Iceberg Ahead!

[Image: Iceland's Vatnajökull glacier].

I will monitor new developments on the topics and articles I have previously posted, so that you may stay on top of current events. Particularly the performance of any funds I have researched will be of interest. Unfortunately it has been alleged that the stunning performance exhibited by Sextant Capital Management was 'too good to be true' as discussed in an article by the Financial Post. The fund has invested in two companies that own rights to glaciers in Iceland and intend to use those rights for the purpose of developing and selling bottled water, but there have been no third party valuations to justify the returns stated by Sextant, you would have thought Otto Spork would have seen the Iceberg!! ahead.


OSC allege Sextant Capital Management has inflated returns

Sextant Capital Management Inc. was one of the bright lights recently in Canada's ailing hedge fund sector, despite the current financial crisis. But on Wednesday, the Ontario Securities Commission alleged that the fund manager's "driving force" Otto Spork inflated returns through self-dealing and investments in glacier companies that have generated no revenues and have no immediate prospects to do so.

The two private Luxembourg companies, Iceland Glacier Products and Iceland Global Water 2 Partners SCA, which together accounted for 92% of the assets of the Sextant Fund, own rights to glaciers in Iceland and intend to use those rights for the purpose of developing and selling bottled water.

"Despite having earned no revenue and having no immediate prospect of doing so, IGP's [Iceland Glacier Products] shares have purportedly increased in value from an initial average cost of €0.226 to €2.45, or approximately 984% since initial investment by the Sextant Fund," the OSC said in a statement of allegations released yesterday.

"There are no third party valuation reports that support the monthly, material upward revisions in value of IGP, and therefore there is inadequate support for the claimed rate of return of the Sextant Fund," the OSC contends.

The regulator said the purported returns contributed to the increase in value of the Sextant Fund by 730.7% over the less than three years since its inception in February of 2006.

None of the allegations have been proven. A hearing is scheduled for Dec. 16.

According to the OSC, the Sextant Strategic Opportunities Hedge Fund L.P

is a mutual fund in Ontario with about 240 investors across Canada, made up largely of Ontario residents. It had a net asset value of $53-million as of Nov. 28.

Investors have contributed more than $22-million to the Sextant Fund since its inception.

In its statement of allegations, the OSC says the two glacier companies are owned almost entirely by the Sextant Fund, the Sextant Offshore Funds and Mr. Spork, who at one time lived in Toronto but now lives in Iceland.

The OSC alleges that approximately 95% of the assets of the Sextant Fund have been invested illegally, in breach of rules against self-dealing by mutual funds. The regulator contends that "substantial" fees have been paid based on the illegal investments.

Walk the Talk

As I delve deeper into uncovering how the world will tackle such a daunting task as climate security, I am inspired and reassured to see positive steps being taken by governments worldwide to impose regulation and independent businesses stepping up to the plate. As the Kyoto Protocol will expire in 2012, negotiations are underway to reach a new global climate change agreement through the United Nations Climate Change Conference in Poznan, Poland on December 13th where 192 nations convened for the final preparatory negotiations for an international summit to be held in Copenhagen next December.

In preparing for a low carbon future, businesses must be aware of the targets that will hopefully soon be imposed. The U.K. envisages global emissions to peak by 2020, with reductions of at least 50% by 2050 compared with 1990 levels. For this to happen, all countries will need to mitigate their emissions; even developing countries must reduce their emissions as they develop.

"The longer we wait to make investments necessary to avert the risk of climate change, the more costly those investments will have to become." Richard Lambert, former director-general, Confederation of British Industry

Global participation on this scale, will create a massive rapidly growing carbon trading market that will drive investments towards low-carbon technology. International agencies could devote as much as $60 billion a year for technology, adaptation and mitigation. Additionally, markets for low-carbon energy products could be worth $500 billion annually by 2050, ushering in significant opportunities across a range of industries and services.

Clearly, there is money and companies will follow it. Those who get there first should benefit the most.

The U.K. is leading the charge forward and I came across this supplement titled the Business of Climate Security published in Canadian Business, which I suggest you read: www.climate-security.com

SRI Funds Match Performance

The front page article in the FTfm this week was titled 'SRI funds not outperforming', and it discussed how claims of socially responsible investments (SRI) funds delivering outperformannce are not true. I believe however this article reinforces the value of investing in SRI, as Edhec research discovered that there was almost no significant difference between the performance of SRI funds and mainstream equity funds. It goes on to discuss that there could be a positive effect from SRI selection over the long term but it is not in the figures. It is obviously a insurmountable task to quantify the value added in investing in companies that will help preserve our environment and make a positive impact on peoples lives, but I believe when given the choice between SRI funds and mainstream equity funds offering the same performance the choice should be obvious.

The DJ Sustainability Index was constructed by Sustainable Asset Management (SAM) in cooperation with Dow Jones Indexes and STOXX launched in 1999. More information on how the index is designed and updated performance figures can be seen here.

Blue Gold

Water is critically scarce and although it may cover over 2/3 of the earth's surface there is only 1% available for drinking, and this percentage is shrinking at an alarming rate due to population growth, industrialization, pollution and climate change. It has been forecast that by the year 2025 two thirds of the world population will be without safe drinking water and basic sanitation services as demand is forecast to continue to grow as shown in Figure 1 with many of the poorer countries being hit the hardest as illustrated by Figure 2.

Figure 1. Global Water Consumption 1990-2025

Figure 2: Global Water Stress Areas

A 2006 United Nations report focused on issues of governance at the core of the water crisis, stated"There is enough water for everyone" and "Water insufficiency is often due to mismanagement, corruption, lack of appropriate institutions, bureaucratic inertia and a shortage of investment in both human capacity and physical infrastructure".

I suggest you watch this video titled, CNN World Water Crisis, discussing the current global problems and re-iterating the statement by the UN that it will be human commitment and will, that will ultimately lead us through this crisis. It also touches on the growing concern of water wars and the potential for conflicts to develop if action is not taken.

There are a growing number of funds who have taken advantage of the opportunities inherent in the water shortage crisis as the demand for water will continue to grow, fueled by an increasing scarcity due to global warming and the effects of climate change. In the market turmoil investors are increasingly looking to uncorrelated asset classes and water is attracting attention, with one such fund posting very impressive results this year that was brought onto my radar by a colleague who works at the firm. I believe this is indicative of the increasing value and demand that will be placed on investments aimed at sustainable and efficient use of our most precious resource, water.

Sextant’s Water Hedge Fund Up 97.5%
September 23, 2008

While many hedge funds are running aground amidst the market turmoil, one Toronto firm is seeing nothing but clear blue seas.

Sextant Capital Management’s Strategic Global Water Fund Offshore finished August up 9.4%, boosting its year-to-date returns to 97.5%. The fund invests in pure water companies and water-related technologies.

According to founder Otto Spork, China’s demand for commodities coupled with global warming has made water a highly sought-after commodity.

“Presently, over one-third of countries have insufficient water resources and this will expand to two-thirds within the next 10 to 15 years,” wrote Spork, in a letter to investors.

Spork said that the deterioration in the quality of the world’s fresh water supply is accelerating; on a global basis, one in 10 diseases originate from unsafe water. “People are only now beginning to understand the relationship between water shortages and poor quality water and the strength of a nation’s economy and the health of its people,” he said.

And Spork sees no trouble ahead for the water fund, adding that last month’s return was “only the tip of the iceberg.”

See Original Article on Sextant Global Water Fund

Toxic Alberta

Following my post on carbon emissions hedge funds, and discussing the role Alberta's oil sands play in Canada's climate change policy, I came across a very interesting film brought to my attention by a friend of mine Drew Marshall. This short film is called Toxic Alberta, and I would suggest taking the facts and viewpoints with a grain of salt, but coming from Alberta and personally having worked in the oil and gas fields as a chemical engineer, there are many issues surrounding the dependency on oil that deserve some thought. It is imperative that if production of the oil sands is to continue, it must be done in a environmentally friendly manner, taking advantage of the latest developments in technology to avoid significant detriment to the environment.

An example of such technologies is, Engineered Drilling Solutions Inc. (EDSI), which is at the forefront of innovation in managing the environmental issues created by the the production of oil and gas. Formed in 2005 with the goal of changing the game in the drilling fluids industry, they deliver better, safer, lower-cost mud systems that improve well-site performance, significantly reduce environmental impact, and dramatically reduce operating and disposal costs.

Few companies can actually lower costs, reduce environmental impact and improve performance. But in the drilling-fluids industry, Engineered Drilling Solutions Inc. is a game changer. From environmentally-friendly drilling mud to the improved disposal of invert cuttings, EDSI is leading the field. And it doesn't stop there. EDSI has developed a proven technique for creating road-building material by taking 4G-based invert cuttings and simply adding RC18. So instead of filling landfills, you can help change the game by recycling the waste sludge into asphalt for paving roads.

EDSI is currently partnered with asphalt and road construction organizations and, with permission from the Energy and Utilities Board (EUB) and Alberta Transportation Board, will be constructing a road built from 4G-based invert cuttings.

It is companies like this that will lead the way in creating a sustainable future as the world wains itself off its dependency on oil.

The Emergence of Carbon Trading Hedge Funds

Recently in October, CF Partners launched a Carbon emission trading hedge fund.

London-based CF Partners (UK), an environmental finance firm specialising in carbon advisory and trading, is launching a carbon emissions hedge fund strategy.

The CF Carbon Fund adopts a relative value and arbitrage-based approach to trading carbon and the correlation of carbon with other global energy markets, seeking to capitalise on pricing inefficiencies and dislocations in these markets. The fund, which is targeting a 20 per cent return, has been running a shadow portfolio (which is up 6.67 per cent since June) ahead of opening up for investor subscription in November.

The carbon strategy is attracting interest from investors due to its low correlation to other asset classes, with -0.45 for the Dow Jones Industrial Average and 0.08 for the iTraxx credit index.

As a result of the arbitrage opportunities that exist in the markets in which it invests, the fund currently requires limited leverage and has minimal counterparty risk since the majority of the trades are carried out on exchanges.

Since its launch in 2006, CF Partners has become active in the carbon emissions market as an adviser to many compliance buyers of carbon credits, such as industrial companies and utilities. It also structures and trades OTC transactions among other buyers and traders of emission credits such as funds, banks and trading houses.

I believe this will be a growing area coming forward for hedge funds, as stricter regulation is imposed after the end of the Kyoto Protocol in 2012.

The world market in greenhouse gases was worth 38 billion euros (48.26 billion dollars) in the first half of 2008, an increase of 41 percent over the figure for the same period in 2007, the UN climate conference heard on Wednesday.

The estimate, published by the International Emissions Trading Association (IETA), highlighted a fast-growing industry which is expected to expand even further if the United States establishes a national carbon market under Barack Obama.

A total volume of 1.84 billion tonnes of carbon dioxide (CO2) -- the principal greenhouse gas -- or its equivalent were traded in the first six months of the year, an increase of 56 percent over the figure for the first half in 2007, when the tally was 1.2 billion tonnes.

"These volume and value numbers suggest a weighted average world carbon price of 20.61 euros per tonne" of CO2 or its equivalent, according to the estimates, compiled by the Oslo-based analyst Point Carbon.

The European Union's Emissions Trade System (ETS), established under the UN's Kyoto Protocol, accounts for the lion's share of trade -- 70 percent of all global volume in the first half of 2008, as against 61 percent in all of 2007.

"While the EU ETS retains the largest share of the world carbon market, we may expect the fastest growth to take place elsewhere," the report, Greenhouse Gas Market 2008, noted.

The world carbon market took off in 2005, when the Kyoto Protocol took effect, although small schemes had been started on a pilot basis several years before. In 2003, world trade was just 70 million tonnes.

Under Kyoto, rich countries are required to curb their emissions as compared to a 1990 benchmark. There is a five-year evaluation period, from 2008-2012, for assessing whether they reach their target.

To help economies meet this objective, the treaty enables several mechanisms that harness market forces.

One is emissions trading. Under the ETS, big-polluting EU corporations have been set individual emissions targets or else pay a penalty for every tonne over this limit.

Companies that succeed in emitting less than their cap can sell the surplus to others that are over their cap. The idea is to provide a financial stimulus to everyone to clean up their act.

The other Kyoto incentives are the Clean Development Mechanism (CDM) and Joint Implementation (JI), under which a company can gain carbon "credits" for emissions-reducing schemes in developing countries (under the CDM) or former Eastern Bloc countries (the JI). These credits can be traded in the marketplace.

Outside the EU, the other significant markets in carbon emissions are at regional level, IETA said.

They are the New South Wales Greenhouse Gas Abatement Scheme (NSW GGAS) in southeastern Australia and the Alberta provincial emissions trading system in Canada.

However, a slew of countries are expected to launch their own national system in the coming years, although it is unclear so far as to how these might connect up with the EU ETS.

Prospective entrants include Australia, with a federal ETS from 2010, Japan, New Zealand and the United States.

President-elect Obama has set a goal of reducing US emissions to 1990 levels by 2020 and by 80 percent by 2050, using a cap-and-trade system and a 10-year programme worth 150 billion dollars in renewable energy.

The talks in Poznan, running from December 1-12, gather the 192-member UN Framework Convention on Climate Change (UNFCCC), tasked with furthering efforts to build a new climate pact beyond 2012.

Canada in particular needs to step up its game!

They have has set firm medium-term targets, which reflect a stunning lack of ambition on the part of the current federal government. The Conservatives, ignoring binding democratic legislation passed by their own parliament, are looking to reduce Canada's greenhouse gas emissions by 2.6 percent below 1990 levels by 2020. While the US surges with high expectations, Canadians are being asked to content ourselves with skyrocketing greenhouse gas emissions, negligible reductions targets and no real vision for the future. Canada's approach does not include a firm cap on emissions, but instead uses an "intensity target" which regulates emissions on the basis of production levels.

The government is seeking to protect the interests of the Alberta Oil Sands projects from potentially tough new U.S. climate-change rules.

Watch Canada to be a developing area in the Carbon Market, and Carbon hedge funds to be popping up in Toronto and New York.

See original article on CF Partners:
http://www.hedgeweek.com/articles/detail.jsp?content_id=272556&livehome=true

Money Does Grow on Trees

This blog will chronicle the developments and point to future opportunities in Sustainable and Responsible Investment. To begin my postings, I would like to talk to you about the merits of investing in timberland as an SRI.

As you all know, trees are inherently valuable to the environment and the well being of humanity. Through the process of photosynthesis they recycle carbon dioxide into oxygen for us to breath.

Traditionally timber is used as a building material and in pulp and paper production. There is a strong and robust correlation between increasing population and economic growth and demand for wood. Additionally, developing countries such as China and India, which have limited supplies of their own, depend heavily on timber imports.

There is also a supply squeeze with ever growing demand putting pressure on existing forests areas, and plantations won’t be able to fill the gap for some time to come. Deforestation is occurring at a rate of 12.9m ha/y per year while the growth rate of plantations is occurring at only 2.9m ha/y. Importantly linked to the decrease in trees, is the rise in carbon dioxide with deforestation account for 18% of global CO2 emissions and climate change discussions are advancing the role of forests as carbon sink through reforestation.

Furthermore, government policies are advocating biomass as a renewable energy source to decrease carbon dioxide emissions. Technologies are being developed that use enzymes and acids to turn cellulose fibers of plants into fermentable sugars that can produce ethanol. There is an opportunity for timber to act as a bio fuel as it has a high energy efficiency and does not compete with food crops as opposed to traditional bio fuels.

There is also increasing interest in wood as a substitute for non-renewable materials in construction as it is superior in terms of energy efficiency, versatility and recyclability.

Characteristics of Timberland

The defining attribute of timber is its steady, long-term biological growth. A tree’s wood volume tends to increase 2% to 8% annually (varying by climate, species, and age). Compounding the effect of this biological growth, trees yield price gains when they grow into bigger product classes. For instance, a small tree that is only suitable for paper products may eventually grow into saw timber, where it can fetch dramatically higher prices per ton and be used for products such as plywood or telephone poles.

An academic study found that biological growth drives more than 60% of total returns, while timber price changes and land appreciation account for the remainder of returns[i].

Figure 1. Determinants of Timber Returns

Advantages

A major attraction of investing in timberland is the competitive returns it offers compared to other asset classes on a risk-to-return basis.

Benchmark: NCREIF (National Council of Real Estate Investment Fiduciaries) Timberland Index Historically, the performance of timberland as an investment is most often measured by the Timberland Index, published by the National Council of Real Estate Investment Fiduciaries, or NCREIF. The index is analogous to the Property Index that NCREIF also publishes for the commercial real estate market. The sample of properties in the Index includes tree farms in the South (Virginia, North Carolina, South Carolina, Georgia, Florida, Alabama, Mississippi, Louisiana, Texas and Oklahoma), the Pacific Northwest (Washington, Oregon and California), and the Northeast (Maine, New Hampshire, Vermont, NewYork and Pennsylvania)[ii].

Returns from timberland investments, as measured by the NCREIF Timberland Index, exceeded the Standard and Poor's 500 Index for 9 of the past 16 years from 1990 through 2005. In the period from 1990 to 2007, the NCREIF Timberland Index annual compounded return was 12.88% versus 10.54% for the S&P500 (Table 1). Yet, the returns from timberland offered lower volatility (standard deviation) of 9.29% against the equity market's 16.91%[iii].

Table 1. Comparison of returns from the NCREIF Timberland Index against the Standard & Poor 500 Index (1990 - 2007).

Sharpe ratio based on a 3.0% risk free rate.
Source: NCREIF, Ibbotson Associates

Figure 2. Comparison of returns of different common asset classes with timberland, as measured by the NCREIF Timberland Index (1990-2007).

Alternate Benchmark: IDP UK Forestry Index The IPD Forestry Index is calculated from a sample of private sector coniferous plantations of predominantly Sitka spruce in mainland Britain. By the end of 2004 the 161 forests in the index had a total capital value of £74.4m. New figures show the IPD UK Forestry Index returned 31.6 per cent in 2007, six times higher than equities (5.3%) and five times higher than bonds (6.4%) and at the other end of the spectrum to commercial property, languishing at -3.4%[vi].

As illustrated in Figure 3, timber a exhibits a moderate correlation to inflation, suggesting timberland assets may serve as a good long term hedge against un-anticipated inflation[iv]. Timber can also improve a portfolio’s risk-adjusted returns by virtue of its fairly low correlation to most asset classes. This low correlation reflects the fact that the primary driver of returns—biological growth—is unaffected by economic cycles.

Figure 3. Timberland Correlation Analysis[v]

Disadvantages

Timber is an illiquid investment and is difficult to sell quickly, which is why timberland is strictly an asset class for long-term investors. Trees generate most of their returns through steady biological growth, and harvesting cycles are typically 15 to 40 years.

Physical risks—such as damage from fire or insects—can inflict significant losses, but not to the extent that many investors fear. Such losses usually erode returns by 0.1% annually, for timberland holdings that are well-diversified by geography, age, and species.

The greatest risk however, is overpaying for timber assets as an influx of money from institutional investors is chasing a limited number of forests, causing more opportunities to exist overseas.

Conclusion

The major attraction to investing in timber is its lower volatility and higher overall return compared to equities.

There are many additional benefits to the environment as timber serves as a carbon sink and decreasing deforestation will decrease CO2 emissions and reduce the effects of climate change.

There is an opportunity for timber to act as a bio fuel as it more energy efficient and does not compete with food crops as opposed to traditional biofuels.

Also, there is a renewed interest in wood as a construction material as opposed to non-renewable resources due to its energy efficiency, versatility and recyclability.


[i] http://www.investmentmoats.com/etf/timber-agg-1-dream-asset-class/

[ii] http://www.htrg.com/pdf/rn_ncreif2002.pdf

[iii] http://www.tirllc.com/whyinvest/timberlandtriskandreturn.html

[iv] http://www.tirllc.com/whyinvest/timberlandtriskandreturn.html

[v] http://www.investmentmoats.com/etf/timber-agg-1-dream-asset-class/

[vi] http://www.forestry.gov.uk/pdf/IPDUKForestryIndex2007results.pdf/$FILE/IPDUKForestryIndex2007

results.pdfhttp://www.greenwood-management.com/forestry-index.html

[vii] http://www.tirllc.com/whyinvest/timberlandtriskandreturn.html

[viii] http://www.tirllc.com/whyinvest/timberlandtriskandreturn.html