A year ago, after the Japanese earthquake, German chancellor Angela Merkel took the bold decision to phase out nuclear power in Germany, today responsible for 20% of the country’s electricity supply, and further increase use of renewable energy. The latest version of the country’s energy law, confirmed at the start of 2012, sets a requirement of not less than 35% of total German electricity to be generated from renewables by 2020, not less than 50% by 2030, 65% by 2040 and 80% by 2050.
A recent estimate from the DIW economic institute in Berlin is that this will require €200 billion of investment in the medium term, not all of it public sector. Some will come from state-subsidized loans and a proportion from private-sector companies investing in their own right.
But uncertainty over government finances clouds the picture of how best investors should play the cleantech theme. Only five years ago, Spain was the most attractive country for renewable investment but today it has dropped out of the top 10, finds Ernst & Young, as the government has temporarily suspended premiums paid to all new renewables plants. Meanwhile the developed world equity capital markets have cooled their earlier enthusiasm for renewables. Cutting-edge investors in the sustainability area are having to fine-tune their approach.
Low-carbon index
"Our first investment product is more associated with the clean-tech space," says Gerrit Heyns, a partner at Osmosis Investment Management, which constructed an index of low-carbon-economy companies against which Legal and General manages a unit trust. "The index is more than just companies that produce solar panels and wind turbines: it includes a wide array of companies involved in energy-saving technology as well as water and waste management. The strategy consists of predominantly small and mid-cap companies that are helping the world transition to a less carbon-intensive future."
Osmosis sought to widen its approach by rummaging through the voluminous sustainability reports that most large public companies now attach to their annual reports and 10K and other regulatory filings. Sticking to the theme of resource constraint, Osmosis sought to identify the most efficient companies by metrics that measure consumption of key resources – energy and water – per unit of revenue and similarly production of unrecycled waste per unit of revenue. It has compiled a database to identify the most resource-efficient companies across sectors and countries in all the constituents of the MSCI World index.
| “The strategy consists of predominantly small and mid-cap companies that are helping the world transition to a less carbon-intensive future” Gerrit Heyns, Osmosis Investment Management |
It sounds simple and the data is all there – indeed Osmosis only uses publicly available data that have been properly audited and confirmed – but it’s a real geek’s job to crunch the figures. "You might think that measuring resource efficiency for companies where there is an obvious key determinant – airlines, for example – is easy," says Gerrit Heyns. "But most airlines will report jet fuel consumed per kilometre seat mile travelled and, trust me, reverse engineering seats and kilometres to then establish a tonnes-of-carbon-equivalent-produced figure that you can compare with a revenue number isn’t a lot of fun. Similarly, a company like John Deere has in the past reported total waste, hazardous waste and greenhouse gas emission measures in kilograms per ton of production. But as those items can range from combine harvesters to golf-course irrigation systems, working back through product tonnage numbers to calculate resource efficiency per unit of revenue is hard work."
But what Osmosis has found is useful for investors.
It seems to have found a practical way to marry sustainability and investment returns, using non-financial data that is freely available to arrive at companies displaying impressive financial figures.
Having constructed its index of resource-efficient companies and indexed back against the MSCI World to 2005, Osmosis has found that a portfolio that includes the top 10% of resource-efficient companies in each sector of the economy shows financially attractive characteristics: high returns on assets, high returns on equity, high operating margins and relatively modest leverage. It outperforms the MSCI World.
The spread between the Osmosis strategy of resource-efficient companies and the MSCI World Index shows a Sharpe ratio of 1.4 on an annualized spread of 5.7% over seven years.
Heyns says: "After we first produced this, investors suggested that we take it to the investment banks to capture the spread through structured notes, warrants, delta one swaps for private banks and wealth managers. We’re now doing that in conjunction with Credit Suisse."
Attracting institutions
Osmosis is also attracting larger, more traditional institutional clients. Oxford University Endowment Management, as an example, already manages money against it. The strategy is especially interesting in countries with a well-developed sustainable investing culture.
The index includes the most resource-efficient companies across all the main industry sectors. That includes some that ethical investors in the sustainability world might avoid: mining, tobacco, armaments. Osmosis argues that pragmatic sustainability should extend to all corners of the productive economy, even those industries whose ethics some investors question.
Heyns says: "We have had investors come to us and ask us to take out companies that may have produced something they object to – say cluster bombs, and other things that are specifically harmful or offensive – and we can easily do that and customize the strategy." He points out, though, that "aerospace and armament companies, just as in other sectors, have outperformers and underperformers in resource efficiency".
The findings seem to show that economics as much as ethics drives companies’ investments in resource efficiency. Japanese steel companies are so resource efficient that one, Blue Scope Steel, recently underbid on a tender to collect rubbish in Tokyo because it has invested in the technology to burn waste in steel production. This was a consequence of the high cost of landfill waste disposal in Japan going back 20 years.
Doing good might be a nice by-product, but the initial incentive was purely economic. Blue Scope now licenses and sells the technology.
