A new study has revealed that the lack of capital allocated from institutional investors is still restraining growth of the venture capital for sustainability (VC4S) sector. Instead, VC4S is often led by such investors as family offices and high-net-worth individuals.

The study Venture Capital for Sustainability, 2007 by the European Social Investment Forum (Eurosif), based on a survey of European venture capitalists, says that European VC4S raised €1.25bn of committed capital in the five years to 2006 - reflecting last year's VC4S boom.

This means that the VC4S sector now represents around 6% of the European VC-only market.

And Eurosif is confident that it will continue to grow significantly. Eurosif executive director Matt Christensen says: "We believe the market has enormous growth potential. Of course, as a new market, the sector is still small compared to the mainstream VC market. It didn't exist five years ago and a rise from 0% to 6% over that period shows incredible growth. Everything - political discourse, investors and companies - is pointing to VC4S and everyone should want to get involved in it legally as well as financially to reap up major rewards."

The study shows that VC4S investments tend to range from €1-5m and focus on the earlier phases of company development, which distinguishes them from mainstream VC. And a majority of VC4S investors surveyed still look for traditional VC returns of 20-30% from their sustainable investments.

Eurosif argues in the study that pension funds and foundations should direct more of their portfolio allocations to venture capital funds that take on sustainability as part of their mission. This approach would not only be consistent with the long-term orientation of pension funds and foundations but also enable market returns and contribute to sustainability factors.

Christensen says: "There is no reason why institutional investors shouldn't be investing as heavily in VC4S as they do in other sectors; they just lack awareness. The returns they get from investing in VC4S sectors are the same they get from traditional VC investments."

The reason why Europe lags the US with regards to the VC subset VC4S is because Europeans are already behind when it comes to VC inclusion in their portfolios, Christensen says. They are still just trying to allocate capital to private equity and venture capital. He adds that European pension fund systems have tended to be conservative, which has left them with large allocations in debt products.

These are safer but do not generate the same returns as allocations in equity, private equity, hedge funds or private venture capital, needed to deal with the growing demographic problem in European countries. He predicts major shifts in continental Europe and portfolios tilting towards equities including VC and VC4S over the next 20 years.

"To achieve better returns, pension funds need to look for equities because they have a better long-term growth potential," Christensen says. "Allocations to debt just beat inflation, while equities traditionally generate 7% or 8%, which is 5% above inflation. I believe huge growth in the VC4S sector lies ahead. To help the growth, institutional investors firstly need to realise that VC4S is an area that is going to make them money, while also helping the beneficiaries for the long-term management of the capital.

"It is already happening in the US and venture capital asset managers today enter the VC4S space because institutional asset owners such as CalPERS and the New York State pension funds are allocating pieces of their large portfolios to the sector. And I expect institutional investors, as allocators of capital, to enter this market in Europe too."

He notes: "We can help the growth politically and legislatively. The EU and different nation states are seeking incentives to grow the private sector and this is one of the areas they are looking at. They view it as a win-win situation because it helps bring in innovation as well as capital. So I expect a shift in the political-legislative as well as in the institutional mandate."

He says that the major lesson from the US is that it was further behind but is now further ahead of Europe after institutional asset owners on the other side of the Atlantic started to favour the VC4S sector.

In California, for example, one out of three dollars is going into clean tech investing due to governor Arnold Schwarzenegger's political engagement and because capital-rich state pension funds started going into VC4S, Christensen adds.