However, one thing in common will be that the answer involves some type of comment with respect to ‘looking after the future’. So, how can super funds have their crystal ball view of the future and at the same time deliver consistent returns to their members?
With the world’s population growing rapidly, becoming more urbanised and living significantly longer, with growing income and consumption patterns for food, water and energy, there is no doubt that unprecedented demand will be placed on the world’s finite resources.
In the last 50 years, global primary energy consumption constantly increased (at more than 2.6 per cent per annum). In non-OECD countries, annual growth has accelerated to more than 5 per cent since 2000. If this trend continues, global primary energy consumption will be 40 per cent higher in 2030 than it is now.
When looking at data from the US Department of Energy and Eurostat, it is estimated there is an under-investment in renewables, with approximately US$750 billion required by 2020, providing an investment supply/demand imbalance opportunity for willing investors.
The sustainable use of natural resources is really about two things: 1) the efficient production and use of scarce natural resources such as oil and gas, metals and minerals, water, food and agriculture, etc; and 2) new ways of producing energy, such as renewable energy or waste-to-energy.
According to a study by Mercer, conducted in February 2011 in collaboration with 14 major institutional investors such as APG, CalPERS and CalSTRs, traditional asset allocation methods do not adequately capture climate and resource scarcity risks.
So how can super funds start mitigating some of these risks?
People talk about investing in tomorrow’s companies; however, many of these are yet to emerge in public markets and those that have are punished and scrutinised by other short-term minded investors when the companies longer term plan hits a speed bump.
So, a practical solution in mitigating such risks, and with the aim of delivering consistent returns to members, is to access tomorrow’s winners via the private equity markets – namely, in established small- and mid-cap companies offering resource-efficient products and services.
According to McKinsey’s recent Resource Revolution study (2012), at least US$1 trillion more investment in the resource system is needed each year to meet future resource demands. As the world experiences a growing supply/demand imbalance in natural resources, companies that develop resource-efficient products and services are expected to have a long-term competitive advantage.
There are many talented and proven private equity managers who specialise in the small- and mid-cap sector that super funds can access. More interestingly, as a result of changes in regulation and portfolio management, an abundant secondary market exists for private equity funds.
The key difference to the general secondary market and the resource efficiency-focused small- and mid-cap market is that the discounts achieved (30 per cent to 40 per cent) are deeper than the broader secondary market (15 per cent to 20 per cent).
This is simply due to the small investment sizes typically ranging from US$5 million to US$10 million and the limited number of dedicated secondary buyers in this portion of the market.
The large secondary players with US$1 billion to $2 billion of dry powder are just too large to access this space.
Discounts, while attractive and providing a benefit to investors, are not the main driver of return from this part of the market. The underwriting of each underlying company is critical and more so than the broader secondary market as it requires specialisation in industrial engineering, science, energy and environmental technology.
Finally, we are starting to see this sector becoming mainstream thereby providing private equity investors with attractive exit opportunities. We see the emergence of large multinational companies such as General Electric, Siemens and BASF buying up privately-owned companies around the word with exciting resource-efficient products and services.
General Electric’s Ecomagination program already has over 140 products and solutions, which have generated US$105 million of revenue. It is more efficient for these multinational firms to acquire growing, profitable and established small- and mid-cap companies than it is to develop new business lines in-house.
Two recent examples include Toshiba Corp, which bought Swiss electronic-metering company Landis+Gyr AG for US$2.3 billion, and Marubeni Corp of Japan which along with other investors acquired Seajacks, a UK wind-turbine installation specialist, for US$850 million.
We expect this sector to play out in a similar way to the big pharmaceutical sector in terms of M&A activity over the course of next decade, allowing investors to generate attractive returns.
Andrew Musters is global head of private equity at ROBECO and Brett Penprase is associate director at ROBECO.
