With environmental issues increasingly affecting investment decisions, Will Oulton looks at how investment in this area is set to grow in the coming years
As the world moves from a post war, industrialised age to that of a low carbon economy over the next few decades, the importance of environmental technologies and services will become increasingly apparent as the key to our future. At the same time it is necessary for the global economy, including governments, to take responsibility in creating suitable investment flow into the environmental arena. Today, we are already seeing the start of this evolutionary phase, with several governments across the globe, pledging high proportions of their economic stimulus packages towards environmental technology investment.
As the UK Chancellor Alistair Darling made clear during his delivery of the Budget this year: “Green technology will be one of the great growth sectors of the world economy over the next few years.” The focus on climate change and its implications in terms of assessing economic cost and investment portfolio risks are increasingly being highlighted by political and industry commentators across the globe. This includes two of the world’s most powerful economies; the US and China, whose pledges in this field have made it clear that the impact of climate change has been recognised as a long term play globally, despite current market conditions.
However, the investment opportunities available for institutional investors which are emerging from this transition to a low carbon economy have in comparison had relatively little attention. Incentives derived from economic stimulus packages are expected to play an increasing role in this growth over the coming months and years, however pension funds, their trustees and advisers should now be examining what synergies lie between these investment opportunities and that of the pensions funds’ strategy in order to gain from a long-term successful allocation in this investment segment.
Green technology will be one of the great growth sectors of the world economy over the next few years
Climate change and the birth of environmental markets
The effects of climate change are expected to transform the global economy over the next two decades and with this there is an increasing expectation that environmental markets, which include environmental technologies, will provide attractive and sustainable investment opportunities for global investors.
This growth will in part be dependent on access to capital by the companies emerging in the areas of renewable energy and energy services, water technologies and infrastructure, pollution control and waste management. In many of the economic stimulus packages being created by governments’ allocations of capital to renewable energy, energy efficiency and infrastructure form key parts. China for example, is devoting a third of its stimulus package to green measures. In addition, Sir Nicholas Stern’s report on the economic impacts of climate change, the former chief economist of the World Bank argued radical and rapid cuts in emissions were needed. Following his report, the G8 recently stated its call for a reduction in global emissions of 50% by 2050, which will require an 80% cut by developed countries.
In order to achieve the above, investment capital will be required to develop, scale up and bring down the cost of the key environmental technologies. In addition public policy derived market mechanisms such as carbon trading are likely to play an increasing role. All of this results in exciting opportunities for long-term superior and sustainable returns for investors.
There have been a number of initiatives, trade organisations and alliances formed in recent years, in order to develop thinking in this important area. These include the Carbon Disclosure Project, Institutional Investor Group on Climate Change and the UN Principles for Responsible Investment (UN PRI). All of these initiatives have been steadily increasing their influence within the global investment community.
More importantly, running parallel to such initiatives is the increasing attention from several niche funds, mainstream index providers and asset management companies looking to provide financial products, such as indices and ETFs. Such innovation not only ensures accessibility to the environmental technology market but also provides transparent benchmarks and a framework of reference for investors.
The snakes and ladders of environmental investment
A decade ago very few environmental technology investment opportunities were available other than those from a small number of pioneers specialising in this area, such as Impax Asset Management. Today, however, the scene is a very different story with institutional and retail investors having access to a wide range of environmental and climate change investment options, with many billions of dollars invested in these funds.
These opportunities, such as specialist funds by Impax, have become an important tool for investors in the early stages of environmental technology investment. Furthermore, industry players such as index providers have also entered the field to provide investors with much needed visibility to the performance of environmental markets, through both tradable and benchmark indices. Environmental indices have successfully provided index funds and ETFs with low cost exposure to this exciting sector, while also providing transparency of performance. In addition, such indices also play an important role in defining and classifying the environmental technology opportunity set.
Until now, such strategies within this investment theme have tended to focus on pure play technology companies (which derive the majority of their business from environmental technology) and have primarily been in the private equity, venture capital or small cap investment space. However, there has been little in the way of products and services which enable institutional investors to invest in the larger listed equities arena. Today, with industry innovation and investor demand, interest in this area is no longer limited to smaller cap pure play environmental technology companies. Exciting investment opportunities are now also emerging from larger companies who are adapting and transitioning their business models to exploit the path to a decarbonised economy. In addition investment tools, including indices, are an important part of this process, providing much needed visibility to the performance of environmental markets.
Today, there are a number of environmental technology indices available, of varying sophistication, taking a variety of approaches in defining environmental technology, covering different regions and with different investability requirements and methodologies. However, as interest has developed in this opportunity, a major hurdle has been how to identify or classify the activities of companies active in environmental markets, on a global scale. An important piece of work being undertaken at FTSE, is to develop a taxonomy for these emerging low carbon sectors and services, which can be used by investors to accurately identify, analyse and measure the performance of environmental technology and service businesses. This increased transparency of the performance of sectors will enhance the ability for institutional investors to implement climate change related investment strategies.
The future of environmental investment
As interest in environmental markets continues to develop, investors will seek sustainable and superior returns from these sectors. This means that further benchmark development is inevitable, challenging the industry and indeed index providers to develop a range of investment tools to reflect this growth and suit the needs of a variety of investment strategies. At the same time, global investors will have a key role to play in decarbonising economies, rewarding companies that adopt sustainable and responsible business practices and in the creation of a sustainable global financial market system.
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