Demand for sustainable investments has grown tremendously. But not all green stocks have performed well. In the second part of this series, industry experts provide some tips of what to look out for when investing in green companies.

TODAY, a wealth of indices are available to investors who want to track the performance of sustainable investments. Several ETFs have been created to reflect the performance of these indices.

These indices include the Nasdaq Clean Edge Green Energy Index, which tracks the performance of clean-energy technology manufacturers, distributors and developers. The Dow Jones Sustainability Index (DJSI), meanwhile, tracks the performance of sustainable companies across the globe.

However, not all who have sought to profit from investments in environmentally conscious companies have been rewarded. Some green stocks have performed exceedingly well, but others have not. 

For example, First Solar Inc — the largest solar panel manufacturer in the US — saw its share price fall from US$168.22 on Feb 18, 2011, to US$60.04 on March 16 this year. 

During the same period, its competitor SunPower Corp saw its share price double to US$31.94, while that of Denmark’s Vestas Wind Systems — the world’s largest manufacturer of wind turbines — rose from DKK172.3 in early 2011 to DKK283.60 on March 16.

Mutual funds have also delivered varying performances against the broader US equity markets. The Shelton Green Alpha Fund, one of the newer funds in the US, returned 51.92% over the past two years, compared with the S&P 500’s 32.84%. 

The Green Century Balanced Fund delivered a slightly lower return than its benchmark — 10.29% compared with the Custom Balanced Index’s 10.94% in the five years ended December 2014.

Not many of these funds have been well received in Malaysia. For instance, three funds that specifically catered to green investors have been liquidated. These are the Hwang Environmental Opportunities Fund, the CIMB-Principal Climate Change Equity Fund and the AmGlobal Climate Change Fund. Launched in 2007, these funds fed into target funds in foreign markets, but suffered losses of between 20% and 45% before shutting down. 

Like those of conventional stocks, the share prices of green stocks are driven by various factors. The recent plunge in crude oil prices sent solar stocks tumbling in the US, amid concerns that cheaper fossil fuel would result in lower demand for renewable energy. 

However, according to a January report by Deutsche Bank, the outlook for solar panel manufacturers is expected to be intact, as oil represents only 5% of global electricity production and the high solar demand from the US is expected to offset weakening demand from the UK and Japan. 

Electricity generated by wind power is expected to be cheaper than that generated by natural gas within a decade, according to the US Energy Department in a recent announcement. According to its March report, it is estimated that wind power can displace more than 12.3 gigatonnes of greenhouse gas emissions by 2050, which will save up to an estimated US$400 billion in damages to the environment.

This, however, does not necessarily translate into better prospects for solar and wind companies. “While solar panel manufacturing is expensive, costs will decrease over time,” says Loic Dujardin, director of research products at Sustainalytics, a global research firm that specialises in sustainability and SRI.

China is currently the world’s largest solar market. This is largely due to the government’s subsidies, which were introduced to encourage solar panel exports. 

“The solar sector is very closely tied to government backing. Therefore, when investing in solar panel manufacturers, one should look at companies that are less dependent on government subsidies,” says Dujardin.

Government support is important for these two sectors because solar and wind energy companies usually sell the electricity generated to those governments. 

“You have to consider the feed-in tariff rates that the government will be paying these companies for the electricity, and this depends on [the government’s] support for the green sectors,” says Jeanette Lee, head of private equity investment at RHB Investment Bank Bhd, whose role is to explore sustainable private companies as investments for high net worth clients.

“The returns for most infrastructure stocks are also typically lower than in other sectors. These businesses are also rather capital intensive. However, most infrastructure stocks will give you stable and predictable returns — they typically give single-digit yields,” she adds.

The water utility sector is set to become more important in green investing in the face of water shortages around the world. According to a January report by Bank of America Merrill Lynch (BoAML), demand for water is set to increase 40% come 2030. Brazil and California are currently coping with severe droughts. BoAML forecasts demand for water energy to double by 2035.

“In my opinion, the water treatment sector is the most promising because the world is facing a water issue,” says Dujardin. “In Asia-Pacific countries such as China, Indonesia and India, water is the number one challenge. If you don’t have enough water, your economy will collapse.”

Companies that are involved in water treatment or the manufacture of water filters will benefit more, he adds. “In China, we see that this generation of people are putting pressure on their government because they want safer and cleaner water. Water is a long-term investment story.” 

Dujardin says investors can look at such stocks as dual-listed French energy and utility company Veolia Environnement SA and Singapore’s Hyflux Ltd, which specialises in water treatment.

Like conventional shares, green stocks are not immune to volatility and sentiment-driven demand. Recently, the stocks of environmentally friendly Chinese companies saw a surge in prices following the release of a documentary on the air pollution in China. Some stocks jumped as much as 32% and approached the daily trading limit, according to news reports.

Jabusch warns that this volatility is to be expected. “Many of [these green companies] rely on technology, and therefore are volatile in the short term. I would say to anyone considering an investment in any of my portfolios that they need to have the long term in mind,” he says.

Ultimately, the prices of green stocks are driven by the fundamentals of a company. Corston-Smith’s Shireen says that at the end of the day, earnings delivery is what drives all stocks, green or not.

“Investors will have to look at green stocks the way they look at conventional stocks, which is the strength of their balance sheet, revenue generation and cash flow. [How these companies] develop technological advances will be one of the key areas that improve margins.

“Like any stock, a green company’s share price is driven in the short term by news about its prospects. But over the long term, its prices are driven by the actual value of its business, or its book value,” says Jabusch.

For Sustainalytics’ Dujardin, the ongoing environmental challenges mean that more governments will be forced to look at more eco-friendly solutions to deal with worsening the situation. “We are going to face more environmental issues, and now we see that governments are starting to tackle them. We will eventually see a shift in consumer behaviour. I think this will be good for green stocks.”

For green companies in the energy sector, it is important to see where they are in the competitive cycle in terms of technology and cost, says Shireen. “If there are tax incentives by governments to support their demand, and if the green energy initiatives are physically and operationally possible, then investors who are in it for the long term should be looking at these sectors.”

This article first appeared in Personal Wealth, a section of The Edge Malaysia, on March 23 - 29, 2015.

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