Clean tech booms despite the bubble talk

Clean tech – shorthand for the renewable energy and environmental technology sector – is where investors see the prospect for returns in the battle against global warming, despite talk of an asset bubble as the prices of some companies soar. In listed equities, a record 15.2% – €4.6bn ($6.5bn) from just over €30bn – of the total sales of global pooled equity funds in the first seven months of this year poured into ecological and environmental funds, according to data provider Lipper Feri. The same sector won only 2.6% of the total collect for 2006 and just 0.6% in 2005. In the unlisted sector, investment is also breaking records. From January to September this year, $5.7bn (€4.2bn) was invested in the sector, according to Venture Business Research. This figure was already 50% higher than the total of $3.8bn for 2006.
As a result, new fund launches and successful private equity closes are monthly events. In September, Canadian investor services firm Criterion Investments launched its Global Energy Fund, advised by Pictet Asset Management. Criterion said the clean energy investment universe had a market cap of $1.4 trillion with expected capital flows of $70bn a year. Impax Asset Management recently announced a £100m fund-raising for a listed environmental fund while London-based Ludgate Investments listed a new environmental fund for pre-IPO clean tech firms.Climate Change Capital, the London-based boutique investment bank, raised €200m for its first private equity fund targeting European companies in green power, transport, energy efficiency, water and waste, including money from Dutch pension funds PGGM and ABP and the UK’s Universities Superannuation Scheme. The fund took Climate Change Capital’s assets under management to over US$1.5bn in the sector. Investment banks have been allocating significant capital to the area while asset managers are working with both equity and debt partners on clean tech funds.
Returns are buoyant. The Nex Clean Energy Index, which tracks 88 companies listed on 25 exchanges worldwide, has risen by 94.7% since January 1, 2006, outstripping most global benchmarks. Investments range across a huge number of nascent sectors: biomass, small scale hydro-electric power, biofuel, solar and wind energy and related technology and service providers.
The logic for investment is clear. In recent weeks Sir John Holmes, the United Nation’s emergency relief coordinator warned that a record number of floods, droughts and storms around the world this year amounted to a climate change “mega disaster”. According to the best available science by the Intergovernmental Panel on Climate Change (IPCC), if the world continues as it is, the amount of carbon dioxide in the atmosphere could nearly triple by 2055.
Scientists recommend levelling off emissions until 2055, at which point emissions should be gradually decreased to the end of the twenty-first century. Alongside strong regulation, investment in clean technology will be crucial to achieving this. As a result, it will be a key driver of economic growth. For example, the IPCC believes future energy infrastructure investment to clean up existing energy plants, amongst other things, could involve decisions on US$20 trillion of capital by 2030. The United Nations has also published research recently which said that clean energy could provide almost a quarter of the world’s electricity by 2030. Today it accounts for just 2% of the world’s total, but the UN says 18% of all power plants under construction are in this sector. Many countries, such as those in Eastern Europe heavily dependant on Russian gas supplies for their power, see renewable energy as a growing means of self-dependency and national security. Investment in clean tech is no duck shoot though. It relies on correctly identifying the technology that will be supported by politicians pressed to find economically and electorally viable energy solutions. Controversy in sectors such as biofuel and ethanol production, where argument has centred on how much land can be realistically allocated to energy rather than food, as well as the environmental impact of clearing land for production, indicate the need for thorough research. Rising wheat and commodity prices have already pushed some biofuel focused funds into the red.
Wind power projects, among the best performers to date, are being tested by environmental controversy. Solar, the other top-performing clean tech segment, is experiencingsupply issues over the availability of polysilicon used in making photovoltaic cells.
Other fractious debates include the efficacy of clean-burn technology for coal, pushed by some as the answer to future oil shortages. In addition, market valuations of companies can be difficult to make when historical data is of little value, if, as many believe, we are at the start of a major energy revolution. Price to earnings ratios have risen to between 20-25 times for some companies in the clean tech area, prompting reminders of dot.com style hype, even if most are already cash generators compared with their internet predecessors.
Lux Research, a US-based consultant in emerging technologies has warned of a bubble in the clean tech energy. It said the value of global initial public offerings rose sharply from $1.6bn in 2005 to $4.1bn in 2006 and venture capital raised went from $623 million to $1.5 billion, primarily on solar and biofuel deals. Conversely, it said the air, water, and waste segments presented opportunities that were short of investment by comparison.
The prospects have not been lost on the relatively few pension funds so far committed significantly to clean tech as a source of future return. The recent €500m joint injection by ABP/PGGM to a private equity fund-of-funds via their jointly owned venture house, Alpinvest, was a watershed because PGGM announced it was part of its fiduciary duty to look at renewable energy bearing in mind its long-term investor status. Another pioneer, the Universities Superannuation Scheme (USS), started allocations to clean tech as early as 2000 when it invested in two funds with Merrill Lynch and Impax. The
fund now has about $200m either invested or committed to the renewable sector. David Russell, co-head of responsible investment at USS, said: “We saw the opportunitiesthen as a result of increasing regulation in this area. We then set about examining the potential investments and decided to invest in external funds rather than our usual in-house approach.” The fund restricted its investment to a maximum 10% of either fund for governance reasons.
It has since upped its allocation with Impax as the fund has grown. USS also has a sizeable allocation to renewable infrastructure, which falls into its private equity allocation. Again, Russell says the investment was driven by regulatory changes it felt would push long-term returns: “The decisions are always made by fund managers and the driver is performance.” The proliferation of unfamiliar names for institutional investors in the sector, particularly venture capital firms, means knowing your investment partner is paramount.
Consultants say there are a number of serious potential fund winners in the clean tech sector, but also many charlatans in the shape of managers promising high returns without the necessary skills, rigour or risk management. Mark Campanale, associate director
of London Bridge Capital a corporate finance boutique which specialises in renewable and environmental technology, says a fund-of-funds approach for pension funds in unlisted investments makes sense bearing in mind that about 1200 private equity and venture capital funds have made investments or have said they will invest in the clean tech field, according to research by New Energy Finance. He says money should not just be aimed at start-ups, noting the prospects for expansion plans at larger, moreestablished energy companies.
Campanale says one “dog that hasn’t yet barked” is real estate: “Pension fund property allocations have been very high but there has almost been nothing clean tech related in the sector. One question all investors should be asking is whether they can get higher returns from property through reduced energy costs or decentralized energy strategies such as small scale hydro electric or biomass energy production. It’s amazing how many funds are out there with the word sustainability in them that don’t invest in the clean tech space, but do rather strangely spend a lot of time comparing whether Shell is more efficient than BP”

“It’s amazing how many funds are out there with the word sustainability in them that don’t invest in the clean tech space.”

Florian Sommer, senior SRI analyst at Fortis Investments, says institutional investors should not only seek to generate good investment returns, but also offer a broader social and environmental return: “Surprisingly, the SRI industry has not focussed on measuring and communicating this broader return. Turning a blind eye has led to some rather strange outcomes. For example, the Dow Jones Sustainability World Index – perhaps the best-known SRI benchmark – includes Total and Shell, but not a single solar company.
But who provides the solutions for tackling climate change: the alternative energy sector or the oil industry?”
Sommer says it is important that once the environmental benefit of a technology is established, it’s value cannot simply be simply assign to the one industry that produces the final benefit: “We need to apportion it throughout the value chain of that industry. For example, the environmental benefit of solar energy needs to be apportioned across silicon, wafer, cell and module production.”
Ian Simm, managing director at Impax Asset Management, which has €930m under management, €500m more than it did a year ago, says there is a consensus amongst investment analysts that the clean tech sector is producing earnings growth of 20% per annum, much faster than the economy. He sees further growth in areas such as the liberalisation of markets for water, energy and waste as well as renewable energy, water quality, recycling targets andclimate change technology: “Investors need to cast a wide net in this area to reach the 600 plus quoted companies and double that in unquoted companies, 85% of which are in Western Europe, North America and Japan. The advantages in investing in clean tech are a low level of correlation with portfolios plus a large amount of corporate activity in terms of larger companies buying up smaller rivals.”
In terms of stock market floats, Simm is cautious: “We have only invested in about 10% of the initial public offerings that have come to market recently because we believe there are a lot of banana skins around, particularly in the area of biofuels. There is a feeling that some solar and wind investments may be overvalued, although we still have some investments in these sectors. We see bigger opportunities though in energy efficiency and waste management.”