Between 2016 and 2020, China spent more than 5.5bn renminbi (715bn euros) on environmental investments. But these massive sums of money are yet to translate into interesting investment opportunities in the country. Fund manager Yi Du of Pictet Global Environmental Opportunities (GEO) explains why this is the case.
‘China’s environmental investments mostly take the form of subsidies, for example in the electrical vehicle industry. These subsidies will be gradually reduced over the coming years, and this makes it hard to judge whether companies will actually remain profitable without these subsidies,’ Du explains.
State intervention
In other segments of the market for sustainable investments, such as the production of sustainable energy, there’s still quite some state intervention as well. ‘The Chinese government pressures utilities to reduce energy prices. There used to be a national guaranteed price for renewable energy, but in the future provincial governments will be allowed to set their own prices. We expect prices will be lowered to counter the economic deceleration. This could be bad news for investors in these companies.’
Nevertheless, Pictet GEO has some exposure to China. ‘Within our investment universe, there are a lot of companies in China with insufficient return potential,’ says Du. ‘But we invest in foreign companies that are active in China. About 25% of the total revenue of the companies in our portfolio comes from emerging markets. The majority of this is from China.’
Some examples of western companies in the portfolio with a large exposure to China are Veolia Environment from France, which is specialised in waste-, water- and energy management, and the US biotech company Thermo Fisher.
Mixed ownership
The fund’s direct allocation to China-listed companies currently amounts to less than 2%. Asked about a Chinese company with good investment potential, Du highlights Beijing Enterprises Water (BEW), China’s largest listed water company. This is one of few Chinese companies that both generate at least 20% of their revenues or profit from environmental solutions (a requirement for eligibility) and are partly state-owned. The city of Beijing is a majority shareholder, while the board also holds a ‘significant’ share in the company. An ideal combination, according to Du.
‘We consider mixed ownership a big advantage’, he says. ‘BEW provides drinking water to the Beijing metropolitan region and treats waste water for industrial companies in China as well. The fact that Beijing is the major shareholder makes it easier for the company to win large contracts because it inspires confidence with prospective clients.’
At the same time DEW is sufficiently market-oriented because part of the shares are owned by the management, says Du. ‘This ensures the interests of the company and the management are aligned, and reduces the risk the company invests in non-viable projects for political reasons.’
400 companies
Pictet AM has identified about 400 listed companies globally that generate at least 20% of their revenues or profit from environmental solutions, making them eligible for the GEO fund. Presently, the three fund managers see the best opportunities in companies that help other companies to reduce their environmental footprint by providing them with the help of technology and software.
‘Those companies can help transform physical activities of their clients, such as testing new machines or cars, into virtual and digital activities so they can reduce their consumption of raw materials and energy in the production process,’ explains Du. Pictet classifies these companies in a separate category: dematerialized economy. The category has seen annual median revenue growth of 7.9% over the past three years.
Software
Examples of dematerialized economy stocks are the American companies Autodesk and Ansys, the fund’s two largest single positions. Both companies are specialised in engineering simulation.
‘These companies help for example car manufacturers in reducing their use of raw materials when developing new models. Before they had to consume tons of raw steel and energy to build prototype and test them. Intelligent software helps car manufacturers to do this digitally, significantly reducing the use of natural resources and energy,’ Du explains. Pictet has had a position in Ansys for more than 5 years, but has recently increased its position significantly.
Another market segment where Du sees opportunities abound is pollution monitoring. The market for testing equipment and air filters is growing fast, especially in emerging markets such as China. However, for now it’s mostly foreign companies benefiting from this trend. Such as the US firm Agilent.
‘This company has grown fast in China because their testing equipment is in strong demand by polluting industrial companies,’ says Du. The trade tensions between the US and China have had no significant effect on American companies active in China, Du claims.
Pictet Global Environmental Opportunities has beaten its reference index, the MSCI AC World, comfortably over both 1- and 3- and 5-year periods, partly thanks to its growth tilt. 2019 was an exceptionally good year for the fund: the fund posted a record return of 41.53%, compared to a return of 29.63% for the MSCI AC World Index.
You can find a recent factsheet of the fund here