Seeking Profit From Sustainability

It’s a widely held belief that the Chinese term for “crisis” is composed of characters translating as “danger” and “opportunity.”  While not strictly true, the concept holds — crises can result in opportunities. That includes environmental crises, along with long-term efforts to put the world’s consumption of energy, water and other resources on a more sustainable footing.

The idea that these efforts can lead to investment opportunities is the philosophy driving Impax Asset Management, an investment management firm founded in 1998 that focuses on companies and projects addressing environmental challenges and the efficient use of resources.

Impax claimed $9.4 billion in assets under management or advice as of August 31, 2017, up 39% from the beginning of the year. About 85% of the assets are in funds of publicly held companies, while the rest are in a pair of private equity funds focused on renewable energy infrastructure projects and companies, and a real estate fund targeting properties to be retrofitted to improve resource efficiency.

Helping establish the firm in the realm of impact investing are proprietary metrics it developed to gauge a company’s impact on the environment. Since 2007, Impax has worked with the index provider FTSE Russell to develop and manage indexes of companies serving environmental markets, which other fund managers use as the basis for index funds or as benchmarks for ones that are actively managed.

Extending Its Reach

Ian Simm, Impax’s founder and chief executive, started the company after seeing investment opportunities while working as a management consultant with McKinsey & Co. The U.K.-based firm has added offices in Hong Kong, New York and Portland, Oregon.

“We’ve served clients in the United States for more than a decade,” says Simm, “but in the last five years, our U.S. business has really taken off due to increasing interest in the markets in which we invest, particularly from pension funds, foundations, endowments and family offices.”

In September, Impax announced it was planning to acquire Pax World Management, which will become its U.S.-based mutual fund division. “Post the closing of this transaction, the group will have almost half its staff and assets in both the U.K. and U.S., and will offer clients extensive resources in both research and portfolio management,” Simm says.

The firm initially offered a Specialists strategy, which targets companies with at least 50% of their revenues tied to environmental solutions. They tend to be on the smaller side in market cap, and often have closer to 80% of revenues tied to environmental solutions. As such they can pose considerable tracking error for a fund, an outcome that appeals to many institutional investors.

The firm has added a Leaders strategy that requires only 20% of revenues to be tied to environmental solutions, although in practice it tends to be more like 60%. This approach accommodates larger-cap companies and reduces volatility and tracking error, providing a more suitable offering for individual investors.

Thinking Long-Term

With both strategies, fund managers invest with a time horizon of three to seven years, says Hubert Aarts, the co-head of listed equities. “The investment philosophy is inherently long-term, expecting government policy changes and changing consumer patterns, which tend to take place across long time frames.”

Over 20 years, Aarts notes, managers have been able to maintain their performance through several economic cycles. “This is partly due to our strategies being structured in a way that allows us to tilt between cyclical and defensive stocks as required. We are also well diversified geographically and by environmental theme, and incorporate risk analysis as part of portfolio construction.”

Currently, he sees three areas as particularly compelling:

• Emerging markets, where he sees strong growth prospects and valuations that are often attractive.
• LEDs, with support from tightening regulations, and next-generation “connected” lighting that integrates sensors.
• Water in the era of the Internet of Things and Big Data, with connection of smart meters and pumps and advances in leak-detection, making systems simpler and cheaper to run.

Measuring Impact

While many investment managers rely on third-party research to assess companies’ environmental impact, Impax does it in-house. “We believe we were the first listed equities managers to develop a methodology of measuring and reporting detailed environmental impact,” says Lisa Beauvilain, head of sustainability & ESG, who co-heads the impact development work.

The metrics support the firm’s research and enable it and investors to evaluate its holdings. The metrics measure CO2  emissions, renewable energy generation, treated or saved water, and the recovery and recycling of materials.

“These metrics allow us to demonstrate a more complete picture,” Beauvilain says. “With carbon, for example, we not only look at direct and indirect carbon emissions, but also the carbon savings and avoidance of each company.”

The firm takes a conservative approach, she adds, by assigning a zero value where data is unavailable or calculations can’t be made, actively engaging with companies to obtain better data, publishing the methodology, and subjecting it, the data and the calculations to assurance by consulting firm EY.

Using the metrics, Impax calculated that $10 million invested in its Specialists strategy in 2015 led to the net avoidance of 7,600 tons of CO2 ; the generation of 3,100 megawatt-hours of renewable energy; the provision, saving or treatment of 2.4 billion liters of water; and the recovery or treatment of 700 tons of material and waste.

Impax works with FTSE to manage and evolve the classification system underpinning the FTSE Environmental Markets Index Series, and more recently has helped develop the FTSE Low Carbon Index. “These indices provide investors with a benchmark, and have led to the development of various index tracking products, attracting further investment into the markets and facilitating the flow of capital to a more sustainable economy,” Beauvilain says.