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03/22/2010

Investment Opportunities for a Low Carbon World


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FTSEAs markets globally struggle with recession, a core part of the message from many political leaders to their citizens is that economic growth can be stimulated in part by investment in the technologies, infrastructure and services that will enable the transition to a low carbon economy.

There is no doubt that the first steps in the shift to a low carbon world are now underway. The implications of this for capital markets are immense and the opportunities that this shift is creating for investors are becoming increasingly clear. Although a number of companies and technologies in the low-carbon space are still in their infancy, there are many that may now be considered well managed, sustainable and mature businesses. By participating in public markets, these companies make themselves accessible both institutional and individual investment. Likewise, investors increasingly are seeking to invest in environmental technology companies that offer strong mid-long term growth, and whose products and services provide for a cleaner environment. 

Growth Drivers 

The growing concern over the potential severity of the impacts of climate change caused by man-made carbon emissions, and the regulatory initiatives to reduce emissions, are some of the key drivers of interest in environmental markets, but not the only ones. Energy security and supply, population growth, water scarcity, economic development, and ecosystem degradation are also contributing to the growth of these markets. These macro socio-political drivers are often intertwined and are unlikely to disappear anytime soon. For example, the world’s population is expected to reach 9 billion by 2050, creating an increase in the demand for food. As agriculture requires huge amounts of water, water scarcity will become an ever greater concern.

The potentially harmful consequences of carbon intensive economic development are also drivers of increasing climate change. As the rapid industrialization of BRIC (Brazil, Russia, India and China) countries continues for example, both demand for energy and the rate of depletion of finite natural resources increases. Increased energy demand leads to carbon intensive pollution, while depletion of natural resources affects ecosystems’ ability to sustain fresh water, absorb carbon, and provide a myriad of functions, from crop pollination to atmospheric regulation, that underpin human society and the global economy.

Policy Updates

While concerns about carbon, energy and natural resources drive interest, putting a cost on carbon is creating the opportunity for investment. In 2005, the European Union introduced an emissions trading scheme (EU ETS). The purpose of this system was to limit and then trade carbon dioxide emissions credits. Over the past five years, this market has been growing steadily. According to the European Climate Exchange, trading volume for the first half of 2009 has already surpassed 2008 totals. Similar initiatives have been proposed in Australia, Japan, New Zealand, Canada and the United States.

In the United States, President Obama has committed to make the U.S. a leader in combating climate change, stating that “the nation that leads the world in creating new sources of clean energy will be the nation that leads the 21st century global economy.” In June 2009, the Waxman-Markey American Clean Energy and Security Act passed through US congress by a narrow 219-212 margin and is now awaiting a Senate vote. Broadly, the bill aims to create clean energy jobs, achieve energy independence, reduce global warming pollution, and transition the US to a clean energy economy. Specifically, it seeks to establish new standards and targets for energy efficiency and renewable energy and would establish a cap-and-trade emissions system in the US. A second bill, the Clean Energy Jobs and American Power Act, also known as the Boxer-Kerry bill, was introduced in the Senate on September 30, 2009 and has been referred to committee. This bill aims to create clean energy jobs, promote energy independence and reduce pollution.

The United Nations is also backing a global “Green New Deal,” which it says could be a historical opportunity to rebuild economies debilitated by the credit crisis and target future investment for environmentally friendly markets. The program’s policy brief, commissioned by the United Nations Environment Programme (UNEP), asserts that $750 Billion in green stimulus packages (approximately 1% of current global GDP) would trigger significant economic returns. Achim Steiner, Executive Director of UNEP and a board member of the United Nations Principles for Responsible Investment, has said that the Green New Deal report prioritizes the support of key sectors that it believes will generate the biggest transition in terms of economic returns, environmental sustainability and job creation. According to the report, these include energy efficient buildings, renewable energy, sustainable transport, agriculture and freshwater. The success of this initiative stands to serve as a catalyst for future government and market-based investment into these areas.

Defining the Marketplace

From an investment perspective, it is important to note that there is a difference between investing in environmental markets and what is commonly considered to be “socially responsible investment” (SRI). Environmental markets are an emerging asset class and are not exclusively linked to ethical or socially responsible investment screening approaches, although they share some common characteristics. Many institutional investors are looking for investment opportunities in environmental markets in addition to allocations they may have for SRI. For example, the New York State Common Retirement Fund, one of the United States’ largest pension funds, recently announced that it would invest $200 million of assets in clean technology companies under the Fund’s Green Strategic Investment Program (GSIP). Incidentally, $100 million of this allocation is benchmarked to the FTSE Environmental Technology 50 index.

One of the greatest challenges to environmental market investment over the past few years has been the lack of definition of the investment opportunity and as a result, a poor understanding of its investment characteristics. A classification system was needed to enable investors globally to identify and measure the performance of these low carbon sectors. The FTSE Environmental Markets Classification System (EMCS) offers this by defining environmental market companies as those providing products and services that deliver solutions to environmental challenges and or provide increased efficiency in natural resource usage.

There are currently six sectors and twenty four subsectors in the EMCS classification structure, which facilitates the comparison of companies across sectors and subsectors as well as national boundaries. The sectors are:

  • Renewable & Alternative Energy
  • Energy Efficiency
  • Water Infrastructure & Technologies
  • Pollution Control
  • Waste Management & Technologies
  • Environmental Support Services

Measuring the Performance of Environmental Technology Companies

Environmental technology or “clean tech” companies require access to capital so that they can develop rapidly enough to meet the climate change and environmental resource challenges that society is currently facing. While this trend provides investors with ample opportunity, it also presents a problem because it is difficult to know which companies will ultimately be responsible for driving this change. The situation is reminiscent of the internet technology explosion experienced during the late 1990s – investors knew that the internet was a winning idea, and there were many companies experiencing rapid growth, but what separated the winners from those who would ultimately fail was almost impossible to predict.

Indexes offer the most efficient and accurate method to measure the performance of any market as a whole. By benchmarking to an environmental market index, investors are able to mitigate risk by capturing the performance of the broad environmental marketplace rather than selecting individual companies in which to invest. Indexes also capture some of the largest publicly traded companies in the clean tech industry, many of which have more distinct performance records than their younger, privately-held counterparts.

The FTSE Environmental Technology and the FTSE Environmental Opportunities Index Series track the performance of companies globally whose core business is the development and deployment of alternative energy, water treatment, pollution control and waste management. The former tracks pure-play environmental technology companies globally that derive more than 50 percent of business from environmental technologies. The later represents a broader investment universe of companies globally that derive at least 20 percent of their business from environmental technologies. These are further broken down by size, geography and sector.

By the Numbers

Data as of the close of Q3 2009 shows that over the past five years, both the FTSE Environmental Technology 50 index of pure-play environmental technology companies and the and the FTSE Environmental Opportunities All Share index have significantly outperformed global equity markets due to strong growth rates as governments and markets have responded to global environmental challenges. These indexes returned 67.9% and 65.4% respectively over this time period, compared to 34.1% and 28.6% for the FTSE Global Small Cap and FTSE Global All Share indexes.

Since the global downturn in 2008, environmental markets have generally performed in line with broader global equity markets. In the equity market rally over the course of 2009, this has been the case, particularly for the FTSE Environmental Opportunities All Share, which has almost mirrored the performance of the FTSE Global All Cap Index.

Looking Forward

While the state of the global economy remains a concern to companies, investors, and policy makers, environmental challenges remain high on the legislative agenda, creating further opportunities for environmental companies to outperform. Sir Nicholas Stern, former Chief Economist at the World Bank has said that “climate change is the greatest and widest-ranging market failure ever seen.” As if in solidarity with this statement, a high proportion of economic stimulus packages put in place by governments following this year’s global economic crisis have now been dedicated to advancing the “green” economy. In fact, an estimated $350 billion has been allocated globally to these areas – particularly Energy Efficiency and Renewable Energy. Ban Ki-moon, the UN General Secretary underlined the importance of these efforts recently when he said that “managing the global financial crisis requires massive global stimulus. A big part of that spending should be an investment in a green future. An investment that fights climate change, creates millions of green jobs and spurs green growth.”

The transition to a low carbon global economic system is critical to help to tackle the damaging effects of climate change. In making this transition, there will be opportunities for governments, the private sector and investors to profit economically and financially from these changes. The growing public awareness of climate change, increasing political support, new infrastructure to support environmental technologies and services, and investment capital will all play important roles in the transition to a global low carbon economy.

--Will Oulton, Director, Responsible Investment, FTSE Group 

About Will Oulton

Will Oulton is the director of responsible investment at FTSE Group. He is a leading figure in the global sustainable and responsible investment industry and sits on the board of the European Sustainable Investment Forum. He has recently led the development of the award winning FTSE Environmental Markets Index Series. He is also responsible for FTSE’s responsible investment benchmark, the FTSE4Good Series. Oulton edited the recently released book Investment Opportunities for a Low Carbon World, published by GMB Publishing Ltd of London and Philadelphia.

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