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Investing for growth and safeguarding the environment

Investing for growth and safeguarding the environment

February 2017

Firms combining strong environmental credentials with innovative products: the building blocks of our Global Environmental Opportunities strategy.

01

Finding corporations with sound ecological credentials

Companies are under increasing pressure to reduce their impact on the environment, and they are beginning to respond to such demands. As Fig 1 shows, there has been a sharp increase in the number of corporations receiving International Organisation for Standardisation (ISO) 14001 certificates, a globally-recognised environmental standard.
Fig.1 - ISO 14001 CERTIFICATE AWARDS WORLDWIDE
ISO 14001 CERTIFICATE AWARDS WORLDWIDE
Source: International Organisation for Standardisation
Progress has not been uniform across industries and sectors, however. Some firms are making bigger strides than others and it is not easy for investors to identify the ones with the strongest environmental credentials. 

One way of measuring the corporate ecological footprint is through a life cycle analysis (LCA) of a company’s activities. This technique seeks to quantify a firm’s consumption of natural resources and waste emissions over the entire product cycle. An LCA encompasses every activity – from the extraction of raw materials and manufacturing through to how finished goods are used and disposed of by company’s customers. 

The technique is a useful starting point for environmental audits of corporate activity. But there are ways to augment the process. 

To hardwire the best available ecological data into an LCA, investment managers running Pictet AM's Global Environmental Opportunities strategy draw on pioneering research into humanity’s impact on the planet. 

The research in question – undertaken over five years by a group of the world’s leading research institutions – finds that the stability of the environment is ultimately determined by the evolution of nine man-made processes. 

These shifts in the ecosystem, which include ozone depletion, ocean acidification and climate change, form the basis of our corporate audit. Companies found to be contributing excessively to any of these processes are clearly placing a considerable strain on the planet. By contrast, firms whose activities do not add significant momentum to any of the nine ecological forces can be considered for inclusion in Pictet AM's Global Environmental Opportunities portfolio. 

02

Sizing the corporate ecological footprint 

Product lifecycle analysis and the planetary boundary model

To measure the corporate ecological footprint, investment managers in Pictet AM's Global Environmental Opportunties strategy conduct company audits using a model that combines LCA with a novel framework developed by a team of leading scientists and biologists.

Fig.2 - The planetary boundary model
THE PLANETARY BOUNDARY MODEL
Source: The Stockholm Resilience Centre
The model attributes ecological degradation to nine processes: climate change, ocean acidification, chemical pollution, changes in land use, ozone depletion, atmospheric aerosol loading, changes in the nitrogen cycle, biodiversity loss, shifts in the phosphorous cycle and the depletion of freshwater supplies. 

Left unchecked, these nine processes threaten to inflict lasting damage on the Earth’s capacity to sustain life.

The model determines a “planetary boundary” for each process, a numerical safety limit that must not be breached if the Earth’s biophysical infrastructure is to stay intact. For example, if the world’s supplies of freshwater are to remain stable, humanity’s total consumption of water must not exceed 6,000 cubic kilometres per year.

Similarly, if carbon dioxide emissions are to remain within acceptable levels, the proportion of CO2 in the atmosphere must not rise above 350 parts per million. Together, the nine planetary boundaries represent the ecological ‘safe space’ within which human activity can take place.

The ecological audit in action

In the early 1980s, scientists detected a worrying depletion in the concentration of ozone in the Earth’s atmosphere, a gas which plays a crucial role in shielding the planet from life-threatening ultra-violet radiation emitted by sun.

Experts later discovered that the hole in the ozone layer was caused by increased commercial/household use of a group of ozone-depleting substances (ODS) known collectively as chloroflurocarbons (CFCs).

Thanks to a co-ordinated effort among governments worldwide, global restrictions on the use of such gases were put in place in the 1990s. As a consequence, concentrations of ODS in the atmosphere have been falling since they peaked in 1994.

Nevertheless, the ozone hole above the Antarctic will persist for decades.

Fusing the ozone depletion planetary boundary and LCA

The planetary boundary model states that the ozone layer should be 276 Dobson Units, or 276 millimitres thick.
For the ozone hole to begin to close, we calculate that the world's total emissions of ODS should remain below 6.6 billion tonnes per year. – Luciano Diana, Head of Environmental Investing
At the firm level, this means that the threshold for ODS emissions is set at 1.05 kilogrammes per USD1 million of revenue per year. Companies whose emissions exceed this limit are less likely to be considered for inclusion in the portfolio.

03

The private sector - a hotbed of innovation

But while a portfolio of the world’s most sustainably-run companies might meet the requirements of responsible investing, it does not necessarily guarantee full access to the investment opportunities associated with environmental change.

That is because a corporate ecological audit – however deep – cannot in itself unearth the firms that offer the best prospects for capital growth. Company-by-company research offers that possibility.
Fig. 3 -  Patents filed for environmental products, by region
By region
PATENTS FILED FOR ENVIRONMENTAL PRODUCTS, BY REGION
Source: World Intellectual Property Organisation

The next step in our investment process, then, is to find responsiblymanaged companies that are also capable of delivering consistently superior returns in industry sectors associated with environmental change. 

In conducting this fundamental research, we place a high premium on innovation and specialisation.

Recent years have seen a mushrooming of publicly-listed firms specialising in the development of innovative environmental products and services. Testifying to this has been a steady rise in the number of patents filed for environmental products over the past decade (see Fig. 3). And there is every reason to suppose this trend will gather strength. As public awareness of environmental matters grows and private organisations struggle to become more ecologically sound, products and services that can increase energy efficiency, raise recycling rates or reduce emissions will be in high demand.
Indeed, spending on environmentallylinked goods and services is, by our calculations, set to increase considerably over the remainder of this decade. As Fig 4 shows, our growth projections for the key segments of the environmental products and services industry suggest the market can expand by some 6 to 7 per cent per year over the next five years. All this has positive implications for environment-focused investors.
FIG. 4 - Size of adressable markets for environmental products and services, forecast, in usd billion
SIZE OF ADDRESSABLE MARKET FOR ENVIRONMENTAL PRODUCTS AND SERVICES, FORECAST, IN USD BILLION
Source: Pictet Asset Management; internal forecasts
Companies with specialised expertise often develop a competitive edge which, in turn, can translate into superior profit and revenue growth.

In our view, such ingenuity and growth potential are in plentiful supply in areas such as energy efficiency, water technology, and the dematerialised economy (see overleaf), segments that feature prominently in the Pictet AM Global Environmental Opportunities portfolio.

Energy efficiency

Using energy more efficiently will form a key part of the world’s transition to a more sustainable future. Currently, only about a third of the world’s primary energy – energy before it is subjected to any conversion or transformation process - reaches the point of use. Two thirds is lost along the way. Innovative technologies to reduce energy consumption and waste are already being introduced across a wide range of activities, including the manufacturing sector, construction, buildings management and transportation. These will have a strong influence on the energy flow within industrialised and emerging countries. The companies developing such technologies present compelling investment opportunities.

Water

It is in the area of water recycling, an activity which will be crucial in helping ease the strains on the world’s water supply, where the private sector’s innovative products are being deployed to particularly good effect.
Fig. 5 - Size of water re-use market, forecast, usd billion
Forecasts, in USD billion
SIZE OF WATER RE-USE MARKET, FORECAST, USD BILLION
Source: Global Water Intelligence

The world currently recycles just 20 per cent of its used water – an unsustainably low level.

The water treatment technologies being developed by private firms can have a significant impact on water re-use rates.

As Figure 5 shows, the market for water recycling equipment is expanding at a rapid rate.

Water recycling is just one of many areas where innovative private companies are making a difference.

The development of more efficient irrigation techniques is another area where such firms are leading the way.

04

Capitalising on the corporate drive to reverse environmental damage

Environmental pollution and the depletion of our forests and supplies of energy and water are threats to sustainability of our planet. Yet it is encouraging to know that the world’s corporations are alert to such risks. Influential research bodies such as the World Economic Forum have described adverse ecological change as one of the major risks to future economic expansion.
PICTET AM GLOBAL ENVIRONMENTAL OPPORTUNITIES STRATEGY, PORTFOLIO BREAKDOWN
PICTET AM GLOBAL ENVIRONMENTAL OPPORTUNITIES STRATEGY, PORTFOLIO BREAKDOWN
Source: Pictet Asset Management, as of 31.05.2015
At the micro-economic level, meanwhile, not only are companies beginning to reduce their impact on the environment, but a growing number are also developing products and services to help the world avert an ecological crisis.

In our view, firms that do both of these things represent an attractive investment proposition. Having a stake in these companies gives investors the opportunity to both safeguard the environment and secure potentially attractive capital gains.

05

Key takeaways

the viable environmental investment of the future

Governments worldwide are tackling the ecological problems.

On the one hand, they are investing heavily to reverse pollution, protect our natural resources and develop more efficient sources of energy On the other, they are introducing new laws and regulations to turn companies both large and small into better stewards of the environment.

Public awareness of pollution and environmental damage is building to a crescendo.  

Bearing testimony to this is the global social phenomenon that is “Under the Dome”, the film documenting the scale of China’s urban pollution that registered 200 million online viewings within days of its release. 

These shifts have significant investment implications. 

In our view, companies that combine strong environmental credentials with innovative products that can safeguard the world’s natural resources represent the viable environmental investments of the future. They are also the building blocks of Pictet AM's Global Environmental Opportunities strategy.