Impax blog

Broad based optimism for 2014

17 Jan 2014 - by Bruce Jenkyn-Jones

It's been a long time since the outlook for resource efficiency stocks and environmental markets has been quite as good as it is right now. The next 12 months look promising across our investment strategies, buoyed by a broad-based cyclical recovery from the deepest downturn in living memory.

But there is much more at play than a cyclical pick-up. Away from the headlines, the last few years have seen the ratchet of building regulations, energy efficiency standards and pollution limits continue to tighten. And, as the global economy recovers, companies exposed to these themes are seeing their earnings start to rise strongly as houses get built, cars roll off the production lines, and long-delayed infrastructure projects move forward.

The above-trend growth we anticipate in sub-sectors such as water treatment, pollution control and energy efficiency is not dependent on costly government subsidies. It is based on improving technologies and new, rapidly expanding sources of demand. There are opportunities for companies to make attractive returns in these rapidly developing markets by deploying proven business models.

Even in renewable energy - the one sub-sector most assumed to rely upon government largesse and an elusive, international climate change agreement - the picture is finally starting to brighten. The policy uncertainty of recent years that has blighted renewables investment has fallen. Substantial consolidation has also improved equipment makers' pricing power. But most of all, we see unsubsidised demand for renewables driving the sector's long term development, as the technologies involved simply get better and cheaper. We remain underweight, but we do expect to increase our exposure in 2014.

One place where bold policy is changing the investment landscape is China. Proposed reforms announced at the Third Plenum in November offered further specific support for resource efficiency and environmental markets. The government is focused is on tackling the country's increasingly dire pollution problems, creating opportunities across the board, for example in catalytic convertors, urban transport, natural gas infrastructure and water treatment.

This illustrates another attractive element of our strategies going into 2014: an emerging markets kicker. The continuing improvement in the economic outlook, particularly in Asia's developing economies, is making capital available for substantial, and overdue, investments in environmental protection.

We expect emerging markets to continue to contribute to our top performing water strategy in 2014. The water sector is also set to benefit from increasing demand in the US, where a more buoyant economy has led to higher-than-expected investments in water infrastructure as well as rapid growth in water treatment companies and in monitoring and equipment manufacturers. We also see interesting opportunities in irrigation equipment, where we believe that bearish sentiment - triggered by bumper US harvests and therefore low prices - is overdone.

For our food and agriculture strategy the outlook for the agriculture sub-sector is somewhat uncertain; however the fall in food prices bodes well for the margins at processing companies, and - medium-term - the secular trend is compelling. By the end of 2014 there will be approximately 75 million more mouths to feed than at the start, and demand in China is only going in one direction. A weather event or two impacting supply could quickly alter the outlook for stocks linked to this theme.

Across our funds more broadly we aim to seek out high-quality businesses with long-term secular growth strategies and mid-teen returns on capital: these are the companies with the potential to deliver strong consistent performance for our investors. We continue to remain more cautious than many of our peers over 'blue-sky' opportunities, such as fuel cells, energy storage, second-generation biofuels and electric vehicles. There are undoubtedly companies in our investment universe that will enjoy enormous success bringing these technologies to market, or will be acquired at attractive valuations along the way. However, we don't believe that listed equity is the place to invest in unproven technologies, preferring to look for road-tested business models, where we have good visibility over the future earnings that will drive performance. That's why we didn't catch a lift with Tesla on its rollercoaster ride!

In terms of considering new investment ideas, we've never been busier. The gradual technological and regulatory advances we've described are turning once speculative plays into stable, viable businesses, and the IPO markets are reawakening for environmentally themed firms. Meanwhile established companies are looking to resource efficiency and environmental protection - either acquiring existing firms, or investing internally to tap into these growth markets.

Although we're not taking anything for granted, we view 2014 with more optimism and confidence in our investment themes than at any time in the last five years.

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