Introducing Schroder's climate change fund

Learn about the seminar on Schroder ISF Global Climate Change Fund.

On an almost daily basis, we are bombarded with news on climate change, whether through reports of broken temperature records, extreme weather events such as hurricane Katrina, or the disappearing habitat of polar bears. While a few sceptics remain, it is now accepted by the majority that we are experiencing global warming, and that human activity is, at the very least, a contributing factor.

Many regard climate change as the single most serious issue facing the human race, with the potential to cause widespread suffering and economic damage affecting literally billions of people. Yet the implications for investors have had relatively little serious coverage.

Schroders' fundamental case is that climate change is likely to have a profound impact at every level, from the macro economic environment, to particular industries and individual companies. Simply put, climate change will be one of the biggest investment themes for the foreseeable future.

While many of the potential effects are undeniably negative, climate change also presents significant opportunities, and almost every company, whether directly connected to climate change or not, has the potential to be affected - as every business of whatever type located in New Orleans found to their cost.

Background

However, the earth is not being left alone. People are taking actions that can change the earth and its climate in significant ways.

The single human activity that is most likely to have a large impact on the climate is the burning of fossil fuels, such as coal, oil and gas. These fuels contain carbon, and burning them makes carbon dioxide gas.

Carbon dioxide gas traps solar heat in the atmosphere, partly in the same way as glass traps solar heat in a greenhouse. For this reason, carbon dioxide is sometimes called a "greenhouse gas".

As more carbon dioxide is added to the atmosphere, solar heat has more trouble getting out. The result is that, if everything else stayed unchanged, the average temperature of the atmosphere would increase.

As people burn more fossil fuels for energy, they add more carbon dioxide to the atmosphere. If this goes on long enough, the average temperature of the atmosphere will almost certainly rise.

This in turn will cause changes in the amount and pattern of rain and snow, in the length of growing seasons, in the frequency and severity of storms, and in sea levels. Farms, forests, and plants and animals in the natural environment, will all be affected.

While carbon dioxide is the main culprit, it is not the only gas released by human activities that can cause warming; human emissions of methane and nitrous oxide together contribute almost half as much to warming.

Globally, the US is the principal source of greenhouse gases, while China is closing in and India is coming up from behind. Contrary to the widely held notion that cars are the main source of emissions, the biggest contributor is actually power generation. Coal is a cheap source of power, and both the US and China have vast reserves to fuel their economies. Rocketing natural gas prices have also led to a boom in the building of coal-fired power plants in recent years.

What do these mean to you as an investor?

By focusing on leading and progressive companies with the greatest growth potential that stand to benefit from mitigation or adaptation of climate change, you can potentially stand to gain from the biggest investment theme of today.

How do these changes translate into investment opportunities?

For investors the most important fact is not that climate change is happening but that governments and regulators are already reacting to the perceived threat of climate change. They are reacting by introducing legislation designed to reduce greenhouse gas emissions by changing economic behaviour which in turn is creating a wide number of investment opportunities.

• Climate change regulation (and the prospect of more of it) is changing the way companies think about running their businesses, and leading them to invest in new areas.
• Massive investments are now being made in R&D by many industries in an effort to conform to the tougher emission rules and regulations.
• Companies which can capture the opportunities presented by these regulatory changes stand to achieve a strong, competitive and sustainable advantage.
• Governments around the world are pushing for regulations on the amount of carbon emissions by companies. The European Union Emission Trading Scheme (or EU ETS) is the largest multi-national greenhouse gas emissions trading scheme in the world. It commenced operation in 2005 with all member states of the EU participating in it, and contains the world's only mandatory carbon trading program. The program caps the amount of carbon dioxide that can be emitted from large installations, such as power plants and carbon intensive factories, and covers almost half of the EU's carbon dioxide emissions. It is only a matter of time before other countries follow suit.

What are some examples of these companies?

The Schroder ISF Global Climate Change Equity (the "Fund") aims to capture the key themes that Schroders believes will encompass the most attractive long term investment opportunities. These may include:

• Power Generation
• Energy Efficiency
• Cleaner Transportation
• Agro-Business
• Forestry
• Water Resources
• Coastal & Ecosystems

Power Generation

We cannot move to these solutions overnight, so interim solutions such as natural gas or coal gasification also have an important part to play.

90% of solar energy is based on silicon. Silicon is the world's second most abundant element, but very pure poly-silicon is required for solar, and this extensive refining is capital intensive,

creating barriers to entry. One beneficiary of this is MEMC, a leading poly-silicon and silicon wafer supplier. New investment is needed in the electricity transmission infrastructure, to carry electricity from new power generators, such as wind turbines, to the population centres. One company that stands to benefit from the multi-year investment cycle is ABB, a clear market leader in a concentrated transmission and distribution industry. Natural gas is twice as ?clean' as coal for producing electricity, and demand for services to the industry is therefore forecasted to grow strongly as the cost of carbon is increasingly priced in. A resulting beneficiary is Nabors, a major oil and gas services company supplying to the natural gas industry in the US.

The companies mentioned are for illustrative purposes only, and do not represent any recommendation to invest or the Fund's intended holding of the stock.

Energy Efficiency

Light-Emitting Diode (LED) lamps and TVs are a highly energy efficient technology, delivering up to 85% energy savings on domestic lighting. Philips is a clear industry leader in this area, being a manufacturer of the popular Luxeon, a high-power LED. It is not just gas-guzzling cars that contribute to emissions; aeroplanes are another significant source. Carbon fibre is a material increasingly used in the aerospace industry as a lightweight replacement for aluminium, thereby increasing the energy efficiency of the aircraft. One market leader in the carbon fibre industry is Toray. SKF's deep groove ball bearings and tapered roller bearings reduce energy loss by up to 30%. Demand for such new products has accelerated total SKF organic growth significantly over the last few years. SKF is the market leader in bearings and therefore a pure-play on energy efficiency improvement.

Cleaner Transportation

In the short term, much stricter emissions standards for gasoline and diesel engines will cause a shift to more fuel efficient vehicles, benefiting auto companies with leadership in those products.

With world focus now turning to low emission vehicles, hybrid cars are gaining popularity as they are significantly more fuel efficient. Toyota is a product leader in this field, with over three quarters of global hybrid vehicle market share.

Honda Motor produces some of the most fuel efficient cars in the world, in almost every category. Their product range therefore places them well to gain market share as consumer preference and government incentives shift demand lower emission vehicles. Energy Conversion Devices holds important patents on designs for nickel metal hydride batteries, which are increasingly in demand for hybrid electric vehicles. The company has licensing agreements with several auto manufacturers.

Agro-Business

The impact of global warming on crops and farming globally will result in changes in yields in some regions and crops, due to warmer conditions and changes in growing period.

Increased use of biofuels globally is also supporting a boom in the global agriculture industry, pushing up commodity and food prices.

The vast investment potential in this theme ranges from tapping into the growth of the agricultural business in booming regions, to investing in technologies that can mitigate the impact of lower yields.

Biofuels are a key focus of US renewable energy policy. US ethanol production is forecast to double by 2012 and corn prices, as the main feedstock, have more than doubled since the policy was introduced.

Increased farm profitability has also driven willingness to invest in new farm equipment, and farm equipment suppliers share prices have taken off. Two beneficiaries of this are farm equipment suppliers Deere and AGCO.

The largest single use of ethanol is as a motor fuel and fuel additive. Sugar cane not only has a greater concentration of sucrose (about 30% more than corn) but is also much easier to extract. Cosan is the major ethanol producer in Brazil, where the sugarcane feedstock grows so well that production costs are well below international levels. Cosan is therefore among the lowest cost producers in the global biofuels industry. The companies mentioned are for illustrative purposes only, and do not represent any recommendation to invest or the Fund's intended holding of the stock.

Forestry

Increasingly, there may be more financial incentives to increase forest areas, to reduce deforestation, and to maintain and manage forests.

Forestry is in the sweet spot of increased demand and reduced supply, and we think the value of forestry assets will be revised higher. Demand is growing as wood is an energy-efficient construction material

as well as an energy source. On the other hand, supply is limited due to efforts to clamp down on illegal logging in tropical regions, as well as pressure on timber land for conversion to agriculture. Sino-Forest Group is a leading commercial forestry operator in China, operating in ten key provinces in China and managing more than 350,000 hectares of plantation trees. Plum Creek and Rayonier are two of the largest private timberland owners in the US. Both are listed as Real Estate Investment Trusts (REITs), which offers investors an ideal way to participate in the ownership of a diversified portfolio of professionally managed timberlands.

Why Schroders for Global Climate Change?

In addition, using the specialist resources from our Commodities, Agriculture, Medical Discovery and Energy funds, the Fund can produce some of the best ideas from which the portfolio is constructed. The experienced team behind the Fund includes:

• Two Portfolio Managers, Simon Webber and Matthew Franklin, who combine consumer, technology and industrial expertise to cover the climate change universe efficiently;
• Four Global Sector Specialists, who work closely with over 60 local fundamental equity analysts worldwide; as well as
• Two Climate Change Specialists, who advise the portfolio managers on the science, government policy trends and regulatory developments relating to climate change, and help define the investment universe of the Fund

There is now a wealth of evidence which indicates that climate change is a reality, and further to that it is a reality which has wide ranging implications. Environmental papers on this subject point to the fact that changes in the environment will have ?hard nosed economic implications', highlighting the need for asset managers such as Schroders to consider how we can incorporate environmental considerations into our investment processes.

Source: Schroder Investment Management (Singapore)