Investing in companies positioned to thrive as the global economy becomes more sustainable is not without its pitfalls. Here’s what two decades of experience have taught us at Impax.
Focus on the “regulatory ratchet”, not the “subsidy spigot”
For many investors, Environmental Markets are synonymous with subsidy, as governments seek to correct market failures that reward polluters, or as they attempt to pump-prime the clean industries of the future. Too often, investors have been blindsided when governments change tack and shut off costly subsidy regimes.
Although well designed subsidies can help a nascent technology break through to commercial scale, they are, by definition, unsustainable over time. They can also generate vocal opposition because they transfer money to a favoured constituency. In contrast, we have found steadily tightening regulations, such as water quality standards, energy efficiency standards, building codes or recycling targets, to be more supportive of long-term investment. These tend to be less expensive for governments to introduce, favouring incumbent solution providers by creating barriers to entry, and they usually avoid the boom-bust cycles that overly generous subsidies can trigger.
Small-caps offer an “M&A supercharge”
In a high-growth sector such as environmental technology, which is disrupting a growing number of industries, merger and acquisition activity can provide a substantial boost to realised returns.
M&A transactions in Environmental Markets since 2005
However, for every environmental technology small-cap that is acquired at a big premium, many more fall by the wayside – especially those with unproven technologies or those that are pioneering new business models. We have learned that the most attractive investment point is when a profitable company with established technology is beginning to scale up.
Knowing when to say no
There has been no shortage of environmental technology fads and fancies over the last 20 years, with hot money inflating bubbles from fuel cells to 1st generation electric vehicles, bioenergy businesses, and carbon traders.
While every bubble ultimately bursts for its own distinct reasons, there are three characteristics that tend to be predictive: unproven technology, high capital intensity, and outsized policy risk. Our focus on proven technologies, with limited capital requirements and a clear business case absent of subsidy or policy support, has helped our investors avoid the worst of the clean-tech bubbles and benefit from some of the best.
1Bubble size represents deal size in USD. Source: Bloomberg. Data as of 30 September 2018. Sustainable Food M&A activity since Impax began tracking these companies in April 2012