Key Characteristics of Environmental Investment
By
Victor Bivell
Eco Investor,
July 2008 Edition
As a stand-alone
investment theme, environmental investment has several key characteristics
that help determine the range of available investments, the risk and return
profile of the sector, and what the sector can offer different types of
investors.
On the positive
side are the sector's high growth rate and the high returns that are possible;
on the negative side is the sector's relative immaturity, evidenced by
a small number of established companies and funds and a lack of diversification
by industry. There is also the issue of understanding and making judgements
about the purity of investments.
The immaturity
of the sector is mostly a problem when adding an environmental theme to
an Australian equities portfolio. North America and Europe offer greater
choice for international equities.
For at least
two decades investors have been anticipating that environmental investment
would start to boom, as did information technology and biotechnology in
the 1990s, but this has begun to happen in a big way only in the past
few years - thanks mostly to the huge public concern about greenhouse
gas emissions and climate change from the global economy's reliance on
high carbon oil and coal.
This change
in thinking and the environmental revolution it created has touched every
sector of the economy. The resulting trend to clean energy and clean technology
has led to an explosion of environment related business opportunities
and the environment is now a major driver both in the formation of new
businesses and in the growth of established environmental businesses.
New business
formation is evident in the boom in the number of companies undertaking
research and development, seeking capital, and listing on the ASX. The
large number of micro cap companies in particular is a clear indicator
that the sector is growing fast.
Established
environmental companies are also growing fast and today the ASX 300 has
a small but record number of pure environmental companies.
Growth is also
evident in the emergence of successful new investment sectors such as
wind energy and coal seam gas, and in the high returns being made by many
companies, particularly the larger more established businesses.
Environmental
investors now have an unprecedented number of investment opportunities
from which to choose, but turning this growth into investment returns
is not easy. Investors have to understand and manage the immaturity of
the sector as it makes successful investment that little more difficult.
The immaturity
of the Australian sector is seen in the small size of the environmental
investment universe, and in the speculative nature of most of the available
investments.
There are reasons
for this. While there are many environmental problems, some of these have
no immediate solution or only a partial solution. Even where there is
a solution some of these are offered by private businesses that are not
open to investment from the general public.
Australia has
an impressive number of unlisted early stage companies with interesting
intellectual property under development, but these are mostly open only
to institutional and high net worth investors.
A shortage
of venture capital funds means many of these young companies list early,
hence the explosion in recent years of environmental micro caps. Micro
caps form the great majority of environmental investments in Australia.
With little or no assets, no revenue, no profits, and no dividends, they
are high risk speculative investments.
While there
are a growing number of emerging companies that do make profits and pay
dividends, there are still only a few environmental businesses among Australia's
major listed corporates. Eco Investor magazine recently identified 16
relatively pure play companies in the S&P ASX 300 Index, and another 24
with an environmental business activity alongside non-environmental activities.
The shortage
of investment grade companies means there are few specialist funds, listed
and unlisted, that focus on Australia. This makes entering the sector
difficult for retail investors who prefer managed funds.
The lack of
investment grade opportunities affects portfolio diversification. At present
the higher quality opportunities are concentrated in a small number of
industry sectors, particularly natural gas, coal seam gas, wind energy,
metals recycling, waste management and aquaculture.
More investment
grade companies and industry diversification will happen as more companies
enter the ASX, more micro cap companies achieve revenue, profits and dividends,
and more of these emerging companies enter the ASX 300. This trend is
likely to continue well into the future, but the process can take many
years.
These issues
confronting Australian environmental equities do not affect international
environmental equities. The world wide growth in environmental investments
means there are many opportunities for investors who want to add an environmental
theme to their international equities portfolio. This can be done through
direct investments in overseas companies, and through listed and unlisted
funds in Australia and offshore.
There are now
also many Australian and international indices for the main sub-sectors
of environmental investment which investors can use to identify opportunities
or benchmark performance.
Another issue
is that not all environmental opportunities are "pure plays" - where the
environmental products or services are the company's sole business activity.
Pure play businesses are preferable because they make it easy to identify
the environmental, financial and investment contribution of the business
activities.
While such
focus is usually the case in highly specialized sectors, such as pharmaceuticals
or information technology, it need not be the case in environmental investment.
Many companies
that offer environmental products or services also offer products that
may have little to do with the environment or may be environmentally harmful.
Examples are engineering firms that offer environmental engineering as
part of a suite of engineering services, and manufacturers that also make
non environmental products.
The shame is
that many of these subsidiaries are mature businesses that would sit well
in the most conservative of portfolios, and as stand-alone companies many
would add greater diversification and depth to the sector such as plantation
timber, rail transport, environmental engineering, and environmental technologies.
However, as
environmental investors generally prefer companies to have both a focus
on and a commitment to their environmental business, investment in these
less focused and less committed companies is a matter for individual investors.
Overall it
is fair to say the environmental investment sector in Australia is not
as mature as many other share market themes, but it is developed enough
to offer options for all types of investors.
This article
was also published in The Australian newspaper
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