Panning for environmental wealth

The range of possibilities in responsible investment has grown tremendously in the past decade, and there are now funds to cover most issues. According to EIRIS, a not-for-profit provider of research into the responsible investment sector, the amount invested in these retail funds has doubled since 2005, standing at about £9.5bn at the end of 2009 – and that is in UK-domiciled funds alone. In France, socially responsible investment now totals €63.8bn as of December 2010 (Source: Novethic)

One relative newcomer to the party is climate change: funds that invest in companies which respond to the challenges of global warming with sustainable products or services suitable for a lower carbon world. Unlike some of the old-style ethical funds, it’s a positive rather than a negative play – choosing companies that are, for example, proactively reducing emissions rather than screening out companies involved in activities such as tobacco for example – but even so, there are plenty of questions to be asked, according to Carlos Joly, chairman of the Climate Change Scientific Committee that enlightens Natixis Asset Management (Natixis AM) on climate change and its impacts.

He cites cement as an example of the complexities that lie behind responsible investment decisions. Cement is generally seen as having a poor environmental image but, Mr Joly says: “Cement is a key ingredient in building sea and flood defences that are needed to adapt to the impact of climate change and is needed for housing and infrastructure in the developing world.

“So we need to ask the question, what is an acceptable cement company? We want to find those companies that are producing cement in an energy efficient way, with less CO2 produced per tonne of cement.”

Not every climate change fund asks the same questions – or comes up with the same answers. In this distinctly grey area, there can be fundamental disagreement even among scientific, let alone investment, experts. Mr Joly says that Natixis AM, for instance, invests in water utilities for good drinking water to the whole population, while avoiding plastic-bottled water for high end consumption.

But it is in such judgment calls and with specialized knowledge that financial outperformance can flourish. Mr Joly, who co-chaired the panel of experts that drew up the UN Principles for Responsible Investment, has long been involved in making ticklish environmental judgements. He was brought in by Natixis AM when it launched its first climate change fund in October 2009 – Impact Funds Climate Change, a fund that invests under three macro-themes: the mitigation or reduction of greenhouse gas emissions, adaptation to the inevitable consequences of climate change, and better management of natural resources.

“Our core belief is that climate change does not seem to be priced into equity markets,” says Sam Richmond-Brown, equity specialist at Natixis AM. “This is a very extensive approach to climate change – we don’t put any relative constraints on the portfolio around sectors or countries.”

The fund selects from a global universe of stocks, but the selection starts with the Climate Change Scientific Committee’s expert research; Joly is backed by six experts in fields ranging from energy efficiency to international environmental law. The committee has no involvement in stock selection, but is there to help analyse the consequences of climate change, providing the kind of in-depth understanding that is needed to tease out the nuances of global warming.

“It’s a very pragmatic approach to gaining top down insight,” says Mr Richmond-Brown. “It’s forward looking and thought provoking.”

The committee meets twice a year to exchange ideas with the management team, while maintaining an ongoing dialogue in between, and not only proffers analysis at the start of the process, but independent and rigorous corporate review once stocks have been selected.

“We review the names for congruence and consistency with our investment themes, and make it known if they do not fit,” says

Mr Joly. “It’s very additive to the process – it’s a partnership between the committee and the management team.”

The three macro-themes are further split to produce a series of sub-themes; so, for instance, the better management of natural resources breaks down in water, soil and waste management.

Companies that fit the criteria include Mosaic, a US company producing fertilizer, and Shanks, a UK listed company that aims to increase recycling of waste. Under the mitigation of climate change heading, fund managers will consider the theme of transport efficiency – anything to do with mass transit, from city trams to more energy efficient ocean freighters. Railroads and rail equipment makers are part of the universe because they are a more energy efficient way of moving goods and people.

The approach has proved successful, but Natixis AM has identified a further refinement and launched a climate change fund focusing on emerging market economies rather than the whole world.

“A frequent mistake made by investors is that the multinationals in mature markets capture the full extent of the growth and opportunities available, and this is just not true,” says Mr Joly. “You have to invest in local emerging capital markets, where there is less government and private sector debt. Performance in emerging markets beats the US, Europe and Japan, and we expect this to continue for the next decade.”

Natixis AM believes there is a misconception that countries such as China or Brazil are not cognisant of environmental risk; but rather, they are making considerable strides towards a low carbon world. China, for example, is fast becoming a world leader in solar technology and wind energy. In Brazil, there is vast growth in new plantation forests, with areas of dry savannah being planted by pulp and paper companies.

“We see very strong investment opportunities in a number of emerging markets, not solely the BRICs,” says Mr Richmond-Brown. “For experienced investors who are able to understand the risks, climate change plus the growth of emerging markets is a winning investment combination”

Again, though, it is all about doing your homework through dedicated and intensive research that is the difference between success and failure. Climate change poses threats to growth, and the balancing act requires the participation of government as well as the corporate world.

Whilst some areas may do well, others will not; in the year ending 30 September 2010, clean energy funds all underperformed the MSCI index, while agriculture and forestry funds showed impressive returns, according to a 2010 Guide to Climate Change and Ethical investing from financial advisers Holden & Partners.

But then, this is exactly where opportunities for investors arise – companies that can take the lead now are the multinationals of the future, albeit Natixis AM skews the fund towards small and medium-cap companies for the present.

Whether you fully grasp the science behind global warming or are the most diehard sceptic, there are investment opportunities in saving the planet. But it’s not everyone that can winkle it out.

What’s wrong with an index?

Neither of Natixis AM’s two climate change funds uses an index as a benchmark – though the MSCI World index could be used as a performance reference for the global fund, and the MSCI Emerging Markets index for the emerging markets fund.

“We don’t follow a tracking error constraint because that would make absolutely no sense,” says Sam Richmond-Brown, equity specialist at Natixis AM. “We’re looking to generate performance in two fundamental trends [the growth of emerging economies, and the impact of climate change] and find the best investment ideas at the intersection – at the end of the day what investors want is consistent outperformance over time.

“The indices are lagging the market, so it’s like driving by looking in a rear-view mirror. Traditional, capital-weighted indices are not relevant; what we see are clients and investors wanting a more representative approach to opportunities within a specific investment universe. We want to capture those opportunities, but without the need to be shackled to the market on the way down.”

Our in-house climate change investment universes have around 15 per cent overlap with traditional indices on a market cap weighted basis

“This is not a portfolio that is sensitive to a benchmark,” argues Mr Richmond-Brown. “But this is a sustainable forward looking approach to managing money, in which we expect to see growing interest.”

Award winner*

Impact Funds Climate Change received the special “Innovation” jury prize at the L’Agefi Actifs du Patrimoine 2010 awards (“L’Agefi Actifs” is the only weekly French magazine for Third Party Distributors, Private Wealth Managers, Independent financial advisors), and the 1st Prize at the Funds Europe Awards 2010 in the “Business – European Fund Launch of the Year” category for its innovative and original characteristics.

*References to a ranking, prize, or grading for a UCITS are not an indication of its future performance.