In our resource constrained world, ethical investments are an increasingly attractive option.
Simon Ellis, managing director at Legal & General Investments, explains why passive funds offer the best way into the low carbon energy theme.
Investors today are confronted with some of the toughest market conditions experienced for several decades. The eurozone lurches from one crisis to the next without any meaningful resolution, creating huge uncertainty and denting investor confidence worldwide. Equity markets are extremely volatile. Cash gives you a negative real return.
Fixed income has been a great investment over the past few years but how long will this be sustained? Gold has also been seen as refuge, but given its price volatility in recent times, this now seems more than a little misleading.
Given the lack of clarity in market direction and the accompanying high levels of volatility, it is difficult to decide which way to turn, even for the most experienced investors. At Legal & General Investments we have spent a lot of time and resources looking at where the world is going and believe we have identified a number of global megatrends that are having a fundamental and long-term impact on the global economy.
Global population growth
It took from the first man on Earth until the early 1900s to reach a global population of around 1.6 billion people. One hundred years on and the populations of China or India alone are not trailing far behind that. There are now seven billion people on the planet, all needing water, food and basic amenities.
Rise of middle classes
Historically, there has been a severe disparity between the wealth of the emerging markets and that of the developed markets. We have seen a significant flattening of this disparity and a massive and growing middle class in the emerging markets. This growing middle class in the emerging markets is driving domestic consumerism.
Resource depletion
Reserves of fossil fuels are finite, yet demand for energy continues to grow exponentially – unsurprising given the demographic megatrends already mentioned above. At the same time, governments throughout the world are legislating in a bid to reduce emissions, effectively placing artificial caps on conventional fossil fuel-based energy consumption and creating the conditions for a major supply and demand mismatch.
Surging energy demand is compounded by the fact that to a large extent we have exhausted the easier and less risky deposits of resources such as oil and we are now having to take on more risk, and pay significantly higher prices, for each additional barrel, increasingly relying on deep water drilling, oil sands and Arctic exploration.
Meeting demand
If we look at the likely impact of these global megatrends, one thing is clear – we need to look at becoming more efficient with the energy and resources we use as well as finding more stable and secure alternative energy sources.
Certainly, the story is not just about these “alternative technologies” like solar and wind-generated power or any other singular industry; it is much bigger than that. There are a growing number of companies that recognise this and are providing products and services that are meeting the needs of a resource-constrained world, ranging from those providing items that we already use everyday, to those at the cutting edge of innovation. We believe these companies offer a growth story to believe in – one that has incredibly strong drivers – and are well positioned to provide long-term growth.
Getting on board
How best, then, to capture this hugely significant investment theme? With the broad and ever-widening global universe of these companies, passive funds are becoming an increasingly attractive option, enabling investors to harness the growth of the low carbon energy theme with reduced risk and without the sector and/or geographical bias of an active fund manager.
Ensuring that the companies within the portfolio derive the majority of revenues from low carbon activities is harder than it may sound. Analysing company activities to ensure that we only include the ‘pure play’ companies can be the most challenging part of the investment process.
Traditional index screens such as market capitalisation, or the negative filtering of companies on a set of environmental criteria, do not capture the full upside of pure renewable energy or efficiency enterprises. Companies like Siemens or Toyota have departments that generate revenue in areas such as wind turbine and hybrid vehicle businesses respectively. But their share price is not primarily determined by these activities.
A fund that is designed to ensure broad exposure both within and across industry sectors can help to curb some of the risks associated with investing in some industry sectors that can be volatile, while ensuring there is the flexibility to introduce new companies and technologies.
In addition, government legislation can have a significant impact on these industries. There are a huge number of different regulations and policies worldwide that make it difficult to predict accurately impacts on specific stocks. It is important to gain broad exposure on a geographic basis and across and within industry sectors that helps to mitigate the impact of changes to government policy.
To capture the low carbon energy theme’s full investment potential, investors need a fund that is diversified across a broad array of sectors, identifying a range of ‘pure play’ companies engaged not only in renewable energy but also energy efficiency products and services.
Source : IFA Online