The future is green

"Despite the onset of the economic downturn the case for investing in low carbon technologies and business models remain compelling" Sir Nicholas Stern - World Future Energy Summit Abu Dhabi 19/01/2009

This month Sir Nicholas Stern, of the eponymous Stern Report on Global Warming, reiterated that the fundamental reasons to invest in climate change have not altered despite the impact of the credit crunch.

Mark Hoskin, partner at wealth manager Holden & Partners, and one of the judges of the Climate Change Investment Awards, says: "Before [the crunch] P/E ratios where running away, often at 25 to 30 times, whereas now they are back at normal levels of 10, 11 or 12, which makes now a very good buying opportunity for those people with the nerve to get into this area."

Mark Fulton, global head of climate change investment at Deutsche Asset Management agrees: "Given the stretched valuations late last year in solar and to some extent wind, the public-private equity climate change universe has given back about 40% of the outperformance it built up in 2006-07."

Deutsche's sister company, DWS Investments, was named Fund Management Group of the Year in the Awards, while Impax Asset Management picked up the award for Innovation of the Year.

Ian Simm, chief executive at Impax Asset Management, says; "This is a sector that is quite heavily exposed to one of the most likely areas of early resurgence when the market does turn. And that is because the fiscal stimulus will be bias toward infrastructure spending, and in particular, clean infrastructure."

This last point highlights two of the three key factors that influence the development of this market which has moved climate change into a distinct asset class rather than being lumped in with ethical investment in general.

The first key factor is the very real need to address climate change. There are still sceptics and those dragging their feet, but heightened awareness of the issue and public opinion, has forced governments to take action.

A recent survey conducted by the HSBC Climate Partnership revealed that 43% of people chose climate change ahead of the global economy when asked about their current concerns, despite the turmoil in the financial markets taking place.

The second factor is the introduction of new legislation and initiatives in response by governments and the international community. These initiatives are unlikely to go way no matter what happens with the rest of the world economy.

In May the World Business Summit on Climate Change will convene in Copenhagen and the UN Convention on Climate Change is scheduled for December 2009. Both of these are expected to introduce new emissions targets.

Here in the UK the Government has recently passed three critical pieces of climate change and energy legislation: the Climate Change Bill; the Planning Bill; and the Energy Bill.

Fulton says this will make the UK the first country in the world to legally bind itself to cutting greenhouse gases; world-class pieces of legislation that will impact on the growth of renewable energy and be instrumental in the removal of barriers to investment in green infrastructure.

Thirdly, most of the developments made in this field to address climate change are tangible products such as equipment and clean infrastructure. These are in contrast to the virtual ones created in the tech boom.

Hoskin says this shows climate change investment is not a fad or investment bubble, because the fundamental drivers behind its existence are human development.

In addition, the products, services and technologies, that are derived from climate change, are very varied, and the size of companies ranges from small specialist outfits all over the world to multinationals.

Furthermore, it is important to note that this is not a single-solution sector. There are 19 sub-sectors recognised by the FTSE, which may often have a low correlation to each other.

For example, water treatment has virtually nothing to do with recycling and energy efficiency, these are totally different markets. And the sector also includes agriculture, forestry, green transport solutions and low carbon technology.

Emma Howard Boyd, head of Jupiter Asset Management's socially responsible investment business, says investors are responding to climate change in two different ways.

Funds that focus on specific companies providing solutions; these require a degree of expertise, understanding and take look at the business backdrop in addition to technological advances.

The other approach is in understanding the risks posed by climate change to companies that may not provide an environmental product, but need to be 'greening up' their operations.

"That is where you see a broader investment group, and entails an understanding of how carbon pricing and carbon neutral legislation will impact upon performance and the baseline," she adds. Jupiter's Ecology fund was jointly named fund of the year in the awards with Allianz RCM Global EcoTrends fund.

Some companies and funds operating in this sector have been around for up to 20 years now, and the industry is quick to dispel any talk of this still being an 'alternative' area of investment.

Hoskin says: "This is the danger when you talk green, but this area will be the mainstream in 15 years. It is just a question of which companies take advantage of it and which investors. Microsoft was a small company in the 1970s and it is now one of the biggest in the world."

Boyd also thinks the sector will become more mainstream and expects to see big changes in the coming year following the World Business Summit in Copenhagen and the election of a new US president.

"Copenhagen will clarify how quickly this whole area will move and Obama is going to focus on global agreements etc," she adds.

Simm says he is cautiously optimistic for 2009 but also expects positive news in the wake of world legislation and Obama's stimulus package, which includes a green component of US$15bn p/a and up to a US$150bn p/a raised from the sale of carbon trading permits.

In November, the UK became the first country in the world to auction its carbon permits. "That has really set the tone for the world. It is really positive and quite an easy initiative because it does not involve building any infrastructure etc," comments Hoskin.

In addition, the range of investors reflects the advantages the sector has on offer, and underscore this as anything but a niche or alternative investment.

Simm says funds have seen investment from increasingly mainstream institutions. "There was a lot of retail money in 2006 and 2007 but we suspect some of that money is being pulled out now.

"Institutions by and large have stayed the course and there seems to have been almost no impact from redemptions, and that is reflective of a pretty sophisticated institutional market where they do actually see the area outperforming quite dramatically in the mid to long term," he adds.

Boyd says interest in climate change funds is coming from right across the board, particularly from those with a long-term focus, and in particular, more from pension trustees who take a longer-term viewpoint. These trustees know they need to look at the potential from climate change perspective and understand how they can increase exposure to it in their underlying portfolios.

"Climate change is becoming an investment theme in itself and might now constitute a relatively small asset location of between 5-15% of a pension fund portfolio," she adds.

Simm concludes: "This is not a new asset class but it is a way for institutions to get some diversification and also, in particular, growth."

The ethical sector grew out of religious movements such as the Quakers and Methodists, who didn't want their members profiting from the slave trade or the exploitation of workers. For much of the 20th century ethical investing was confined to the church and charities, avoiding investments in arms, alcohol and gambling.

The sector began to take off in the 1980s. Friends Provident launched the UK's first ethically screened unit trust, Stewardship, in 1984. By 1989, the sector had around £199m in pooled funds (source: EIRIS). A decade later that figure had grown to £2.45bn, with around 170 pooled funds across Europe. The investment approach grew more sophisticated. It moved on from the 'dark green' strategy, which promoted the exclusion of certain 'unethical' sectors, such as alcohol, tobacco or arms, towards a 'light green' strategy of engaging with companies to help them improve their ethical footprint.

The companies that make up the natural hunting ground for ethical investors also grew more sophisticated. For many years, these tended to be small, unprofitable companies, but as regulatory impetus grew and other drivers - such as the high oil price - prompted a search for alternative energy sources, these companies became larger and more profitable. More companies moved into the sector, providing investors with greater choice.

As companies began to recognise the business and reputation risk in ethical issues, corporate governance, environmental footprint and disclosure have improved, expanding the universe of stocks for 'light green' funds.

The 'dark green' stock universe has not expanded as rapidly. Audrey Ryan, manager of the Aegon Ethical Equity fund, says she can invest in around 35% of the FTSE All-Share and this is little-changed during her 10-year tenure on the fund. Some banks have come into the investable universe having signed up to the Equator Principles, which set out a benchmark for the financial services industry to manage social and environmental issues in project financing.

Recent launches in the sector have been eclectic and have ostensibly been led on investment grounds, with ethical principles a benign side-effect. Many have been sector-specific funds such as water, renewable energy or climate change.

The New Earth Solutions Recycling fund is typical of the way ethical and investment drivers are being combined. David Connor, director of Premier Group (which helps market the fund), says: "This fund aims to help solve Britain's waste problems. It also has a low correlation to equity markets and is underpinned by contracts with local authorities, which are almost as secure as gilt income."

Exchange-traded fund providers have also entered the socially responsible market: BGI has its iShares KLD 400 Social Index fund. BBVA has just received a licence to use the FTSE4Good IBEX index as the basis of an ETF to be listed on the Spanish Stock Exchange. Invesco has a Wind ETF. Shari'ah-compliant funds have also been a source of new launches in the SRI sector.

Also, ethical funds are increasingly becoming distinct from green funds. For example, the Neptune Green Planet fund invests solely in green technologies and environmentally friendly solutions. Other 'ethical' funds may also look at green issues, but this is likely to make up a relatively small part of the portfolio. The result of this divergence is that some 'green' or climate-change focused funds will invest in sectors that ethical funds would never touch, such as nuclear energy.

George Latham, head of sustainable and responsible investment at Henderson Global Investors, says the group follows 10 themes, five of which are environmental, and five of which are social. He says: "Alternative energy is between 6% and 16% of our portfolios. Last year, some valuations got too high and we cut our weighting. We see increasing energy efficiency and reducing carbon emissions as just as important, and these also form a significant proportion of the fund.

"Waste management and environmental services are other important themes and would include insulation and automation companies. These tend to be more mature companies."

Looking forward, Mark Mansley, director at ethical IFA Rathbone Greenbank, says the high oil price is providing support for alternative energy sources. He adds: "Wind energy is now competitive with oil and the strong oil price continues to give a fillip to renewable energy sources."

A look at the shortlist of groups and funds in the awards shows the diversity of investment opportunities but also the appetite of investors outside the UK who have committed a significant volume of assets to the sector.

The future is green, but the UK has a lot of catching up to do.

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