Third Quarter 2015 GEOS Update – Fahrvergnügen

We believe the Essex Global Environmental Opportunities Strategy (GEOS) investment philosophy to be quite differentiated: Companies with technologies that increase the efficient use of scarce resources will deliver strong shareholder returns over time. The companies we invest in enable natural resource optimization, limit greenhouse gasses and provide energy efficiency solutions. We designed and manage GEOS to harness associated global macro-economic trends such as non-OECD economic transitions and the related effects: urban density, an increased middle class and associated environmental degradation. These global risks and stresses are converging, and are compounded by threat multipliers such as climate change. We seek the most direct expression of our investment philosophy, and therefore favor companies that have focused, pure exposure to our GEOS themes, resulting in portfolio holdings that are primarily in the small and mid-market capitalization arena. We like managing assets in this segment of the equity market, as aside from strengthening the GEOS investment philosophy, the stocks of focused and smaller companies are often priced less efficiently than larger-cap equities such as those that constitute the S&P 500 Index. Smaller companies have less analyst coverage, giving us better access to management teams. These focused firms generally have higher growth financial profiles than larger companies, allowing for better long-term capital returns for share owners. There are risks to smaller companies, which were exhibited over the course of the third quarter of 2015: given less mature capital structures, and exacerbated by occasional misperceptions regarding business risks, these equity issues can be victims of exaggerated stock price volatility. The “risk-off at all-cost” environment of the third quarter, which grew increasingly shrill as the quarter unfolded, led to increased short-interest in many GEOS holdings, as investors bet against small cap, growth, and clean tech, given the false assumption that clean tech companies will be damaged by cheap oil.

It is ironic that over such a volatile period for clean technology stocks, we observed, managed and researched a multitude of progress globally of catalysts that we believe will benefit companies allowing companies to do more with less. We also observed some significant signs that clean tech investment is rising, while increasingly, society calls for climate change mitigation and increased investment in solutions. In late September, Mark Carney, the governor of the Bank of England, declared that climate change is contributing to economic and financial instability, and regulators and businesses need to move in much swifter fashion to contain the economic damage. Carney echoed what many have already posited, that once climate change becomes the defining financial risk, it may already be too late. It was apropos that Carney delivered his speech at Lloyd’s of London, the venerable firm that has been providing global trade and risk mitigation since 1688. As countries posture prior to climate change negotiations later this year, we believe the recent announcements will lead to enhanced investment visibility and viability. Just last week, India pledged to slow greenhouse gas (GHG) emissions by rapidly scaling clean-energy sources to reduce emissions intensity by 35% below 2005 levels by 2030. While Prime Minister Modi will double the current share of electricity provided by clean-energy sources, coal will still be an important energy source to power economic growth in India. While India’s emissions are just 1/4 of China’s, India is the world’s fastest growing polluter, and is home to the bulk of the world’s dirtiest cities. While government action provides investment catalyst for clean technology, we believe corporate commitment to climate change mitigation coupled with increased investment is a more stalwart indicator of GEOS trend succession. One recent example is the release of the financial sector statement on climate change by financial institutions such as Goldman Sachs, Morgan Stanley, JPMorgan Chase and Bank of America. To abate the climate change trajectory, Ceres and the banks estimate $90 trillion will need to be invested over the next 15 years in new energy and urban infrastructure. While the signatories obviously stand to benefit commercially from this recommended action, said firms are willing to provide capital for these actions – and these are long-tailed commitments.

Fahrvergnügen

Efficient transport has been an important GEOS theme tied to our investment objective of doing more with less. Over the years, GEOS has held companies engaged in optimizing engine block efficiency, or companies making the auto safer and more efficient. We also have exposure to the automotive sensor market, with technologies designed to optimize energy efficiencies from cabin power consumption, to drive train solutions that improve fuel consumption. Automotive efficiency will also be increased by light-weighting the auto through increased usage of carbon fiber. VW’s illegal jury-rigging of emissions control equipment to bend environmental regulations will be felt in the automotive industry for years to come. There is a reason particulate matter in the form of SOX and NOX is much higher in European cities than in the U.S. – diesel engine block use in passenger cars is much greater across the EU. This incident at VW highlights the need to accelerate the adoption of new, clean technologies as the increasingly stringent environmental regulations cannot be achieved with traditional technologies. Recall the VW advertisement from the early 1990’s, an ad campaign that had a deleterious effect on the U.S. auto consumer’s opinion of VW –  the use of the tag-line, Fahrvergnügen, a Madison Ave combination of “to drive” in German, and  “enjoyment.” Certainly, after the fall of VW, to ensure driving enjoyment and environmental responsibility, we anticipate an increased regulatory framework with technology adoption that will benefit the GEOS efficient transport theme.