The Future of Investing in Environmental Markets

Author : Will Oulton Monday, July 27, 2009

The impact of climate change is set to alter the shape of the global economy over the coming years and as a result of this there is an expectation that the environmental technologies sector will benefit and grow, providing both attractive and long term investment opportunities for global investors.
It is important to note however that it is not only the renewable energy sector that will benefit from the changes required to deliver a low carbon economy. Companies emerging from sectors such as energy efficiency, water infrastructure and pollution and waste control also have important contributions to make in addressing not only climate change but the interrelated wider environmental threats facing society. Growth in this sector will in part be dependent on access to capital by companies emerging in all of these areas.
Additionally, it is necessary for the global economy including governments, to facilitate capital investment flows into the environmental markets 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.
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 U.S and China, whose pledges in this field have made it clear that addressing the impacts of climate change are critical to economic growth and prosperity despite current market conditions. Incentives derived from economic stimulus packages are expected to play an increasing role in this growth over the coming months and years; therefore global investors and their advisors should now be examining these investment opportunities as part of their asset allocation strategies.
Climate change and the birth of environmental markets
Although environmental technology businesses have existed for decades, it is in the last few years that they have begun to attract increased investor interest. In 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 to limit the effects of increasing the worlds “stock” of atmospheric greenhouse gases. 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 a larger role. All of this results in exciting opportunities for long term superior and sustainable returns for global 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). 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.
Investing in Environmental Technology
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 into these funds.
These opportunities 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 such as the FTSE ET50 Index have successfully provided index funds and ETF’s with low cost exposure to this exciting sector, whilst 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, 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 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.
As more and more 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. FTSE Group has developed a taxonomy for these emerging low carbon sectors and services that can be used by investors to accurately identify analyse and measure the performance of homogenous groups of environmental technology and service businesses. This new Environmental Markets Classification System is used to create the FTSE Environmental Opportunities Index Series, which includes both sector and regional breakdowns. 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 Markets Investment
As many of the drivers of environmental markets continue to catch political and public attention such as energy security and supply, water scarcity and disruptive weather patterns from a changing climate, the interest in those companies and sectors providing solutions to these issues will attract the interest of global investors. It will become increasingly clear that attractive returns may be achieved from the investment opportunities emerging from the leading companies in these sectors.
This increased investor interest will challenge 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. The challenge for the next decade, against a backdrop of recession and a contracting financial services sector is to continue to build on these many successes. Global investors will have a key role to play in decarbonising economies, rewarding companies that adopt sustainable and responsible business practices and creating a sustainable global financial market system, the latter being the biggest challenge of all.



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