Morning Note: Market news and an update from Impax Environmental Markets.

Market News

Asia stocks were little changed this morning after gains on Wall Street on Friday – Hang Seng (+0.1%); Shanghai Composite (-0.1%). The Nikkei 225 was closed for a holiday. The yen carry-trade blow-up is haunting markets rattled by the rapid-fire unwind and consequent fade-out. Traders are trying to gauge whether most of the selling is over as so much leverage had built up around a trade JonesTrading called the “epicentre of everything in markets right now.”

The options market is pricing in ongoing volatility around both Wednesday’s US inflation report and Jerome Powell’s Jackson Hole appearance later this month. Michelle Bowman said she still sees upside inflation risks and may not be ready to support a Fed rate cut next month.

The FTSE 100 is currently trading 0.4% higher at 8,203. BT Group is up 7% on news that India’s Bharti Enterprises is to buy a 24.5% stake in the company from Altice UK for £3.2bn. Bharti says it has no intention of making an offer to acquire the whole of BT.

The UK should not be “seduced” into thinking the battle against inflation is over after a short-term drop in the headline measure, the BOE’s Catherine Mann told the FT. Sterling trades at $1.2764 and €1.1688.

US oil refiners are cutting run rates this quarter due to weakening demand, adding to concerns that a global crude glut is forming. Brent Crude is currently $79.80 a barrel. Gold ticked up to $2,440 an ounce.

Source: Bloomberg

Fund Update

Impax Environmental Markets (IEM) has this morning released its half-yearly results for the six months to 30 June 2024. Although the backdrop remains difficult for investment trusts, the fund’s portfolio companies continue to trade well. The shares continue to trade on a sizeable (10%) discount to NAV.

IEM is a £1.1bn London-listed investment trust that invests globally in companies active in the growing resource efficiency and environmental markets. The managers are the highly respected Bruce Jenkins Jones, Jon Forster, and Fotis Chatzimichalakis. The ongoing charge is a reasonable 0.81%.

The fund is founded on the belief that, with insatiable demand for higher living standards on a finite planet, companies enabling the cleaner and more efficient delivery of basic needs – such as power, water and food – or mitigating environmental risks like pollution and climate change, will grow earnings faster than the global economy over the long-term.

The fund is well placed to exploit themes including resource scarcity exacerbated by expanding global population, replacement of ageing infrastructure, demand for new infrastructure driven by urbanisation, energy security, climate change, and environmental pollution. In particular, we would highlight the transition away from internal combustion engines towards hybrid and electric vehicles, the global push to reduce plastic waste and the move away from single-use plastics, and the drive towards more efficient use of resources.

Looking forward, IEM should benefit from the requirement for countries to improve energy security, the drive by thousands of companies to achieve “net zero” targets, and regulations such as the US Inflation Reduction Act, which support US domestic manufacturing in emerging industries. Most recently, China’s third plenum has, for the first time, pledged to pursue decarbonisation, signalling a significant policy shift for the world’s largest emitter.

The manager uses a proprietary classification system to define six higher growth markets: Energy, Clean and Efficient transport, Water, Circular economy, Smart environment, and Sustainable food. To qualify for IEM’s investable universe, a company must derive at least 50% of its revenue from these markets. As a result, IEM’s investments are predominantly in small and medium-sized companies, which tend to focus their business models on fewer activities. The (predominantly quoted) companies provide, utilise, implement or advise upon technology-based systems, products or services in environmental markets, particularly those of alternative energy and energy efficiency, water treatment and pollution control and waste technology and resource management (which includes sustainable food, agriculture and forestry).

The first half of 2024 has been marked by material volatility, which have created an uncertain backdrop generating headwinds for the small- and mid-cap companies in which IEM invests. As a result, net assets fell by 8.8% to £1,113m, while the NAV per share fell by 0.5% to 429.3p, helped in part by the reduced share count (see below). After a period of strong performance in the three years to end 2021, the fund has struggled over the past two and half years, pulling the longer-term returns down. Despite the decline in asset value, the manager highlights that the underlying earnings of the portfolio companies remains robust with excellent prospects for growth.

As at 30 June, the portfolio breakdown was resource efficiency & waste management (24%), energy management & efficiency (22%), water infrastructure & technologies (18%), sustainable food and agriculture (15%), Digital infrastructure (11%), Alternative Energy (10%), Transport Solutions (3%), Environmental resources and services (3%). By geography, the fund is split across North America (59%), Europe (36%), and Asia Pacific (10%).

The portfolio has a good balance of cyclical and defensive stocks, although pockets of weakness continue to be driven by temporary headwinds such as inventory destocking in solar, bioprocessing, and some select industrial stocks. We note across the fund there is c. 20% aggregate exposure to construction.

At 30 June, there were 62 holdings – the usual range is 55-65. The top 10 stocks account for 28% NAV, with the largest at 3.5%. The largest current holdings are Stericycle (regulated medical waste management services); PTC (lean manufacturing software); Pentair (energy and water efficient systems); DSM Firmenich (specialty chemicals); and Aalberts (fluid technology).

The relative valuation of the portfolio fell during the first half – at the end of last year, the average PE was 20.7x, a 26% premium to the MSCI ACWI. That multiple was little changed in the first half, but the premium fell to 16%. IEM has start to see the benefits of M&A as market participants acknowledge the disconnect between holdings’ long-term growth prospects and their low valuations, with Stericycle and Terna Energy both subject to takeover bids.

The dividend policy is to pay out substantially all earnings by way of dividends, the quantum of which is affected both by the level of dividends received by the company and by the number of shares in issue. The payout for 2023 was 4.6p (1.2% yield), whilst last week the group announced a first interim dividend for this financial year of 1.8p, up 6%.

A modest level of gearing is used – up to 10%. In a bid to avoid over-burdening its fund managers with too much cash, the board has already restricted the amount of borrowing it uses to ‘gear up’ investment returns. However, the de-rating of the portfolio compared with wider equity markets creates a compelling valuation and, for this reason, the fund has increased its gearing. As at 30 June 2024, it was 7.5% with average borrowing maturity around nine years with a mix of fixed (40%) and floating (60%) debt.

As an investment trust, the shares trade at a premium/discount to NAV. Although they traded at a premium between 2019 and 2021, for much of the time before and since, they traded on a discount, sometimes as high as 20%. The discount is currently around 10%, a narrower margin than the market average of 14.6% and the company’s own AIC sector (c.25%). In response, since 2022 the board has been buying back shares at a steady rate, with 21.8m repurchased in the first half (7.7% of the issued share capital). All buybacks were accretive to the company – by 0.7% so far this year.

Source: Bloomberg