Environmental equities, particularly renewable energy, have enjoyed a significant recovery in the past 12 to 15 months, on the back of the general recovery in the global equities market. The market perceives that the underlying fundamentals for renewable energy remain strong, despite the challenges that the sector faces.

Renewable energy stocks are those that belong to companies whose businesses tap energy resources that are continually replenished – such as sunlight, wind, rain, tides, waves and geothermal heat.

Impax Asset Management (Impax AM), a boutique under the umbrella of BNP Paribas Investment Partners, is a specialist in investing in environmental and natural resources. Its renewable energy stocks have driven strong performances of some of its investment strategies during this period. Such stocks accounted for only 10% to 20% of the total portfolio.

In an interview with The Asset, Bruce Jenkyn-Jones, managing director, listed equities, Impax AM, says: “While other sectors such as energy efficiency, water, waste and recycling performed in line with or better than global markets from 2010 to 2012, renewables underperformed tremendously and our funds were affected. But over the last 12 to 15 months, the renewable sector has improved substantially for a number of reasons.”

Sector improvements

The better performance was a result of (i) a consolidation in the sector which had seen excess capacity; (ii) clearer regulations governing the environment; and (iii) a rationalization of subsidies in the solar and wind industry that has driven down cost.

“In some cases, the solar sector is now able to compete with fossil fuel in places without a power grid including Africa, Latin America and India. Because the solar distribution chains are now in place, consumption is picking up. Overall, the sector is growing and the pricing for the producers and their cost structure are improving,” Jenkyn-Jones says.

The water fund which Impax manages for BNPP IP (BNP Paribas Aqua Fund) is focussed on opportunities created by the scarcity of natural resources and the growing demand for cleaner, more efficient products and services, through both listed and private equity strategies. It had total assets under management of US$3.7 billion as of October 31 2013 for institutional and high net worth investors globally. Impax AM’s investment team consists of 28 professionals, with an average of 18 years’ relevant experience.

“Renewable energy is only a small part of our funds, but it can have a significant impact on the performance of some of our strategies. In the last 18 months, our global equity funds have outperformed the MSCI All Countries World Index by 5% to 10%, depending on the specific strategy,” he points out.

Impax AM’s water strategy, which centres only on one sector, has had strong numbers since its inception in January 2009. It posted a 49% return (all returns quoted for US dollar class) in the three years to July 31 this year, compared with the 43.2% gain by the MSCI World Index and the 36.6% increase in the FTSE Environmental Opportunities All Share Index during the same period.

The firm’s Asia strategy, known as the Asian Environmental Markets Fund, has also outperformed the regional index year-to-date, posting 10.4% as of September 2013 versus the MSCI AC Asia Pacific Ex Japan Index’s 1.1%. The Asia strategy has been outperforming the regional index because of the emerging market content. In general, emerging markets have been performing well in 2012-2013 with the FTSE Emerging Market Index rising sharply to 17.9% year-to-date as of October 31 2013, after plummeting by -19.0% the previous year.

Emulating Europe

Impax AM launched its food and agriculture fund on December 1 2012. Although it is still early days, the fund has managed to raise £2.8 million and stood at 10.7% year-to-date as of September 2013, slightly lower than the MSCI AC World Index which registered at 14.49% in the same timeframe.

“The strongest message is good performance. In terms of the thematic trends, the cyclical recovery is helping relatively high beta mandates. In terms of asset-raising, we have been most successful in the US,” Jenkyn-Jones notes.

Interest is coming from investors at the interface of shale gas development and environmental protection in the US, particularly on pollution-related issues. Companies that offer clean-up solutions, hazardous waste disposal, as well as pick-and-shovel operations in the shale gas industry, are outperforming the market.

In Asia too, there is increasing awareness among institutional investors about the environmental sector. Today, a still limited number of Asian entities invest in environmental stocks – mostly private groups and family offices. But for the first time, Impax AM has been invited by three local insurance companies based in Taiwan to make presentations, a positive indicator of investor interest.

In Hong Kong, investors are principally family groups that have specific interest in the environmental market. No substantial pick-up from institutional investors has been noted.

“Our feeling is that it will be similar to the UK and Europe 10 to 15 years ago when we started off with family offices and private groups as investors. But as the sector has demonstrated better performance and has become better known, our assets have grown substantially. We are hoping that in the Asia-Pacific, something similar will happen, particularly in Hong Kong,” Jenkyn-Jones enthuses.

There has been a better reception in Australia, where Impax AM has won a mandate. “In Australia, we have a busy schedule talking mainly to consultants and to the superfunds. We already have a mandate with a local government superfund and I’m meeting four or five others, which is encouraging,” he shares.

Investors are particularly keen on environmental stocks not only for diversification but on the thesis that resource scarcity is a major challenge.

“Typically, investors have looked at the supply side – buying into commodities, the energy sector, and food and agriculture. Impax funds focus on investing in companies using resources more efficiently so it really is a resource-efficiency story, which is another way of playing the same theme. In Australia where they are overweight resources, this resource-efficiency opportunity is attracting interest,” Jenkyn-Jones says.

Impax AM believes the long-term performance of the sector can be sustained based on the track record of its fund strategies that have outperformed substantially over the past ten years. That track record shows that funds which are biased towards industrial technology materials have a high tracking error. Hence, periods of underperformance would be expected over the long term.

Historically, Impax AM strategies outperformed 2% to 3% during the period between 2003 to 2009, under-performed from 2010 to the first half of 2012 and then began outperforming in the second half of 2012. This may be an indication that the sector has entered a period of relative outperformance that may last for a while.

Based on its track record, Impax AM funds tend to perform better when the global economy is stronger. There is a cyclical bias that affects the performance of the funds. If an investor believes that the global economy is in a state of recovery, it is expected that the renewable energy funds and environmental funds in general will outperform.

In addition, on issues such as water quality, energy efficiency, building codes, or water infrastructure needs, there haven’t been major regulatory changes anywhere since the global financial crisis that would have affected the sector.