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Investing in climate change

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20 November 2015

Jon Forster and Bruce Jenkyn-Jones look at what is making sectors in environmental markets so compelling for investors.

Jon Forster and Bruce Jenkyn-Jones, Managers of Impax Environmental Markets plc.

View the Impax Environmental Markets profile page

There is no doubt that we live in interesting times and the diverse set of high growth environmental markets in which Impax Environmental Markets (IEM plc) invests, namely energy, water, waste and sustainable food and agriculture, continue to expand rapidly.  We are currently seeing unprecedented investor interest in these markets.  So what is making these sectors so compelling for investors? 

The drivers of these markets are now well recognised.  They include an expanding global population, rising living standards across the developing world, a global infrastructure deficit, finite natural resources and pollution.  We expect that these trends, which will progressively drive the transition towards a more sustainable economy, will create opportunities for well-positioned companies.

While we do see continuing strong growth across all environmental and resource efficiency markets, it is the energy sector that, for several reasons, is front and centre of investors’ mind as we approach the end of 2015.

New disruptive technologies

The emergence of numerous clean energy technologies is accelerating and moving to mainstream unsubsidised markets as the cost continues to fall rapidly.  For example, global solar installations have skyrocketed as prices have dropped by more than 75% in recent years. Lithium ion batteries and LEDs are also developing and gaining wider adoption.  These cleaner and more energy efficient technologies are posing a real economic threat to the traditional energy sector and present many compelling investment opportunities.

UN climate talks

Meanwhile, climate change continues to dominate the media headlines as we await the outcome of the next round of UN global climate change talks (COP21) in Paris this December.  The objective of these negotiations is to achieve a legally binding and universal agreement on greenhouse gas emissions, from all nations.  A global carbon price is still a way off, but we will inevitably see governments implementing stricter emissions targets.  It is this additional regulation to reduce the world’s greenhouse gas emissions that poses a systemic climate risk to investment portfolios, but this potential regulation can create substantial opportunities for solution providers.

Stranded assets

The burning of fossil fuels is of course the main contributor to emissions so if we are to keep global warming to 2○C, which is the generally accepted maximum increase if we are to maintain a habitable planet, we may not be able to burn many of the reserves that are currently valued on the balance sheets of these companies.  These assets will stay in the ground - effectively stranded.  Companies with higher extraction costs are likely to see their valuations significantly eroded.

Source: Impax Asset Management

So what does this mean for investors? 

Many investors remain wary of “missing out” from the dividends from fossil fuel stocks.  But they should also think about capital preservation.  In spite of a relatively high level of dividend payments, such stocks can lose core value quickly; on average, the share prices of the stocks of leading coal companies have fallen 90% over three years. 

In contrast, there are approximately 200 stocks with an aggregate value of nearly $1 trillion operating in the energy efficiency sector.  This high tech, diverse sector is forecast to grow more rapidly than the economy.  By investing in energy efficiency across industrial, transport and buildings, investors can maintain their exposure to the energy sector, while benefitting from rising retail energy prices. 

How to access the opportunity

IEM plc has a current exposure of approximately 30% in energy efficiency and 16% in renewable and alternative energy and a further 25% exposure to adaptation opportunities.  With over 80% of underlying revenues exposed to environmental solutions providers, IEM provides one of the purest investment opportunities to access this global megatrend.