Looking at climate change from a broader perspective

One drawback with renewable energy funds is the sector´s relatively small universe of eligible investment opportunities. Of the 600 SRI funds available, around 100 can be categorised as thematic or climate change funds. Those that understand that climate change involves a number of issues beyond renewables can access a much wider opportunity set across a range of industries. Eligibility is more broadly based on whether companies are taking steps not only to mitigate carbon emissions but also to provide solution to the impact of climate change—adaptation solutions.

For some funds, the definitions are so wide that they include companies that incorporate the impact of extreme weather conditions into their business models, opening up opportunities in everything from consumer goods companies to insurance companies that are modifying their products to deal with environmental change.

Funds with a broad brief can select from 30 or more sub-sectors, giving a broader diversification than traditional alternative energy and sustainability portfolios.

“Climate Change has not really been factored into the market and this provides interesting opportunities across a range of industries and sectors,” says Carlos Joly, who heads the Climate Change Scientific Committee for Natixis Asset Management.

“Society at large recognises the impact of extreme weather events, but it has been priced into only a narrow segment of the economy, largely only the alternative energy sector, such as solar companies and wind turbine companies. The problem with these sectors is there are relatively few publicly-listed names, and as a consequence these are either priced at high multiples which results in a bubble phenomenon, or they get bombed out when the bubble bursts.”

“The approach we’ve taken at Natixis Asset Management is to look at climate change from a broader perspective,” he explains. “We look conceptually at three issues, based on three forms of response to climate change. These are mitigation, which is anything to do with reducing greenhouse gases; adaptation, how we can adapt to the increasing frequency of extreme weather conditions such as floods and droughts for instance; and better management of natural resources, such as looking after soil and water.”

This latter approach opens up a fund to investing in consumer goods companies which have a conscious policy of producing products that make a contribution to reducing carbon footprint.

An example is packaged household goods, which have a strong R&D pipeline. Consumer goods companies are increasingly involved in conscious policy of producing products that make a contribution to reducing carbon footprint. The most engaged companies into climate change issues, have put a lot of research into coming up with ways to wash clothes at lower temperatures, which results in an enormous energy saving and reduced costs for households. Some of them are also involved in the substitution of palm oil from new plantations using a different species of plants, so reducing deforestation in Asia.

Another example is the rail transportation sector, which is benefiting from public policies to incentivise rail transport for passengers, crops and raw materials.

About one third of the stimulus efforts made by the US, UK, European, Chinese and Brazilian governments to rekindle their economies will be spent on the greening of the economy, including mass transit. This will open up opportunities in locomotives and other equipment, while at the same time improving energy efficiency.

Suzanne Senellart, the portfolio manager of Impact Funds Climate Change at Natixis Asset Management, also highlights the rail sector, explaining how it offers better prices and improved carbon footprint than transportation by road, while the presence of public funds is not the only way governments are influencing the SRI sector.

“One of the advantages is that change and developments are often driven by regulation and government incentives,” says Suzanne Senellart. “For example in the lighting business, the progressive switch is becoming mandatory, from 2012 in the European Union and for Chinese public sector. We will all have to change existing lighting progressively – there is no choice in medium-term. From the automotive industry prospective, people will start to shift to electric cars, with a direct subsidy to the consumer, this new policy encourages the car producers to new-energy car research in China and in Europeans countries. “

Consultants say the efficiency gains made by improving sustainability are underestimated. Climate change factors can influence a business’ reputation, costs, revenue, profitability and competitive positioning.

For the vast majority of industry types, research depicts an actual cost benefit to a business for improving its efficiency in terms of reducing greenhouse gas emissions.

This is something that corporate executives, on one level at least, understand and appreciate. Climate change factors provide strong reasons for superior investment performance precisely because the process behind selecting these companies is based on finding long term trends in society and its attitudes to the environment.

There is a question mark over how many companies actively seek opportunities to invest in sustainability or embed it in their business practices.

Mr Joly says many industrials are ahead of the game, but that the financial world as a whole is only at the very beginning of a period where understanding will grow.

“There is more understanding on the industrial side but not in financial markets which lag behind,” he says.

“For all of the creativity the financial markets have, it is directed in the wrong areas. Large parts of the market are very conservative and that goes against being able to implement forward-looking policies. The impact on earnings and growth in companies is here now and it will increase over the next three years.

Leading the way in the take up of climate change funds are public pension schemes and wealth funds with long horizons, while high net worth clients are also quite proactive, particularly on the private equity side.

There is a belief among leading fund players that the broader thematic funds are well suited to high net worth clients. For man institutional investors, broader thematic funds can be strange animals because they are not sure exactly where to put them in their portfolios. They do not appear to sit naturally in any one geography or sector. Private clients, however, do not have these constraints.

This also makes their performance hard to evaluate. Comparing funds can be difficult because fund houses must evaluate companies making the wind turbines and solar panels alongside companies with credible policies to reduce their own emissions. On the whole, thematic and environmental funds outperform mainstream indices but there is certainly a wide disparity between the best and worst funds in this sector. Over one year, the top performers are up by around 30 per cent, while the laggards have plummeted by 15 per cent.

The broader global climate funds are not as volatile as the more specialised single sector funds. The global bias to most broad climate funds increases the opportunity set and allows managers the freedom to switch between markets.

Most have substantial holdings in emerging markets as developing nations gear up to actively promoting green, clean industries in the knowledge they need renewables to secure the sustainability of their growth. China for example is starting to promote electric cars with a direct subsidy to the consumer. This new policy should encourage car producers to conduct more research into this sector.

The Natixis Asset Management fund is 19 per cent invested in emerging economies with room to manoeuvre to 25 per cent. “ The fund is also invested up to 22 per cent in the North American markets,” says Suzanne Senellart (as of 05/31/2010). “These make for a very different story.” There Natixis Asset Management is focused on large and medium caps technology leaders, for example video conferencing, and instrumentation to capture resources such as water and electricity meters and smart reader companies.

Many of the funds also have a general bias to smaller capitalisations, which can present challenges in liquidity and the disclosure of information, but can offer greater appreciation prospects. Around 500 companies qualify for the Impact Funds Climate Change universe, and their average capitalisation is less than $10bn, half that of the MSCI World Index at $20bn.

In recent months, demand for SRI funds has remained flat, partly because the Copenhagen meeting last December produced little concrete progress. However coverage of the BP spill has put environmental issues back in the headlines.