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Funds for a low carbon world

Created:

28 May 2010

Written by:

Maike Currie

Labelling climate change as "one of the gravest threats we face", the UK's new coalition government has pledged to use a wide range of levers to decarbonise the economy and support green technologies. And despite threats that climate projects could be slashed under the spate of spending cuts announced, a comprehensive 'green agenda' should ultimately see sustainable energy, and low carbon initiatives, play an important role in the economy going forward. Share prices have been volatile, and performance somewhat haphazard, but a number of funds invested in the sustainable energy space have managed to deliver strong, consistent returns over the long term.

A feeble history

The appointment of Liberal Democrat candidate, Chris Hulne, as Secretary of State for Climate and Energy, has been welcomed by fund managers in the renewable energy space, given the Lib-Dem’s credentials as the 'greenest' party.Many hope the appointment will put an end to what has been a prolonged history of weak government support.

The lack of opportunity in the UK is testament in the absence of UK-based climate change stocks in fund portfolios such as the WHEB Sustainability Fund, which, according fund manager, Nicola Donnelly, only holds one UK climate change stock, EAGA - the UK's largest supplier of heating and renewable energy.

But Ms Donnelly is positive that things will change. She expects the new government to make incremental improvements, which over time may lead to opportunities and the development of 'national champions' in the renewable energy space.

"We expect the UK to push for a 30 per cent C02 cut, like Germany, and to support the EU Emissions Trading Scheme. The use of carbon trading to achieve targets would raise EU wide carbon prices although we are not positioning the fund towards this due to the high degree of uncertainty," she says.

Despite optimism from fund managers, the UK's big deficit and the planned spending cuts leaves many sceptical on where any meaningful funding will be found. The emergency budget scheduled for 22 June is expected to provide greater clarity on policy intentions, and the future of renewable energy.

Julian Parrott, partner at ethical advice firm ethicalfutures, says there will be no 'gold rush' benefits for investors in green and environmental technologies but it will help to underpin development and uptake of these technologies making them even more attractive. "It's a long-term investment play as the markets are still in early stages of development and investors need to be 'persuaded' by a combination of investment incentives and tax penalties to move away from fossil fuel and polluting industries and into renewable," he says.

That said, valuations in the renewable energy space are at very attractive levels, especially when compared with rest of the equity market, while funds like the BlackRock New Energy investment trust are trading at a substantial discount of 14 per cent, which could signal a good time to buy. "Concerns over Southern Europe have combined with investors fleeing from higher-risk stocks to send some valuations to rock bottom levels. An example is Abengoa, which is trading on a multiple similar to the one it traded on during the depths of the financial crisis in 2008. The turning point in these stocks is probably not for a while but they are certainly worth watching closely," comments Ms Donnelly.

Opportunity knocks

The coalition government's 'green' initiatives which include the creation of a green investment bank, the aviation passenger duty replaced by plane tax, no new runways at Heathrow, Gatwick or Stansted, a new high-speed rail network, an increased target for share of energy from renewable sources, all have the potential over the longer term to feed into funds which invest in renewable energy.

Ms Donnelly sees opportunity in renewables on the back of the government's plan to establish a full system of feed-in tariffs in electricity. These are generally described as those fees that the microgenerator - who is normally the power supplier's customer - will be paid when they can show that they are putting power back into the grid.

"Feed-in-tariffs are the preferred mechanism to support wind, biomass, and marine power rather than current Renewables Obligation Certificates (ROC) system.

"A fixed-price subsidy could benefit offshore wind developers and we will monitor developments closely. We hold Vestas, a Danish turbine company, which produces world class offshore wind turbines and the UK could become a new market for their turbines," comments Ms Donnelly.

Steve Mahon, CIO of Low Carbon Investors, the investment manager of Alternative Investment Market (Aim)-listed cleantech fund Low Carbon Accelerator (LCA), says companies dedicated to developing feed-in tariff qualified small-scale generation projects are emerging across the UK. "LCA has identified an opportunity here in Vigor Renewables. Through Vigor, LCA has exposure to Vigor's pipeline of renewable energy projects and has the rights to 90 per cent of Vigor's distributable profits.

"We have further exposure to the feed-in tariff policy driver through Proven Energy, a market leader for the manufacture and supply of small-scale wind turbines, all of which are certified for the new feed-in tariffs regime," says Mr Mahon.

But while government initiatives promise to open up a number of investment doors, Bill Weil, portfolio manager of the Ludgate Environmental Fund, a close-ended fund listed on Aim says his fund aims to identify long-term growth prospects - independent of government stimulus. However, he does welcome support from government regarding some of Ludgate's key technology areas such as anaerobic digestion, renewables and energy efficiency.

"As a Europe-wide investor we have seen how regulations can help drive companies to make significant investments that many green technologies will require. Germany, which has clear and long term renewable energy regulations has been able to develop a leading position in various cleantech sectors," comments Mr Weil.

Active management

Unless you're set on building an 'ethical portfolio' or giving your existing investments a green overhaul, renewable energy funds should not typically make up the core part of your portfolio, and should only take up a small proportion of your overall investments. In essence, you are playing a long term theme with these funds. Given this, many might argue in favour of a more cost effective tracker fund.

A number of exchange-traded fund (ETF) providers have some interesting propositions: Invesco PowerShares offers UK investors the PowerShares Global Clean Energy Fund which seeks to provide investment results which, before expenses, correspond to the price and yield performance of the WilderHill New Energy Global Innovation Index in euro terms.

iShares offers a S&P Global Clean Energy ETF and a S&P Global Water ETF. Lyxor's similar offering, the World Water ETF tracks the World Water Index, while db x-trackers offers an ETF which tracks the S&P US Carbon Efficient Index, offering investors the opportunity to track the S&P 500 with a 50 per cent lower Carbon Footprint and 60 per cent lower Greenhouse Gas emissions.

All these passive vehicles come with an attractive price tag. However, given the volatility and the stock-specific nature of investing in renewable energies, there is a strong case to be made for active management.

"There are few listed large-cap companies in the clean tech sector, which inherently suggest greater volatility. A fund allows you to diversify over a number of companies, reducing operational risk. Furthermore, fund managers review hundreds of investment proposals, often from small, fast-growing companies to which investors would not otherwise have access," says Mr Weil.

Justin Fearns of wealth manager, AWD Chase de Vere, adds that it will take "a brave and very knowledgeable investor" to take part directly in some of the start-up projects that may arise. Instead, she suggests a number of UK retail funds that already invest in some these areas and which should eventually be the beneficiaries of the greater investment and momentum into them.

These include the Allianz Global Investors Ecotrends Fund which invests in companies that follow one of three themes: eco energy, such as wind turbines and building insulation; pollution control, such as clean motor vehicles, waste storage; and clean water, such as desalination and infrastructure. Ms Fearns also recommends the Schroder Global Climate Change Fund which seeks out companies that will benefit from efforts to accomodate or limit the impacts of global climate change.

"Other funds that should benefit are the Impax fund range and the Guinness Asset Management Alternative Energy Fund which is an offshore fund. These are very small funds, which need to be considered with caution, regardless of the impetus behind them. The Ventus Funds, managed by Climate Change Capital, also fit in this space. The funds are VCTs, so are tranche based, and focus on investing in companies that develop and construct renewable energy projects in the UK. As a specialist product, they are not suitable for everyone," explains Ms Fearns.

Some of the main considerations with all these funds are that they are all very specialist, and therefore only really appropriate for investors who have a long time horizon and can tolerate a higher degree of risk. Some of them are quite small in size too, which can increase the risk profile considerably.