How to invest in clean tech

A guide to selecting investment strategies and fund managers in this nascent asset class.

A variety of funds are now available to long term investors wanting to capitalise on the investment opportunities present in clean energy and technology. In brief, funds tend to be private or public equity, project finance (including infrastructure) or a combination of these. Funds can be sector or theme specific, ranging from broad clean tech funds to narrower alternative energy funds or even narrower ‘niche’ funds such as methane recovery and water funds. Most funds are actively managed; although a number of public equity index funds have recently been introduced as have exchange-traded funds. At Mercer, we have undertaken considerable research into the investment opportunities available in these areas. With many hundreds of funds available to investors we have focussed our initial research efforts on a selection of funds across a number of asset classes, geographic regions, sector focus, size and business structures. Some of the early insights and common investment characteristics we have encountered are:

  • Investment horizons tend to be long-term, and investors may wish to take a longer-term view to allow the maturation of markets, investment managers and investment opportunities* Risk and return profiles are hard to establish given the relative immaturity of these sectors and their associated uncertainties.

Risk and return are driven by the underlying holdings that will tend to have high idiosyncratic risk and characteristics of sector concentration.

“Most funds do not yet have meaningful track records.”

Many fund managers are estimating that their funds will have comparable risk and return profiles as their counterparts in mainstream private or public equity markets, or project finance and infrastructure, although this varies on a fund-by-fund basis. Most funds do not yet have meaningful track records. Where track records exist these may be unhelpful in trying to forecast future risk and return profiles due to the rapidly evolving investment environment in which they are operating. The business environment five years ago in this area is vastly different to the operating environment today.

  • Manager skill is likely to be a decisive factor.

The clean energy and clean tech sectors are still young and rapidly evolving, and it is very difficult for even experienced technicians or investors to keep up-to-date with new technologies and opportunities that are emerging throughout the world across these sectors.
‘Niche’ funds that track a single sub-sector allow fund managers to become experts in a particular area, develop a strong network of contacts, and enable superior access to investment opportunities. The funds with the best chances of success are likely to be those that have a clearly articulated focus that is designed to suit the experience and skill set of the manager or team and the resources at their disposal. In such a dynamic field, and one so dependent on a mix of technology, politics and economics, a team that can demonstrate an ability to correctly forecast and stay ahead of current trends has a definite head start.

  • Funds are being launched by both boutique organisations, as well as large, well-established financial organisations, either directly or through affiliations.

Each organisational structure can have its advantages. For example, the backing of a large organisation can be positive as it can bring business management benefits, access to resources and access to investment opportunities. Boutique organisations on the other hand may be able to move more quickly, have greater freedomand be less hindered by bureaucratic processes. In assessing manager ability, it is more difficult to get a true sense of how well run and controlled these smaller players are, and so investors looking to invest with a smaller organisation need to look even more closely at the management of business to consider whether the financial and management resources are stable and sufficient.

  • Idea generation and implementation are crucial to the overall success of the fund.

Given the rapid increase in capital being allocated to this sector, if there is a lot of money chasing too few investments, there is the danger of a bubble being created where companies become over-valued due to immediate market conditions as opposed to long-term value creation prospects.
In our research, we found a variety of approaches to idea generation and implementation, concluding that funds that actively research the sector, source their own deals, and use their personal networks to find leads are likely to have better access to good investments than those that passively screen direct approaches, and are therefore better placed to perform in the long term.

  • In portfolio construction, diversification is a key issue for investors wanting to reduce their portfolio risk.

This may be done through consideration of a mix of fund characteristics such as geographic distribution,

asset class, sub-sectors and stages of technologies. For example, broader strategies such as particular cleantech funds will include a range of sectors from energy to information technology whereas niche funds will obviously offer less diversification. In addition, the variety of asset classes discussed previously offers a way to address diversification. Investors may also consider one of a few cleantech/clean energy fund of funds. In summary, the risks here are similar to those of other investment strategies, requiring the viewing of cleantech in the context of an investors’ overall portfolio.
For investors considering an investment in these types of funds either a satellite investment or a part of the normal asset allocation (i.e. private equity allocation, public equity allocation, alternative assets allocation, etc.) may be appropriate. Either way, while only a small portion of the assets is likely to be invested, the investment should be meaningful to ensure active oversight of the investment.
Benchmarking is notoriously difficult to undertake in this area, whatever the asset class. This is due in part to the wide definitions being used by fund managers. For example, one clean energy or clean tech fund may be defined very differently to another making it difficult to compare like with like. Similarly, clean energy or clean tech public equity funds have severely restricted universes and different capitalisation exposures in comparison with mainstream global equity indices such as FTSE Global or MSCI World. As these sectors mature, benchmarking may become easier. In the meantime, a cautious and developed understanding of theexpectations of the funds and how it fits into the overall portfolio are recommended, together with close monitoring and oversight. Clean and renewable energy investments could play an important (and multi-dimensional) role within a long-term investor’s broader investment strategy.
Generally they will be viewed as an absolute return investment and due to their high specific risks will probably have a relatively small but meaningful allocation within a diversified portfolio.

“Benchmarking is notoriously difficult to undertake in this area”

Given the secular trends in place, and the idiosyncratic nature of investments, we expect a low correlation with other assets. Hence, a diversified “clean” portfolio can, in turn, offer diversification benefits by lowering the overall risk of the investor’s portfolio. For investors pursing responsible investment strategies, cleantech may offer the benefits of allocating resources to the resolution of environmental issues.
Long-term investors are now beginning to direct their money into these funds. State-sponsored funds that have invested funds include California Public Employees’ Retirement System, Oslo Pensjonsforsikring (Norway’s largest municipal pension plan), ABP (the Dutch government and education sector retirement fund), the Ontario Teachers’ Pension Plan in Canada and several local authorities in the UK.
Investment has also come from corporate pension funds
including British Airways. Many major corporations including GE, Siemens, Shell, BP, Sanyo and Sharp, have also made considerable renewable energy investments and acquisitions.
Finally we would note that ‘clean energy’ does not necessarily mean ‘responsible’ or ‘environmentally friendly’. The growth potential of the clean energy and clean tech sectors has led to many funds brandingthemselves ‘cleantech’ in order to ride the wave of popularity, but many do not consider the true social or environmental impact of their investments alongside the financial returns. Hence investors looking at this sector as part of a responsible investment strategy need to ensure they identify funds that have a philosophy aligned with their own.
Emma Hunt is head of responsible investment, Europe at Mercer Investment Consulting