overcoming Data Limitations | 4 | 3 | 0 | 1 | Ted questions how qualitative ESG and carbon metrics can be quantitatively reconciled inside a traditional DCF valuation model. Tony explains discount rate adjustments and the challenges of self-reported social data. | |
| Portfolio Construction and Dynamic Market Adjustments | 4 | 2 | 0 | 0 | Tony breaks down Inherent's 15-long concentrated portfolio construction across valuation risk, total return credit, and low LTV credit, detailing rapid tactical shifts during the March 2020 liquidity shock. | |
| Constructive Engagement Strategy with Corporate Leadership | 4 | 2 | 0 | 0 | Tony explains his constructive engagement model with management teams, contrasting his long-term hedge fund approach with private equity's shorter horizon and external activist hostility. | |
| The Short Strategy and Identifying Governance Red Flags | 4 | 2 | 0 | 0 | Tony reviews shorting strategies, explaining how Inherent targets SDG laggards and uses screens like the 'cult of personality' to find governance vulnerabilities. | |
| Pandemic Accelerations, Macro Trends, and Share Buybacks | 4 | 2 | 0 | 0 | Ted asks about the pandemic's broader market implications and share repurchases. Tony articulates the public optics challenges for companies taking state aid while paying out capital. | |
| Distressed Credit and Bankruptcy as an ESG Transformation Catalyst | 5 | 3 | 1 | 1 | Ted observes that distressed debt and ESG are usually seen as polar opposites. Tony reframes restructurings as ideal opportunities to reset governance, culture, and alignment from the ground up. | |
| Allocator Due Diligence and the Future of ESG | 4 | 2 | 0 | 0 | Tony provides actionable advice for allocators evaluating ESG funds, recommending inspecting investment committee memos and evaluating internal firm diversity. |
Statements from this episode (30)
Davis: There were no utility bankruptcies for 20 years before Enron and PG&E
“So, you know, at that point, I don't think there'd been a utility bankruptcy in two decades and lo and behold, We had Enron. And then we had Pacific Gas and Electric the first time around.”
Goldman promoted Davis to distressed desk because external hires cost 3x
“And in the end, they asked me and another guy to co-manage the distressed bond desk there. I think we were doing a reasonably good job, but I also found out after the fact that everyone else was asking three times what they were paying me to come in and take t…”
Multiple fund products create revenue stability to fund infrastructure and talent
“Our approach was to say, really focus on the customer, the client. What do they want? What of their needs are we solving and design products around that have multiple products so that it creates some stability of revenues to the GP and management company and a…”
Investors must avoid un-termed leverage to play offense during market stress
“From an investing standpoint, the biggest sort of takeaway was just make sure that you're in a position to go on offense when the markets are under pressure. And so that's really informed how we think about managing the portfolio risk here at inherent as well.…”
Foundations ignore the 95% of endowments invested contrary to their core mission
“And I've never understood in the foundation space, you know, people spend so much time programmatically on the five percent that they put out each year, which is, of course, incredibly important. But the other hundred percent of their assets are sitting on the…”
Inherent funded a non-profit coding bootcamp using an income-share repayment model
“We led a financing for a not-for-profit coding bootcamp in Queens that focused on that population that really wasn't the for-profit coding bootcamps weren't accessible to them. These were non-college grads, median income of 18,000 dollars a year. That over nin…”
Davis: Most Inherent Foundation endowment assets target commercial returns in MRIs
“Most of the endowment Is in what I would call MRI, mission-related investments, where we expect, they're aligned with our mission, but we expect commercial rates of return.”
Blended finance organizations solve social challenges more efficiently than governments
“Some of those organizations are just more efficient in allocating capital and tackling social challenges than if you asked a pure, purely nonprofit to do it, or you asked a government program to do it.”
Blended finance imposes financial discipline by setting capital return expectations
“There's also something about this blended finance models that also, I think there's a governor accountability effect that there is an expectation of return of capital, let's say. And so it does sometimes cause the receiving organization to have to be a little …”
Davis: IPCC estimates at least $2T yearly needed in clean energy
“The IPCC, the Intergovernmental Panel on Climate Change, tells us that we need two trillion a year, at least, invested in clean energy systems to have a chance of staying below one and a half degrees C of warming.”
Davis: Externalities beyond carbon will be priced over time
“I think other externalities are going to be priced over time.”
ESG leadership drives higher valuation multiples by de-risking future cash flows
“You have two companies doing exactly the same one, but one leads on ESG and one doesn't. You're willing to pay more for the cash flows of the one that leads on ESG because those cash flows are less risky. They're less volatile.”
Hedge funds must adopt long-term horizons to avoid competing against algorithms
“I think if you're trying to compete quarterly against the machines, that's a tough place to be. So you need to be able to take a longer term view.”
Inherent Group trades lower fees for long-term capital and three-year payouts
“And so we structured it so that the majority of our capital is longer term capital and, you know, in exchange for that, what we offered was lower fees, a hurdle, and we pay ourselves at the end of three years.”
UN Sustainable Development Goals provide a multi-year structural investment tailwind
“I like this description of the sustainable development goals as the strategic plan for the planet, which I believe. And if you believe that there's just going to be over many, many years, a tailwind to invest in these SDG aligned areas. And conversely, if you'…”
Board diversity improves corporate risk management and capital allocation decisions
“Is there diversity on the board? Again, not because it's the right thing to do, because it's the right business thing to do. It leads to better risk management. It leads to better capital allocation.”
Tesla produces equal or more Scope 1 and 2 emissions than GM
“On scope one and two, for example, Tesla has the same or even more emissions per unit volume than do GM and Ford.”
The COVID-19 pandemic will elevate the 'Social' pillar of ESG investing
“I think in this current moment of COVID, S is going to get its day in the sun.”
ESG rating agencies frequently disagree on companies' actual ESG performance profiles
“Even the ratings agencies themselves often don't agree on whether a company is a good ESG company or a bad ESG company.”
Corporate social ESG data is self-reported, unaudited, and chronically stale
“Social is much more difficult today. Let's start with the fact that the data is self-reported, unaudited, and stale by the time you get it from those corporates.”
Davis: Mandatory ESG disclosures and data frameworks will improve
“So I think that's going to improve. Mandatory disclosures are going to improve. Different frameworks for taking that data then and figuring out how to use it in a useful way are going to improve.”
Private equity's short holding periods disincentivize long-term investments in sustainability
“Private equity average hold is much shorter, so the incentives are different, and investing in sustainability is often synonymous with a long-term orientation. Some of these things of investing in good processes and investing in your people pay off over multip…”
PwC found one-third of fired CEOs were ousted for ethical lapses
“PWC had a report out, I don't know, maybe it was six months ago and said that a third of all the CEOs that had been laid off in a prior year, it was due to ethical lapses.”
Long-tenured CEOs with poor governance scores often create destructive personal fiefdoms
“We look for companies where the CEO has been in the seat, 15 years or longer, and where NSCI or Sustainalytics gives them a bottom quartile score on governance. And we've just seen over and over in our career that And sometimes the CEO is there because they're…”
Medicare going cash-flow negative will end excess rents for healthcare monopolies
“And I think that trades over because Medicare is going to go cashflow negative in the next few years.”
Legislation will eliminate surprise billing profits for physician practice management businesses
“And conversely, companies that are, have been earning excess rents, I'd say some of the physician practice management businesses where they've benefited from surprise billing, you know, that's now Looks like it's going to be legislated away.”
Eliminating dividends and buybacks destroys owners' ability to redeploy corporate profits
“If you eliminate those, you kind of take out one of the core tenants of capitalism, which is the ability for owners to redeploy their profits into more productive activities.”
Tony Davis: Restructurings offer a unique opportunity to overhaul corporate governance
“The other thing I would point out is there is an opportunity in a restructuring to hit the reset button. You have this moment in time where you can completely rethink governance and put in place best practices in terms of governance and executive compensation.…”