Impax Environmental Markets (IEM) has a strong long-term track record, having beaten both the FTSE ET50 Index of the largest pure-play environmental technology companies, and the broader MSCI All Country World Index over 10 years. However, over three and five years it has not beaten the MSCI All Country World Index, partly because of the difficult time the environmental sector has been going through.
However, Impax has beaten the FTSE ET50 Index over three and five years, and still achieved double-digit positive returns over these periods. It states in its most recent interim management statement that it "remains positive on the outlook for equity markets into 2014, while recognising the potential for consolidation in the near term. Prospects continue to strengthen based on an improving macro outlook in key industries, notably automotive and construction, and at a micro level on improving fundamentals in a number of environmental markets. The portfolio represents a basket of high-quality growth companies which are well positioned to perform in the long term."
Bruce Jenkyn-Jones, the trust's manager, explains that the difficult economic environment is starting to improve and there has been an upturn in some of the trust's critical markets, which include infrastructure and industrial. "As these get better our companies do well, which is why we now expect to outperform," he says. "There are also lots of new initiatives on products that allow users to increase their efficiency, as well as a boost from regulation. The outlook is positive for the main sectors we invest in: energy, water, waste, and sustainable food and agriculture."
He explains that over the last few years alternative energy has seen some significant headwinds but this has stabilised over the past nine months, and has been ticking up over three to five months.
In the waste sector, recycling companies and general waste management companies are starting to turn. The main areas for potential growth are in reducing waste, within recycling, logistics and leak repair. Impax has around 12 per cent exposure to these areas and holdings that fall into this theme include Regenersis (RGS), Pure, Lee and Man (HKG: 2314) and Tomra (OSL: TOM).
Areas for growth within pollution control include: city gas, metro and rail expansion and lower-emission vehicles, and Impax has around 13 per cent exposure to this area. Stock examples of companies in this area are ENN Energy (HKG: 2688), Hollysys, Porvair (PRV) and Umicore (BRU: UMI).
The development and adoption of shale gas is considered by many to be a threat to environmental investments. But for Impax this is another area of potential growth via investment in companies involved in water infrastructure and hazardous waste, and environmental consultants. Portfolio holdings in this area in which the trust has 10 per cent of its assets include Clean Harbors (NYQ: CLH), RPS Group (RPS), Pentair (NYQ: PNR) and Franklin Electric (Nasdaq: FELE).
A new sector of focus is sustainable food, agriculture and forestry, although the trust has always looked at companies operating in this space. FTSE has recently added sustainable food, agriculture and forestry as a new sector within its environmental markets classification system. "These are central to the main themes of the fund and will add diversification," adds Mr Jenkyn-Jones.
The universe of possible investments in this area is not large, with only 10 to 20 companies, but Impax has already added two and will be able to invest up to 10 per cent of its assets in this area. These are US-listed Trimble Navigation (NSQ: TRMB), which produces software to make agriculture more efficient and has strong growth prospects in emerging markets.
Netherlands-listed Nutreco (AEX: NUO), meanwhile, produces animal feed.
Other opportunities include solar. "We are encouraged by better fundamentals and strong Chinese growth, so are looking for more solar names," says Mr Jenkyn-Jones.
Additions this year include GCL-Poly, a Hong Kong company that makes solar energy generation equipment.
A range of government policies going ahead should benefit companies operating in the environmental sector. In European Union countries this includes:
■ a target of 20 per cent renewable energy by 2020;
■ the approval of the energy efficiency directive in September 2012; and
■ the air quality and pollution review in September 2013.
Europe is Impax's largest geographic exposure, accounting for 41 per cent of assets, although this is an outcome of picking companies the managers like, rather than a deliberate choice.
Partly because of the managers' positive outlook, and also because debt is cheap, the investment trust is looking at taking on some debt. It is in talks with a number of banks and Mr Jenkyn-Jones expects that it will be at a level of about 7 to 10 per cent of assets.
The trust has recently changed its primary benchmark from the FTSE ET50 to the FTSE ET100, which Impax says is more appropriately balanced and better diversified.
The MSCI World and MSCI World Small Cap Indices will be replaced by the MSCI All Country World Index, which has a more representative geographical split, including 21 emerging market countries, and this better reflects Impax's investable universe.
The trust still has a strong bias towards small caps, but Mr Jenkyn-Jones says its shareholders investors do not buy it for small-cap exposure but to focus on a specific area of global equities.
Impax Environmental introduced a discount control mechanism this year, whereby via share buy-backs it targets a level of 10 per cent or less. This caused the discount to tighten from 18 per cent on 31 December 2012 to less than 11 per cent now.
Investment trust analysts at Winterflood said in a recent note: "There are signs of conditions picking up and with discount risk alleviated by the 10 per cent discount target, Impax Environmental Markets may represent an interesting investment for contrarian investors. The fund has a bias to small- and mid-cap environmental technology companies, which often have high growth expectations and higher price-earnings (PE) multiples than the wider market. It is fair to describe the fund as a higher risk, higher potential growth vehicle (macro conditions have to be right for this fund to prosper), although the risk is mitigated to an extent by a diversified portfolio, particularly across significantly different sub-sectors. We rate the Impax team highly as recognised experts in this area."
Mr Jenkyn-Jones adds: "We have been on a discount for years and investors were concerned but we are now confident performance has turned, and expect long-term outperformance and that the discount will narrow."
He also argues that even if investors are not interested in resource efficiency, the trust is invested in high-quality businesses that are particularly geared to the economic cycle. "The fund is overweight cyclicals which in a [US central bank] tapering scenario will benefit."
Meanwhile, Alan Brierley, director of investment companies at Canaccord Genuity, says: "While sentiment remains poor, we believe that the environmental sector has the potential to deliver secular growth and, accordingly, it has a natural role in our Risk-On portfolio. Impax has undoubted sub-contraction value and offers a diversified exposure to this specialist sector."
