Impax blog

Environmental Markets hold the promise of significant outperformance

11 Jan 2016 - by Ian Simm

We start 2016 with confidence that the resource efficiency and environmental markets hold the promise of significant outperformance. This month we consider the outlook across our asset classes, and discuss the likely impact that the Paris Climate Agreement, struck last month, will have over the longer term.

We believe that the Paris Agreement changes the lens through which governments, companies and investors view the future. After many years of negotiations, the agreement establishes for the first time a truly global mechanism to rein in climate change, and one that will be subject to further tightening through periodic reviews. It looks set to shift corporate positioning and make capital more readily available to businesses specialising in low-carbon goods and services. It should also generate a tailwind for resource efficiency and environmental and markets.

Renewable infrastructure

Since 2013, more renewable than fossil fuel-fired generating capacity has been built worldwide. We anticipate further superior growth in investment in wind and solar farms. For example, as part of EU’s ambitious Paris pledges and transition to a low carbon economy, the EU Renewable Energy target will be increased to 27% of all energy by 2030, up from 20% in 2020.  Continuing cost reductions – with renewables increasingly able to compete with fossil fuel energy without subsidies – will alleviate concerns over affordability.

Sustainable Property

The built environment is responsible for around 40% of global carbon emissions. In a low-growth, low-interest rate environment, income-generating assets such as real estate are already attractive to investors: premium returns are to be had by investing in energy efficiency, simultaneously cutting building emissions and their occupiers’ costs.

Listed Equities

Air pollution is likely to be as important a factor as greenhouse gas emissions in driving the share prices of environmental technology stocks in the year to come. Growing public disquiet about poor air quality has already encouraged China to begin to curb its coal burning.  We expect that the country’s forthcoming 13th Five Year Plan will significantly increase targets for reducing sulphur dioxide and nitrogen oxides, benefitting pollution control equipment manufacturers.  India, while defending its right to exploit its domestic coal reserves, also faces crippling local air pollution. The consultancies that will be called upon to help governments retool their regulatory regimes, as well as companies that supply real-world exhaust testing equipment look set to benefit. While a shift away from diesel towards gasoline vehicles may hurt catalyst manufacturers, we expect the emissions scandal to assist the long term uptake of electric and hybrid vehicles.

The outlook for investment in water infrastructure and water treatment equipment is also healthy, driven by construction markets and recovering municipal spending, particularly in the US. In Asia, enormous infrastructure investment is needed to catch up with demographic and economic growth, with water provision and wastewater treatment set to see continuing strong capital flows.

The waste management sector faces some headwinds from mediocre global GDP growth and ongoing weakness in markets for recycled commodities. But opportunities exist in sector niches, such as hazardous waste, where high barriers to entry are keeping margins healthy.  Specialist recyclers that are able to dominate their particular recycling stream are likely to outperform the wider market and we expect this to be reinforced as the demands of the EU Circular Economy Package takes effect.

Food production is a major contributor to greenhouse gas emissions. The food value chain is being disrupted by environmental and regulatory developments as well as changes in consumer preferences, particularly in developed markets.  We see particular opportunities in natural foods, food safety, and advanced packaging solutions.

But perhaps most importantly, the Paris Agreement has underscored the impact that environmental risk can have on portfolios. Be it the collapse of VW’s share price, or the introduction of a global climate regime, environmental issues can have profound short and long-term effects on company share prices and portfolio performance.  Investors ignoring them do so at their peril.

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