If there has been one key lesson about ‘the environment’ over the past few years, it is that measures to support it will not be implemented through inspirational messaging alone.
The war in Ukraine, soaring inflation, and a cost-of-living crisis, have all served to refocus attention on economic growth. This has taken place across governments, businesses and consumers alike.
However, the mistake in popular debate has been allowing these goals to be positioned as natural opposites. As if measures to improve energy efficiency or optimise resource consumption are not themselves inherently accretive to the bottom line.
This is the premise Impax Environmental Markets (IEM) was established on more than 20 years ago. IEM gives investors access to the superior earnings growth potential of companies operating across environmental markets.
By this we mean businesses whose products and services either i) enable the more efficient, and therefore cleaner, delivery of basic needs such as power, water and food; or ii) address environmental risk such as climate change or pollution. These areas are enjoying structural growth, regardless of political sentiment.
The rationale which underpins environmental markets is fundamentally economic. Whether it’s food, energy, water or commodities, resource efficiency boils down to ‘doing more with less’.
Companies like PTC, which specialises in computer-assisted design (CAD) and product lifecycle management software, help customers spend less money on prototypes, improve manufacturing, and repair products before they fail.
For PTC’s customers, energy and CO2 savings are largely a by-product of measures designed to boost the bottom line.
Similarly, the proper management of environmental risk is ultimately an exercise in minimising long-term costs. Hotter temperatures, rising sea levels, and more powerful storms all make for challenging conditions, both as a business and consumer. Yet demand for ever higher living standards is insatiable.
Ensuring environmental pressures do not constrain the global economy is one of the surest ways to ensure that living standards continue to rise affordably.
Environmental risks can be managed in two ways: mitigation or adaptation. Mitigation methods aim to tackle risk at the source and have historically had the highest profile.
Think reducing CO2 emissions, eliminating plastic waste or regenerating agricultural land. Companies that provide solutions to these challenges are respectively seeking to tackle climate change, pollution and biodiversity loss, on the assumption that not doing so will be more costly down the line.
In recent years, macroeconomic conditions have made investors, governments and consumers alike less patient. Soaring inflation, a sharp rise in interest rates and open geopolitical conflict has eroded appetites for expenditure which does not visibly address the cost of living.
This is a stark change to just a few years ago, when president Joe Biden’s Inflation Reduction Act, alongside the Infrastructure Investment and Jobs Act, ushered in over $2trn of spending.
Nowhere is this change in sentiment more clearly visible than in renewables. In IEM’s portfolio, this sector now accounts for less than 8% of the portfolio and a stock like Boralex – a Canadian specialist in wind, hydroelectric and solar electricity – now trades at 11.5x enterprise value to earnings before interest, tax, depreciation and amortisation (EBITDA) down from a peak of 16.2x in 2021.
While the levelized cost of electricity generation from offshore wind is now globally lower than that of gas, the upfront cost has become less politically palatable. To that end, a sustainability premium for these assets may only return when negative externalities like CO2 emissions become globally regulated and priced.
Yet adaptation to environmental risk has risen rapidly up the agenda. The World Meteorological Office recently published a study predicting average global temperatures will reach and stay at record levels for the next five years.
This has a very real and visible impact – 2024 was the ninth consecutive year in which damages from natural disasters cost the US more than $300bn. As a result, spending on the products and solutions for populations to survive and thrive in a more hostile environment is far more protected.
Adaptation to environmental risks therefore is an investment theme that continues to have high growth visibility, resilient drivers and a broad opportunity set. Significant areas of exposure for IEM include HVAC companies such as Aaon, water infrastructure and utilities such as Brazil’s Sabesp, and US-based Advanced Drainage, through to purveyors of electrical infrastructure such as Italy’s Prysmian.
Financial stocks also have a growing role to play, with reinsurance companies such as RenaissanceRe increasingly leading on both quantifying environmental risk and providing the funding to tackle it.
World Environment Day last week served to remind us of both the environmental challenges and solutions that surround us. Since its founding, technological advances have made the latter more affordable, and increasingly superior to their more resource intense predecessors.
At the same time, greater economic uncertainty is pushing some to favour the potential cost of environmental risk over upfront investment, even as those costs become a part of daily life for others.
Tom Morris Brown is a portfolio specialist for Impax Environmental Markets. The views expressed above should not be taken as investment advice.