Matt Sherwood

Jenna Gerstenlauer: This bonus series is kindly supported by Soundmark Partners. Soundmark Partners LLC is a women-owned and led private credit firm focused on commercial real estate. Matt Sherwood is a former guest and friend of this podcast. We featured him in episode 157, which you can find in our hub, in which we discussed his experience in the world of hedge funds and how suddenly losing his sight mid-career affected his journey but not his hunger and ambition. We follow that ambition now to his founding of Pothos Partners, which is inspired by the golden pothos plant’s resilience and its remarkable ability to purify air by removing CO2. It is a firm that believes in thriving against all odds, just as Matt has triumphed over his visual impairment. Its mission is to provide investors with unparalleled access to the green energy and regulated carbon markets. I sat down with Matt to speak with him about Pothos and hear about this investment opportunity, how it relates to the Inflation Reduction Act, and how it could contribute to the journey towards net zero that many investors now find themselves on. So Matt, can you tell us about Pothos Partners and its focus?

Matt Sherwood: Yeah, so Pothos Partners, the, the name is an origin from the golden pothos plant. It actually sequesters the most amount of carbon out of plants, and it’s also hard to kill. So we thought it’d be a great name for us given what we do and, and our goals in this business. But Pothos Partners is a fund structure, it’s a partnership. So we’re the management company of LP partnerships that we really identify opportunities in the green economy. And our goal is to take advantage of these opportunities. Most specifically, we have one fund right now that is in the regulated California carbon emission allowances market. That’s where our main focus is. But given the Inflation Reduction Act of 2022 and the financial monetization of carbon as well as water, solar, and other aspects of the green economy, it’s a timely opportunity for us to pursue. We believe there’s a lot of upside here for investors.

Jenna Gerstenlauer: So let’s talk about the motivation, maybe considering what you were doing. Why now? What motivated you to found this firm now? Can you maybe sketch the opportunity?

Matt Sherwood: Yeah, so let me just talk about what motivated me. Well, as we last spoke, I, I had a startup that we, we raised 2 rounds of venture capital, and I was immensely focused on that. However, I have the background in impact investing and ESG investing. The second edition of my textbook actually published earlier this year, and that has been a focus of mine throughout my quantitative and qualitative research career and my investment career. And one of my partners, Paul Blavin, who’s a well-known, extremely successful investor, Blavin and Company, reached out to me to discuss the California carbon allowances market and the special situation that we have identified there. When he brought this to me, it was something that I soon learned after digging in and doing research that I have been looking for my entire investment career. This is an opportunity that the government is a tailwind. The state government of California wants these prices of this asset to go higher, and they do so for multiple reasons. One, that’s the goal of the program, to force emitters to change. And the emitters, the polluters like PG&E and Chevron and Exxon, they will start changing their infrastructure and facilities, which is a massive task once it becomes cost effective for them to do so. Right now, they’re going to just buy these compliance instruments and use them. So this is well known by the state government of California. They want these prices to go higher, closer to that marginal cost of abatement, as well as this now is north of 2% of California’s state budget. This represents the fifth largest economy in the world behind Germany. It’s real money for them. So the other aspect that I was so excited about, it’s pretty simple. This is an increasing demand, decreasing supply story, right? Economics 101. And when you have that, you’ll generally see an upside movement on price, you know, significant price discovery. And that’s an opportunity we’d love to take advantage of for investors because not only will we be you realizing, know, significant returns, but also as these you prices, know, rise, we’re forcing change and that’s positive impact on on the world.

Jenna Gerstenlauer: Would you say that there’s an aspect of this that people or markets are not getting? Do you think it’s well understood? What are we missing? And is it maybe too complex for many to understand?

Matt Sherwood: Well, I think it’s definitely esoteric for many relative to traditional equity and credit. However, it’s, it’s also uncorrelated to equity and credit beta. The biggest, I guess, difficulty I’ve had when approaching investors is often they compare it to the voluntary carbon offset market. And this is where you may have a group organization planting trees and trying to certify that they are sequestering carbon or reforestation and then trying to look at government assistant programs or offset programs to be able to monetize that. That is not what we’re doing. We’re purely playing the regulated market. That these are carbon emission allowances, they’re printed from the state of California, they’re in a quarterly physical auction that we participate in. So very, very different than a voluntary offset market, which we’ve seen in the EU, the European allowances market could be riddled with fraud at times and was in the past. So it’s very different apples and oranges, but often people that I’m speaking to confuse that. And that’s been a difficult hurdle to overcome at times.

Jenna Gerstenlauer: You mentioned policy with the, I suppose, IRA and with the Inflation Reduction Act, and now some of the struggles that some of the sustainable energy producers are experiencing. Do you think that the policy is clear-cut going forward? Are there any potential uncertainties around that?

Matt Sherwood: Yeah, well, policy in California for our post-hose carbon funding which is purely focused in the California carbon allowances market, it is pretty clear this was brought under Arnold Schwarzenegger, Republican governor of California, and started in 2012. It’s not a nascent market, right? 3 governors, it was passed in supermajority, the state House and Senate. It’s well defended as a program. I would say it’s not a nascent market. It’s a $50 billion market cap here. And policy in California is very supportive. Donald Trump actually went after this program twice. He was trying to deregulate energy in California. He went after it twice, but Dormer Commerce Clause, like interstate commerce laws, as well as precedent law, so like EPA v. Massachusetts and Pike v. Bruce Church, set a precedent that really insulated and protected this program. I actually believe future policy will be adopted really worldwide, federally or amongst other states to link to California’s program because it is really a well-thought-out, well-operated program to make positive impact on reducing carbon emissions and reducing greenhouse gases. Right now, California’s goal is to have at least a 40% reduction of greenhouse gases at 1990 levels by 2030. So relative to— so stepping back from the specific regulated carbon market, overall, Inflation Reduction Act really unlocks a lot of value for companies. And They’re going to take advantage of making changes to their infrastructure facilities, which is not an easy task, and they’re going to do so because there’s just an incredible amount of money that they can now access to make it cost-effective and really beneficial in the next 10 years through the Inflation Reduction Act. So we’re really excited. We believe that there’s tailwinds there for us as well and for our investors that want to partner with us. Based on areas like methane digesters, solar renewable energy credits, biofuels. There’s a lot of opportunity here. Our main focus right now is in the carbon sequestration, carbon emission market, and particularly we’re really narrowly focused right now on this California carbon market opportunity.

Jenna Gerstenlauer: And let’s talk about maybe the size of the opportunity in terms of the fund. What fund size do you think can be supported And I’d also like to talk about the investor experience, but first the size.

Matt Sherwood: Yeah, well, we are capacity constrained by regulation. The physical auction under California Air and Resources Board has limits on how many carbon allowances you can hold. One carbon allowance represents one metric ton of carbon emission. And this year, just like the auction has a structural deficit on how many Allowances are auctioned each year. They’re reduced every year. Same goes for the holding limit. So this year, for example, no individual, no entity, no partnership, both indirect or direct, can own more than $10.5 million allowances. Right now they’re trading around $36, close to $37. The year after is $10.18 million and then below $10 the following year. So we actually are not going to be holding more than $10 million allowances. To be prudent of both what we’re allowed to do by regulation, but for investors as well, we’re very focused on long-term capital gains rather than churning our portfolio. This is not really a trading strategy. This is a buy and hedge strategy. So we are hedging out risk, but that’s the capacity constraint we have. So current market prices were around $360 million. So it is smaller in nature, but the opportunity for significant ROI exists here. So really excited about it.

Jenna Gerstenlauer: And then in terms of the investor experience, so where would you suggest this strategy fits for an investor, and what can they expect? And let’s initially speak about return and yield, but I want to speak about the net zero impact as well. Investor experience for return and yield.

Matt Sherwood: Okay, well, let me tackle those. Great, great question. Investors do look at where to bucket us. I mean, unfortunately, the bucketing is part of investments, whether you’re dealing with a family office or wealth platform. And we are often bucketed in a few different places. One is going to be an infrastructure or commodities or real estate area. The other is often private credit or private equity. Often we are put in an opportunistic or portable alpha as well. And we are, really complimentary because of the fact that there’s not correlation to other betas. So it’s a very unique opportunity to have a diversification for investors relative to yield and opportunity. We, we do not believe this is an evergreen strategy. We’re taking advantage of a true supply-demand imbalance that will be worked out when there’s significant price discovery. These are compliance instruments that need to be utilized and They’re surrendered and retired once they’re used by the mandatory required reporters. Those are the emitters or polluters. And we believe the time horizon for this is around 5 years. So it could be less, could be 3 to 5 years, could be 5, 6 years, but that’s where we envision us returning capital to LPs. We know this because of the— there’s going to be a drawdown in any stockpile of credits. There’s going to be a true significant price discovery because you’re going to have these emitters and polluters that are going to have to find these compliance instruments on the open market. They’re not going to have enough option because of that structural deficit. And that’s a great Economics 101 simple, they will need to buy higher at a higher price. And the best part about that as well, outside of that great financial return, we’re going to provide It also is helping them identify reason and cost-effective opportunity to change their infrastructure. So that’s important. That’s where we’re going to really see— without participants like us and investors that are partnering with us, you’re not going to see real change to the system or real change to their infrastructure facilities to reduce carbon emissions and still be able to produce the same amount of power or refine the same amount of oil, for example. Relative to risk and return, implied volatility, very low here. Volatility, standard deviation in general has been relatively muted compared to equities or other commodities, even credit nowadays. We do believe there’s going to be a significant return over the course of our holding. I mentioned that 3 to 5, 3 to 6-year holding period. We believe it’s going to be a 100 to 300% net return potential. So we use 200% as a median. We do have a hedge that’s right around 20%. For any black swan events. So we do want to preserve capital, around 80% of the investor’s capital, just in any unforeseen events.

Jenna Gerstenlauer: And you talked about carbon sequestration. It seems that that’s an essential piece of the net zero journey. To what extent would this be an ingredient in a portfolio that has a target of net zero by, say, 2035, 2040, maybe sooner? How would this fit? Would this have any contribution to the net zero profile of a portfolio?

Matt Sherwood: Oh, and the, the renewable portfolio standard plays out really well for us. This is not just an ingredient, this is a driver for those that want to reduce carbon overall in their portfolio. By partnering with us as investors, we’re able to really illustrate based on right down to the, the metric ton of carbon How many metric tons that portfolio is actually reducing as part of ownership in this fund, right? As far as being an investor in LP, that’s significant. So if an investor who’s running a large portfolio sees there’s some energy, oil, dirty aspects, whatever it may be that they’re really having a large footprint, you can view. And it’s really easy to measure scientifically the complement of what we’re doing as a handprint, right? So we are truly handprinting, we’re sequestering carbon by owning these compliance instruments that are going to be utilized in the future. And we know by metric ton how many allowances we have, how that reduction of carbon is happening. So for us, it’s not just a great complement to return and being a true alpha, component to someone’s portfolio, but we’re taking what their portfolio is likely doing on a carbon footprinting basis, and we’re actually providing hand printing. So we are helping their portfolio find neutrality and, and hopefully net positive.

Jenna Gerstenlauer: We’re gonna take a quick break to hear from our sponsor of this series, Sandmark Partners. I sat down with Jenna Gerstenlauer to talk about their private credit strategy. We spoke about hiring challenges in particular. It’s hard to find talented people to hire. When you add in the desire to hire people who are from different backgrounds from the partners or managers who run the firm, it becomes even harder as human beings typically network and socialize with people who are like them— same gender, same ethnicity, same educational background. But it’s not impossible, and we have to keep challenging ourselves every day to think outside of our comfort zone and figure out ways to make those connections. Every person on the planet interacts with real estate. Properties are located in cities, suburban areas, rural areas, in markets that are located on the coast, in the heartland, in affluent neighborhoods, and in working-class neighborhoods. We need an investment team made up of people who are connected to all of these real estate types, which means we need a diverse set of employees. It’s actually just pretty simple. And now back to the show. And of course, we have this— we referred to the earlier podcast where you shared your disability, and this is a disability-led business. Can just tell us a little bit about that classification?

Matt Sherwood: Yeah, so I’m blind. I’ve been blind for 15 years now, unfortunately. And I guess we dig a little bit deeper on how I lost my eyesight in our last podcast, but this is a huge opportunity for me. This is a business that I have majority of, and Paul Glavin wanted it that way. Andrew DeVito, our third partner, he’s also a disabled veteran. Andrew spent his first 21 years of his career in the US Army. Dealing with government regulations and compliance. And when he wasn’t doing that, he did serve 4 tours in Iraq or in Middle East. So for us, I think it’s really, you know, I don’t view myself in any different way. I’m blind, this is just who I am. But I do hope that others recognize that I can do anything that anyone can do, even if they have sight. We said regardless of my own disability, We did say, as we discussed previously, right, it’s not the disability that’s very hindering, right? It’s the perceptions of my abilities that are hindering. And that’s one thing I hope that investors look past and see we have the right infrastructure, the right execution management to be a business that’s operated by someone who’s blind and achieve great returns for our investors. But that’s one thing, that’s the disability-led having a veteran, and I am just appreciative of even everything you’ve done and what you’re doing for the disability community. You know, I’ve listened to your last podcast, and very encouraging, and I just commend you for that. Uh, inclusion is important, not just in the investment industry but for all of us in the world.

Jenna Gerstenlauer: Well, thank you so much, and thank you for your support of that podcast with Emma Olivier. Wonderful to have that and have her voice amplified as well. And thank you. You’re always pushing boundaries, Matt, I feel, showing us what’s possible. And thank you for coming here to share insights on this important segment, which will probably be growing in terms of the bandwidth it takes of our coverage of media and our knowledge and understanding of the investment world. So thank you for coming here and sharing your insights with us.

Matt Sherwood: Thank you so much for having me. I’m a big fan of 50 Faces and I, I love your work. So thank you.

Jenna Gerstenlauer: This podcast is for informational purposes only and should not be construed as investment advice, and all views are personal and should not attributed to the organizations and affiliations of the host or any guest.