To coincide with National Ethical Investment Week, Hubert Aarts of Impax Asset Management explains how investing ethically across rapidly growing global environmental markets appeals to a broad range of investors.
An ethical investment is simply an umbrella term for any investment that takes environmental, social and/or governance issues into consideration. However, this definition is open to a range of interpretations.
Mr Smith and Mrs Jones may both be thoughtful investors who seek to invest in products with investment criteria closely aligned to their personal values. However, what Mr Smith considers ethical may not be so for Mrs Jones. Everyone draws their line in the sand in a different place, although there are several areas that are generally deemed beyond the pale such as:
– Animal exploitation
– Human rights abuse
– Environmentally damaging practices
– Poor employment practices
These sectors are usually screened out of ethical funds and it is this exclusion aspect which has given rise to the common misperception that negative screening leads to weaker of performance. Not necessarily so.
Well managed companies, committed to strong sustainability and good governance, generally demonstrate superior long-term performance. We are all painfully aware of the result of years of poor governance within the UK banks and the far reaching impact this continues to have. The omission of companies that don’t deliver on these practices is simply another layer of risk reduction.
However, we believe that it is the additional layer of positive vetting that can add real value for investors. In our case, this is the commitment to investing in efficiency solutions to the problem of finite resources across high growth global environmental markets.
This focus is also high on the priority list for most ethical investors as it endorses the important theme of optimising our limited resources and/or in finding alternative solutions. But it is also gathering interest from investors who do not necessarily consider themselves ‘ethical’ or ‘green’ but are simply seeking long-term growth opportunities in global equities.
Alternative and renewable energy, energy efficiency, water, waste will be amongst the fastest growing global markets. The drivers are compelling and as the world economy stabilises these markets should deliver superior returns relative to the more over-valued yield stocks which have been preferred in recent years.
Drivers for strong long-term risk-adjusted returns
The world population is growing rapidly. We are seeing massive wealth creation in developing countries and subsequent changes in consumption. In the future, more of us will inevitably live in water stressed areas and water shortages will be further exacerbated by changes in agriculture and an increase in extreme weather patterns and possibly longer term climate change.
These resource efficiency markets are growing considerably faster than most other sectors, as companies are seeing rapidly increasing demand for their products and services. Globally there are currently some 2,400 listed companies with a combined market capitalisation in excess of $7.3 trillion.
Successful investing in these sectors not only requires a deep understanding of the industries in which these companies operate, but also the mispricings that occur because of the inherent complexity of technologies, increasingly strict regulation and the fact that many of these companies are generally not well understood or deeply researched by the investment community.
Alongside the obvious benefits of rising earnings and wider investor confidence across the economy, stock ratings should rise further following the announcement of new US policies to conserve water, reduce flood risk and limit greenhouse gas emissions, and news on Japanese, Chinese and European energy policy and pollution regulation. Investors who ignore these fundamental economic drivers could miss out on an enormous opportunity for value creation.
The prospect that these markets should outperform the wider economy over the next decade and beyond, resonates strongly with a broad-based interest in long-term ethical investing.
Hubert Aarts is managing director listed equities at Impax Asset Management and co-manager of the Old Mutual Ethical Fund.