A ‘nutty’ investment idea bears fruit

17th September 2010

Seb Beloe chuckles as he recalls the scepticism that greeted the launch of the first ethical fund in the UK, way back in 1984. Friends Provident named it the Stewardship Fund but City cynics at the time dubbed it the ‘Brazil Fund' to reflect their view that you had to be nuts to invest in it.

 Beloe, head of Sustainable and Responsible Investment (SRI) research at Henderson, is keen to stress just how much has changed since the launch of the ‘Brazil Fund', with SRI, an umbrella term encompassing the now very wide range of ethical investment channels, having grown into a multibillion pound industry.

 For the UK alone, despite the financial crisis, interest in SRI remains encouraging. The latest quarterly fund of funds survey by the Investment Management Association (IMA) shows net retail sales of SRI funds totalled £98m in the second quarter of 2010, well above the average of the past four quarters and the highest since the fourth quarter of 2007. For the first half of 2010 overall, SRI funds had £135m in total net retail sales.

 More broadly, SRI funds under management totalled £5.6bn at the end of the second quarter, down 5% on the previous quarter but 22% up on the second quarter of last year. The proportion of gross retail sales of ethical funds, meanwhile, came in at 0.9%, in line with that of the past seven years.  

 Beloe says of the IMA figures: "It is impressive to see investments in SRI products bounce back so vigorously after the dip – which all funds experienced – in 2009.The figures clearly underline the increasing popularity of SRI as an investment strategy among a growing community of investors."

 The success of SRI investment funds since their humble beginnings are in part attributable to legislative pressures in fields like environment and health & safety – two of the key areas of interest for Henderson SRI fund managers. But Beloe now sees a period of a few years over which legislative pressures will play a lesser role: "I think the pace will slacken somewhat on this front, not be quite so gung-ho, as countries around the world go through the austerity phase and governments try to reduce cost pressures and help companies remain competitive."

In assessing legislative pressures and attendant investment opportunities, regional variations have to be taken into account. EU car emission legislation, for instance, is now in its fifth phase and while European standards in general have been much more demanding than in the US and China these countries are now catching up fast. "China has been particularly impressive in this regard," says Beloe, adding: "In some categories of emissions standards the Chinese are stricter than the Americans. Typical of China to have achieved so much in the space of five years – it's quite extraordinary."

But while legislative pressures on industry may ease over the next few years, Beloe sees a continuing racheting up of ethical demands on suppliers to the big companies. "To supply to Wal Mart, for instance, you have to comply with all sorts of environmental and social requirements so to a certain extent market drivers are becoming more important than legislative measures."

 While Henderson's SRI exposure to clean energy is not great, with Beloe indicating 7% currently, with flexibility to go as low as 6% and high as 15%, depending on how it feels about the economy, there are some clear favourites.

Solar power has traditionally been an industry that has required government support globally but Beloe and his colleagues are very bullish about the sector and see it extremely well placed now to move beyond government subsidies after decades of promise.

He says: ‘Solar is likely to be competitive against retail grid prices in countries like Italy, Japan, Israel and California within the next 6-12 months. At that point you will not need government subsidy because the technology will be generating electricity at the same price or cheaper than you can buy it off the grid."

The key to solar having become suddenly so competitive has been the dramatic fall in the price of solar modules. In the space of just over two and half years, module prices have slumped by an astonishing 50% thanks to volume module production in China having grown enormously. Chinese solar module makers are even making white label models for the likes of BP.

With solar technology clearly much depends on location, the intensity of its exposure to sun over time. But the march forward for the technology in terms of its investment potential and economics appears inexorable, even for London, which Beloe reckons will be in a position to benefit in as little as four or five years. "The key point is that solar is no longer decades away. I personally am very optimistic about the technology."

Sustainable energy production and energy efficiency are themes Beloe clearly believes have considerable upside potential for investors. In the latter sector, he is particularly excited by the prospect for ‘smart grids'. He explains that the current electricity grid infrastructure is "pretty stupid", with no sophisticated means of modulating demand according to need. Smart grid infrastructure of the near future, by contrast, would enable monitoring of electricity use, right down to the level of a household, in real time, and allow demand to be managed much more effectively.

"Fridges and air conditioners do not have to be on all the time, you could automatically turn them off for very short periods, minutes, and while that does not sound much, if you multiply that across hundreds of thousands of households you begin to save a lot of energy."  Such a system, all done with the permission of incentivised users, could clearly save utilities considerable amounts of money and allow energy to be used much more efficiently.

Beloe is convinced smart grid development will offer many opportunities for SRI investment ranging from the nuts and bolts of upgrading the grid infrastructure to software to monitor energy use. 

Another key SRI investment theme at Henderson revolves around water. Beloe says: "There is no doubt that there is a growing population around the world living in areas that are going to be ‘water-stressed' in the future. Indeed some already are, for instance in California, and parts of Spain, Australia and China."

The underlying problem with the economics of water is that its market price does not reflect its scarcity and, as a result, there is no incentive to use it efficiently. Henderson's SRI team, alert to how this discrepancy could offer upside potential, is very interested in companies specialising in technologies that enable water to be used much more efficiently whether it be by car makers, farmers, power plants or households.

Henderson's investment exposure to water is holistic, covering water utilities including Southern Trent and Suez; water treatment specialists like US-based Nalco and water processing technologists including companies specialising in desalination.

Looking ahead, Beloe, naturally, is very bullish about the prospects for SRI. It may have been the butt of jokes in the City  when it is first emerged in the UK but very few now would cast doubt about its future. Indeed for Beloe the advances made by the sector in the intervening years mean that it is no longer even the case that investors need look at the merits of SRI "as part of a balanced portfolio".

He says: "In the old days, SRI was about what you could not invest in – like tobacco. The whole thing has become inverted and now it is about all the areas you can invest in, should invest in. Our whole proposition is that these markets are handsomely placed to grow, make money for i
nvestors, and that if you care about the fact that it is an environmental technology then fine, but if you do not, then that is fine as well."

"I personally do not want to invest in anything to do with tobacco or gambling – my personal ethics if you like – but the fact that we have SRI funds that outperform, that are in the top or second quartile over five years and which do not invest in these areas is a win-win situation. Why wouldn't one want to invest in such funds?"

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