This year’s growth selloff has clobbered Impax Environmental Markets (IEM ) but fund managers Jon Forster and Fotis Chatzimichalakis believe the cause of sustainable, green investment is set for a rebound as Europe races to cut its energy dependency on Russia and the world deals with crises in biodiversity and food shortages.
Half-year results this week showed the 60-stock portfolio suffered a 17% fall in the value of its investments in the six months to 30 June. The shares did even worse, slumping 27% as investors shunned the growth stocks and smaller and medium-sized companies the managers favour in sectors delivering clean and efficient use of the world’s finite resources.
Having stood at a 15% premium over net asset value at the end of last year, IEM, at £1.2bn the biggest and best of a small band of environmental equity investment trusts, de-rated to a 3% discount below NAV by the end of June as investors switched to ‘value’ stocks in financials and energy which the closed-end fund does not hold.
Forster and Chatzimichalakis, who replaced co-manager Bruce Jenkyn-Jones in April after his promotion to chief investment officer at Impax Asset Management (IPX), also blamed a cooling in investors’ enthusiasm for environmental investing.
‘Greenwashing’ needs action
The fund managers said investors were disenchanted by the sudden poor performance in previously highly-rated growth stocks, whose valuations were slashed in response to rising interest rates.
They also took aim at the problem of ‘greenwashing’ where rival fund managers have overstated the environmental, social and governance (ESG) credentials of their funds.
‘This is a real concern for an emerging sector such as ours. Definitions of ESG and sustainable finance are fluid. The popularity of the theme over the last few years has encouraged many to jump onto the bandwagon of ESG. It is a concern drawing regulatory scrutiny, with the US Securities and Exchange Commission proposing to follow the EU with rules on ESG fund labelling. We welcome the increased scrutiny being applied,’ said Forster and Chatzimichalakis.
Fortunately, Impax has been managing sustainable investments for 20 years and the trust’s longer-term record remains intact, despite this year’s setback.
After an 8% rally in the past month, underlying five-year investment returns total 77.1%, beating the MSCI World’s 63.7% and rivals £43m Jupiter Green (JGC ) and £81m Menhaden Resource Efficiency (MHN ), which have increased net asset value (NAV) by a total of 38.7% and 63.4% respectively.
While the half-year period saw the trust underperform the 11% decline in the MSCI All Country World index, it did better than the specialist FTSE Environmental Technology 100 benchmark which tumbled 20.6%.
There was also good news on the dividend with a first-half payment of 1.5p per share up 15% from a year ago.
The managers explained their decision to avoid several over-valued tech stocks, such as electric car pioneer Tesla (TSLA.O), as well as hyped early‑stage companies that floated last year but ‘dramatically underperformed’, helping it beat the environmental index.
However, they acknowledged they could have done more to reduce their exposure to hot areas of the market.
‘We would admit in retrospect that we could have been more aggressive in reducing expensive growth holdings, even though these remain conviction holdings for the long term,’ Forster (pictured above) and Chatzimichalakis said.
With the portfolio’s companies back at their long-term averages, valued at 18 times next year’s forecast earnings compared to a heady multiple of nearly 25 times in December, the fund managers felt optimistic.
Consensus earnings forecasts showed their companies were growing faster than the market after recently reporting mostly solid results. Consequently, the managers said they were looking to add to their holdings in companies that had de-rated this year.
These included ‘quality growth’ stocks such as Spirax (SPX), the UK manufacturer of steam management systems; Nibe (STO: NIBE-B), the Swedish heat pumps maker; and Generac (GNRC.N), the US power storage group.
They were also encouraged by signs of a return of mergers and acquisitions after US data centre Switch was bought for $11n by private equity bidders paying a 15% premium to the share price to gain control.
The duo also looked forward to further advances in renewable energy companies Terna Energy (FRA: 44T) of France and Northland Power (TSE: NPI) of Canada whose shares were bright spots in the portfolio after Russia’s invasion of Ukraine dramatically revealed Europe’s reliance on Russian power.
‘European dependence on Russian gas has likewise reawakened energy security concerns, which should accelerate the net zero transition. We believe this bodes well for the long‑term growth and performance of IEM,’ the pair said.
In particular, they cited the European Commission’s ‘ambitious’ REPowerEU plan in May, which sets out how it proposes to switch to other suppliers of oil and gas and hasten plans to decarbonise its economy, providing a plethora of opportunities for environmental investors.
The Commission increased the 2030 target for renewables to 45% from the current 40%, including via mandating solar panels on all new buildings and addressing bottlenecks in permitting of renewable energy projects.
The plan also proposes doubling the rate of heat pump deployment to reduce gas use and promoting domestic biomethane and renewable hydrogen production, as well as increasing its binding energy efficiency target to 13% from 9%.
The measures, which have been approved by the European Parliament and member state governments, will require additional investment of €210bn (£175.5bn) by 2027, compared to the €100bn per year the EU is currently spending on Russian fossil fuel imports.
The plans were not perfect, but laid the foundation for more work, the managers said. ‘The response from energy efficiency stocks was more muted. We believe that the Commission could have gone further with its energy efficiency goals, and we expect subsequent action in this area to support that sub-sector,’ they said.
Hunger and extinction
Another silver lining from the appalling war in Ukraine is the pressing issue of food security. With tens of millions of people at risk of starving across the world from the disruption to supplies of wheat, sunflower seed oil and corn from Ukraine and Russia, the Impax managers said the emergency underlined the importance of sustainable agriculture and food production.
The trust holds several companies in this space. In the US, Darling Ingredients (DAR.N) is converting food waste into animal feed that can replace corn, and Trimble (TRMB.O) is providing global positioning software to help farmers target pesticides where they are needed and thus reduce their use; while in the Netherlands Corbion (AMS: CRBN) was cutting food waste with preservatives extending the shelf life of bakery products.
Separately, with one million of the world’s eight million plant and animal species threatened with extinction, biodiversity was emerging as a challenge as big as climate change. ‘As well as an ecological disaster, the loss of biodiversity will have profound economic impacts,’ the managers said, pointing to businesses’ engagement with talks for a new UN convention.
‘We see opportunities for investments that are contributing to solutions and biodiversity is systematically included in our investment framework as an environmental problem that needs to be addressed,’ Forster and Chatzimichalakis said,
IEM ‘only option’
Mick Gilligan of wealth manager Killik was impressed: ‘IEM traded at a 15% premium to NAV as recently as last December. It is entirely conceivable that it could see these levels again. IEM is the only viable environmental option for investment trust investors that wish to regularly allocate capital to a diversified equity portfolio in this area.’
He added: ‘Jupiter Green and Menhaden Resource Efficiency are both too small and illiquid for most but have scope to grow if they can deal with their discounts, get back to a premium rating and then issue more equity.’
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