The road ahead looks very different from that in the rear-view mirror. The global population is rising, as are standards of living, particularly in developing economies. As these standards rise, so does demand for animal-based, protein-rich diets, which require lots more feed grain to produce. Once abundant natural resources, such as clean water, are becoming scarcer. Aging infrastructure is threatened by both rising demand and long-term underfunding of repairs and upgrades. Pollution has become a systemic challenge to economic growth, as well as being a major threat to public health. Solving pollution challenges requires extensive and expensive measures, particularly in Asia. Perhaps most challenging of all, a warming climate is resulting in unpredictable and increasingly extreme weather patterns and potentially disastrous geophysical consequences in the decades ahead.
Recognition of these global challenges is leading to a significant change in sentiment. Governments, businesses and investors have made commitments to reduce their environmental impact, and the transition towards a more sustainable global economy is underway. These trends will profoundly shape global markets, creating both risks and opportunities for investors. Innovative companies providing solutions to address environmental risks and opportunities are well positioned to benefit from this transition.
Impax, subadviser to the Pax Global Environmental Markets Fund, has been investing in environmental markets for 20 years and, in collaboration with the leading index provider FTSE, developed and continues to evolve the classification system that underpins the FTSE Environmental Markets Index series. We classify these as follows:
Higher growth in a low growth world
With the rising demand for environmental solutions, companies active in these markets have generally delivered higher growth in earnings than broader global equity markets. Given the powerful and rising macroeconomic drivers mentioned above, this trend looks set to continue for many decades.
Diversifying risks and opportunities
Investments in environmental markets can enhance portfolio diversification by providing exposure to innovative, high-growth companies that tend to be under-represented in broader market portfolios. These are often smaller high-tech companies that are not widely understood and often relatively under-researched by investment analysts. Exposure to these markets can also help to reduce carbon risk in portfolios, as these are the companies that will benefit if/when carbon taxes are imposed (e.g., energy efficiency) while avoiding sectors that will be most negatively affected (e.g., fossil fuels).
Future proofing portfolios
Investing in environmental markets is investing for the long-term transition to a more sustainable economy. Within the U.S., state and local politicians, universities, and business leaders, have pledged to reduce their carbon emissions. India, China and Europe have also reiterated their pledges to tackling climate change. India is investing billions of dollars into infrastructure development and tightening pollution regulations, while China’s current five-year plan, the 13th, has a strong focus on addressing environmental issues. It details plans for investing in clean water projects, a migration from coal to natural gas and a commitment to a major increase in the proportion of the country’s electricity produced from renewable sources (solar, wind and hydro). It is also promoting electric vehicles as part of its pledge to reduce air pollution.
Making a positive impact
Our primary objective is to deliver superior long-term, risk-adjusted returns. However, we have developed a sophisticated method, assured by EY, a leading sustainability consultant, in order to measure the positive environmental impact of an investment in the Fund. For example, in 2017, the Pax Global Environmental Markets Fund made the following impact per $10m invested:
1US Tons. MWh stands for megawatt hour. Impact of $10m invested in the strategy for one year. Impax’s impact methodology is based on equity value. Note that this is representative of the portfolio holdings and AUM of this fund as of December 31, 2017. This data is based on the most recently reported annual environmental data for all holdings. Methodology has been assured by Ernst & Young LLP.
Additionally, we developed a methodology to measure net CO2 emissions, which takes into account carbon emissions from the manufacturing process of a product and the CO2 emissions that the product could offset annually.
The chart below helps illustrate the Fund’s contribution to the transition to a lower carbon economy. The global economy (left-hand column) is currently producing an unsustainable level of CO2 emissions. The Pax Global Environmental Markets Fund, by contrast, makes a meaningful contribution to carbon emissions reductions. As a result of its carbon abatement, the Fund surpasses the goal of a “2 degree Celsius economy,” as advocated by climate experts.
2Source: United Nations Framework Convention on Climate Change (UNFCCC), 2016. Aggregate effect of the intended nationally determined contributions: an update – synthesis report by the secretariat, McKinsey Global Institute, Haver, BIS, Deutsche Bank estimates, 2014, and IMF, National Central Banks and Statistical Offices, Thomson Reuters, 2014. Black bars reflect the range of estimates of value invested. 3Impax Asset Management, 2017. Impax’s impact methodology is based on equity value.
The environmental challenges ahead are real and daunting. However, solutions do exist and we are seeing an increasing number of innovative companies developing technologies to address these challenges.
For investors, there is one conclusion: the times, they are a changin’. The transition to a lower-carbon economy is underway, and investing in environmental markets means investing in companies that are providing environmental solutions and capturing exciting growth opportunities, while helping to maintain a better quality of life on our planet.
ALPS Distributors, Inc. is not affiliated with Impax Asset Management.