Introduction

PGS Global Green Fund is designed to capitalize on growing concerns over the risk to portfolio investing posed by global climate change. The Fund presents the opportunity for institutional investors to allocate capital to managers that are focused on investment opportunities in areas such as renewable sources of energy, emissions trading, water supply and pollution control, and weather derivatives. The strategies employed by the underlying managers include long/short equity, long only equity, niche fixed income, and private equity-like strategies. The managers have been selected for the Fund based on their understanding of the risks and opportunities presented by global climate change and the need to manage climate risk, along with other types of risk, as a part of an effective investment strategy. While there is a long history of socially responsible investment, the "greenwave" as some have come to call the interest in making allocations to investments that take into account environmental responsibility, is building. Parker Global Strategies believes that this will be an area of significant growth and opportunity in the future as the number of investors incorporating climate risk into their investment models grows.

Brief History of SRI

Socially Responsible Investing (SRI) utilizes both positive and negative screens on social and environmental factors, along with more traditional fundamental analysis, to make investment allocations. In using qualitative factors such as the impact of corporate policies and practices on social and environmental areas of concern to the investor, SRI works to improve the quality of life in society as seen through the eyes of the investor. Religious groups have been using socially responsible investing criteria for over a century. Originally based on the premise of avoiding "sin" stocks (e.g. alcohol, tobacco, pornography, and gambling), the criteria for socially responsible investing began to broaden in the 1960s to include civil liberties and civil rights issues. During the 1980s and 1990s management and labor issues came to the forefront as a result of NAFTA and growing globalization related concerns such as child labor laws in developing countries. Over the past five years, with the collapse of Enron, WorldCom, and Adelphia, among others, the focus on management issues and shareholder activism increased dramatically as key criteria for socially responsible investing. These screens were primarily negative screens based on avoiding companies that had bad corporate governance or were involved in businesses that were deemed unacceptable to the investors. Positive screens that have developed include looking for investments in companies that have ethical corporate governance, strong environmental policies, active community involvement, and take care of their employees. Today, SRI uses both positive and negative screens, shareholder activism, and community investing as its primary approaches to integrating social and environmental issues into the investment decision making process.

In 1995, The Social Investing Forum began monitoring the assets invested globally on behalf of individuals and institutions in separately managed portfolios using socially responsible screens. According to their 2003 report, Socially Responsible Investing Trends in the United States, the assets in these accounts have grown from US$150 billion in 1995 to US$1.99 trillion in 2003. While these investors are still mainly the purview of groups with religious affiliations, the interest in SRI by non-religion affiliated groups is growing. In Europe, the leader in SRI development, growth has been very strong in the socially responsible investment area. Ethical investing is the fastest growing sector of the UK retail funds market and legislation supporting this effort was passed in 2000. France has also seen phenomenal growth with assets in ethical investing tripling from 2000 to 2002. Much of Europe has now passed legislation requiring pensions to take into account social environmental, or ethical considerations as part of their investment process. In Asia, Japan has been the leader in SRI investing. Unlike the religious-based screens common in the West, the focus in Japan has been on environmental, human rights, and supply-chain issues. According to Nikko Asset Management, SRI investors in Japan do not consider, "cigarettes, alcohol, gambling, nuclear, or weaponry as anti-social." Pension plans are generally leading the way in making SRI allocations in Asia. Australia is the largest market in the Pacific region for SRI investing. In 2002, the government passed legislation requiring all superannuation funds to disclose whether or not they use SRI criteria in their investment allocations.

The table below shows the common screens and approaches to socially responsible investing by region:

In the last two years, environmentally responsible – or "green" – investing has taken on a more prevalent role among the list of socially responsible investment screens used by non-religious institutional investors. The increase in interest is the direct result of escalating concern over the fiscal impact on public corporations due to climate change. Environmental responsibility has tended to be implemented as a positive screen with investors seeking out companies that have good environmental records or who have made a commitment to the environment by reporting their progress in addressing environmental issues, particularly those related to climate risk. One of the primary objectives of green investing is to invest in companies that are actively developing sustainable clean technologies to replace those technologies using greenhouse gases in their processes. Another key aspect of green investing is the effort being made by institutional investors globally to require corporate disclosure of information related to climate risk and how companies are addressing climate risk both operationally and from a governance perspective. Like the more traditional SRI approaches discussed previously, shareholder activism is also a part of the strategy to effect change. In addition, institutional investors are looking to require their investment managers to add resources and expertise in order to assess the climate risks associated with their underlying investments.

Parker Global Strategies sees the drive for increased oversight by institutional investors into climate risk as a process that will be much broader and more encompassing than traditional SRI investing has been in the past. The concern over global climate change is real and ingrained among leading institutional investors globally. The concerns are based on the science behind the "greenhouse effect" and the reality of water supply issues that have led to desertification, risks to water supply, and water pollution issues, particularly in Asia and Africa. As such, we believe it is worth examining some of the basic issues behind these concerns and why this will be a long-term process providing a number of investment opportunities well into the 21^st Century.

Concerns over global climate change are not new. In the 1950s, the United Nations Educational, Scientific, and Cultural Organization (UNESCO) brought the issue of arid lands to the attention of the global community. Studies conducted by UNESCO during this time raised the awareness of, and interest in, studying arid lands and measuring the degree of land destruction resulting from improper grazing practices, deforestation, improper water management leading to salinization, and the resulting potential for desertification. A drought in the Sahel region of Africa from 1969 until 1973 further raised awareness as to the issue of desertification, the result of which was a Plan of Action to Combat Desertification established in 1977 under the auspices of the United Nations Environment Program. Subsequently, the United Nations Convention to Combat Desertification (UNCCD) was established as a part of the global response to climate concerns addressed at the 1992 Earth Summit in Rio de Janeiro, Brazil.

In the 1980s concern over global climate change, and specifically the "greenhouse effect," began to move to the forefront. In 1988, the Intergovernmental Panel on Climate Change (IPCC) was established by the United Nations and World Meteorological Organization to conduct unbiased assessments in the area of climate science. IPCC has subsequently conducted three studies on climate change, the most recent of which was published in 2001. The IPCC report provided scientific evidence of global warming and said, "there is new and stronger evidence that most of the warming observed over the last 500 years is attributable to human activities." The IPCC findings were corroborated by reports issued by the US National Academy of Sciences (NAS) later in 2001 and in 2002. As a result, all but the United States, Australia, and several smaller countries ratified the Kyoto Protocol to the United Nations Framework Convention on Climate Change on February 16, 2005. Ratification places support for initiatives to reduce the human causes of global warming through international law.

Global warming is a natural phenomenon that results from the retention of the heat generated by the sun as it radiates back to space from the Earth’s surface. Gases such as water vapor, carbon dioxide, nitrous oxide and ozone trap some of this heat and keep the Earth warmer than it would otherwise be. Without the impact of natural global warming, life as we know it could not exist on our planet. The result is a "greenhouse effect" – so called because these atmospheric gases retain heat somewhat like the glass panels of a greenhouse. However, in the last century, the dramatic increase in emissions from human activity has added to the emission of greenhouse gases into the Earth’s atmosphere and led to a significant warming of the Earth’s mean surface temperature. This increase has raised concerns over global warming and its impact on the environment and climate change.

Some greenhouse gases occur naturally in the atmosphere. These include water vapor, carbon dioxide, methane, nitrous oxide, and ozone; while other greenhouse gases result solely from human activities. Certain human activities, however, add to the levels of most of the naturally occurring gases. Carbon dioxide is released to the atmosphere when solid waste, fossil fuels (oil, natural gas, and coal), and wood and wood products are burned. Methane is emitted during the production and transport of coal, natural gas, and oil. Methane emissions also result from the decomposition of organic wastes in municipal solid waste landfills and livestock yards. Nitrous oxide is emitted during agricultural and industrial activities, as well as during combustion of solid waste and fossil fuels. Of the non-naturally occurring greenhouse gases, the most problematic for the environment include hydrofluorocarbons (HFCs), perfluorocarbons (PFCs), and sulfur hexafluoride (SF₆), all of which are generated in a variety of industrial processes common in the industrialized world.

Each greenhouse gas differs in its ability to absorb heat in the atmosphere. HFCs and PFCs are the most heat-absorbent. Methane traps over 21 times more heat per molecule than carbon dioxide, and nitrous oxide absorbs 270 times more heat per molecule than carbon dioxide. Estimates of greenhouse gas emissions are generally presented in units of millions of metric tons of carbon equivalents (MMTCE), which weights each gas by its Global Warming Potential (GWP) value. GWPs are quantified as a measure of the globally averaged relative radiative forcing impacts of a particular greenhouse gas. In the 1996 IPCC report Climate Change 1995: The Science of Climate Change – GWP is defined as "the cumulative radiative forcing - both direct and indirect effects - integrated over a period of time from the emission of a unit mass of gas relative to some reference gas," where carbon dioxide (CO₂) serves as the reference gas. Direct effects occur when the gas itself is a greenhouse gas. Indirect radiative forcing occurs when chemical transformations involving the original gas produce greenhouse gases, or when a gas influences other radiatively important processes such as the atmospheric lifetimes of other gases.

The mean surface temperature of the Earth has increased by 1.08°F since the late 19th century. Over the past 100 years, the warmest years have occurred in ten of the last 15 years, with 1998 being the warmest year ever since records have been kept beginning in 1861. As a result, snow coverage in the Northern Hemisphere and floating ice in the Arctic Ocean have both noticeably decreased. On a global basis, the sea level has risen 4-8 inches over the past century and precipitation over land has increased by about one percent. The following graph shows the movement from the long-term mean temperature over the period from 1880 through 2000:

Recently issued scientific reports indicate that human activity has dramatically increased the level of greenhouse gases, particularly carbon dioxide, in the atmosphere, and this is leading to more heat being trapped and a rise in surface temperatures. The Third Assessment of the IPCC issued in 2001 reported that the level of heat-trapping carbon dioxide in the atmosphere had risen from 280 parts per billion for the period from 1000 until 1750 to 365 parts per billion by 1998. This is significant, because the broadening of the industrial revolution and major shifts in agricultural practices began during the mid-18^th century. These changes in human activity have resulted in the burning of fossil fuels to power cars and trucks, heat homes and businesses, and run factories. Fossil fuels are responsible for about 98 percent of US carbon dioxide emissions, 24 percent of methane emissions, and 18 percent of nitrous oxide emissions. Other contributors to the increase in greenhouse gas emissions in the atmosphere are changes to agricultural cultivation practices, deforestation, and mining. The dramatic growth in many developing parts of the world, particularly what are commonly referred to as the BRICs (Brazil, Russia, India and China), have also added to the problem, as these countries do not have as stringent environmental laws as developed regions such as the European Union and the US.

The table below shows the change in the levels of five greenhouse gases - carbon dioxide (CO₂), methane (CH₄), nitrous dioxide (N₂O), sulfur hexafluoride (SF₆) (including halocarbons and perfluorocarbons), and tetrafluoromethane (CF₄) – between pre-industrial times (1000-1750) and 1998. The table also illustrates the rate of concentration change between 1990 and 1999. The bottom row of the table summarizes the expected lifetime of each of these gases in the atmosphere, including the indirect effect of the gas on its own residence time.

Global atmospheric concentration (ppm unless otherwise specified), rate of concentration change (ppb/year)

and atmospheric lifetime (years) of selected greenhouse gases

Based on the IPCC report published in 2001, which was supported by later reports issued by the National Academy of Sciences, if aggressive efforts are not undertaken to reduce greenhouse gas emissions, the mean global temperature may increase from 2.2°F to 10.4°F during the next century. The result of such an increase in temperatures will vary from region to region, but scientists generally believe that on a global basis, sea levels will rise, soil moisture will decline leading to increased risks of desertification, precipitation will rise as evaporation increases with higher temperatures, and intense rainfall will become more common.

Long-term measurements of the Earth’s atmosphere and temperatures indicate that carbon dioxide levels and temperatures are closely correlated. When carbon dioxide levels decline, temperatures also decline; and when the Earth’s surface is warmer, carbon dioxide levels are higher. The following chart illustrates this point:

One of the areas that may be the most impacted by the potential increase in higher temperatures is global water supply. There are a number of factors that could make water supply a critical area of concern. As the sea levels rise, salinity levels in freshwater sources, including lakes, rivers, and aquifers, will likely increase due to saltwater incursion. This has already begun along some coastal areas. Another risk to water supplies, as climate changes occur, is an increase in droughts and floods due to changes in rainfall patterns.

Freshwater is a critical component of life. Earth viewed from outer space is predominantly blue, given that 74 percent of its surface is covered by water. Saltwater oceans and seas represent 97 percent of the global water supply, while only 3 percent is classified as freshwater, and not freshwater is available for human consumption. Ice makes up 77 percent of available freshwater and another 22 percent is found in soil moisture and ground water supplies. The balance of the freshwater, making up less than one percent of the world total, is contained in lakes, rivers and wetlands. The loss of freshwater as a result of climate change induced desertification and wetland loss adds another risk to be considered as part of one’s analysis of climate risk and its impact on investing.

Desertification impacts both the emission of greenhouse gases and global economics. Defined by the United Nations as, "a process by which susceptible areas lose their productive capacity," desertification can result from both human activity as well as climate change. Desertification threatens food security and is a contributor to famine and poverty levels in a number of places around the world. According to the UN, over seventy percent of the world’s 5.2 billion hectares (one hectare equals 2.47 acres) of agricultural drylands are degraded. The map below shows the areas around the world impacted by desertification.

These drylands support more than one billion people as both a source of food and habitat. Human activities that contribute to desertification include deforestation, overgrazing, and poor cultivation practices. The burning of wood as a fuel source and the emission of methane by livestock, particularly where heavily concentrated such as in large feedlots, both contribute to greenhouse gas levels in the atmosphere.

The ecosystems of agricultural drylands are most impacted by climate change. Too much water can result in water logging leading to soil degradation, damage to crops, and the loss of natural vegetation. Drought can produce the same results, and the degradation may be compounded by wind erosion as well. Loss of agricultural drylands to desertification leads to increases in poverty as food and fuel supplies become impacted. Water supplies can also be impacted as a result of desertification as soil changes can reduce the rate at which natural aquifers are replenished.

Natural wetlands have an impact on both freshwater supplies and climate change. Wetlands are defined as, "those areas that are inundated or saturated by surface or ground water at a frequency and duration sufficient to support, and that under normal circumstances do support, a prevalence of vegetation typically adapted for life in saturated soil conditions. Wetlands generally include swamps, marshes, bogs and similar areas." (Source: US Environmental Protection Agency). Wetlands are among the most productive ecosystems in the world, comparable to rain forests and coral reefs. An immense variety of species can inhabit a wetland ecosystem. The complex and dynamic relationships among the species living in a wetland environment result in what is commonly referred to as a food web. Many species rely on the wetlands as a source of food for part or all of their lives. As an example, dead plants break down in the water to form detritus, which in turn serves to feed small aquatic insects that become a food source to migratory birds such as ducks and geese.

Wetlands are an integral part of the global cycles for water, nitrogen, and sulfur. As it relates to climate change, studies indicate that wetlands may contribute to the balance of atmospheric conditions. Wetlands store carbon within the plants and soil that inhabit them, rather than releasing the carbon into the atmosphere as carbon dioxide.

As the importance of wetlands has become better understood, efforts have been made in the US and elsewhere to recover natural wetlands and reduce their loss. Climate change has had an impact on wetlands globally and the loss of wetlands has added to increase costs of flood and drought damage.

These are costs that have a significant economic impact on the areas affected and cannot be ignored as a part of one’s analysis of risk.

The risks of climate change to the bottom line of both corporations and investors can no longer be ignored. In fact, the impact of climate change may be the fastest growing area of interest in terms of risk analysis. The change in perspective is a result of numerous factors. As noted previously, a number of scientific reports have been issued over the past three years that clearly indicate that climate risks are increasing as greenhouse gas emissions increase. On February 16, 2005, with ratification by Russia, the Kyoto Protocol entered into the force of international law requiring its signatories to reduce greenhouse gas emissions by specific agreed upon targets by 2012 or face significant consequences. The European Union instituted an emission trading system (EU ETS) in 2004 creating a market for the trading of carbon dioxide credits by 6,000 companies. Since the introduction of trading in January 2005, the price of carbon credits has risen three-fold from seven to twenty-one euros in August. Despite not being a signatory to the Kyoto Protocol, the US federal government has called for voluntary reductions in greenhouse gas emissions by 2010. Entergy, a US utility, has traded over one million tons of carbon since the beginning of 2005. The Chicago Climate Exchange (CCX) was created to be the first voluntary market for the trading of greenhouse gases. The CCX owns the European Climate Exchange (ECX), which created Carbon Financial Instruments (CFI) traded on the International Petroleum Exchange for the EU ETS. State and local governments are taking actions to require even stronger standards and, as a result, many companies are asking the federal government to set regulatory standards that will be uniform across states to mitigate the costs of meeting regulations.

In 2000, the Carbon Disclosure Project (CDP) was founded in the United Kingdom to serve as a coordinating secretariat for institutional investor collaboration on climate change. The objective of the CDP is two-fold: "to inform investors regarding the significant risks and opportunities presented by climate change, and to inform company management regarding the serious concerns of shareholders regarding the impact of these issues on company value." In February 2005, the CDP sent out its third survey to corporations on the FT 500 list of the world’s largest corporations asking about corporate climate disclosure and plans to alleviate the emissions of greenhouse gases. This survey represented 155 institutional investors with assets in excess of US$21 trillion, up from the 35 institutional investors representing US$4.5 trillion of assets in the first survey conducted in May 2002. The third report (CDP3) was issued on September 14, 2005 in New York and is to be subsequently launched in Amsterdam, London, Tokyo, Paris, Amsterdam, Melbourne, Toronto, Frankfurt and Hong Kong – a testimony to the global nature of the interest in the report. Parker Global Strategies participated in the New York launch, which was attended by over 150 people representing large institutional investors, government officials, investment managers, and the press.

The response from corporations to CDP3 has improved markedly since the first questionnaire was sent out in 2003. In the third report, 71 percent of the companies answered the questionnaire, up from 59 percent for CDP2 and 47 percent for CDP1. Another 8 percent provided some information, 10 percent declined to participate and only 11 percent of the companies provided no response at all. The key changes that the CDP3 report has found are summarized in the following table from the CDP3 report:

Another European group that is UK-based and focused on the area of climate change and investing is the Institutional Investors Group on Climate Change (IIGCC). Its mandate is similar to that of the CDP and its membership is comprised of pensions funds and institutional investors. The objective of the group is to serve as a forum for its members to study, understand, and act on the risks and opportunities to their investments resulting from climate change. In their own words, "to occupy the overlap between ‘interested investor’ (aware of the implications of climate change) and ‘responsible investor’ (acting to manage the risks climate change poses to our investments). IIGCC does not seek to become a ‘campaigning investor’ (advocating immediate or otherwise radical changes in energy and economic activity)." This position of serving more as a steward, rather than an advocate, is common among those investor groups that PGS has found active in this area.

In the US, one of the groups leading the effort to assess climate change risk in investing has been CERES, a national network of investment funds, environmental organizations and other public interest groups working to advance environmental stewardship on the part of businesses. The group was established in 1989 and now oversees the Investor Network on Climate Risk (INCR). Since 2003, the number of major US institutional investors that are actively engaged in "green investing" has quadrupled and the assets that they represent have grown from US$600 billion in 2003 to US$2.7 trillion in 2005 – an increase of 450 percent. While all of these assets are not being invested in "green" or even broader socially responsible assets, the potential and commitment is there for significant future growth in this asset area.

The 2005 Institutional Investor Summit on Climate Risk was held in New York City on May 10, 2005. Out of this event came a commitment from institutional investors, including state treasurers, state and city comptrollers, public pension funds, labor pension funds, foundations, religious institutions, and European institutional investors, to make investments of US$1 billion in companies developing and deploying clean technologies. It further called for investors to support shareholder resolutions and company efforts to improve corporate disclosure and governance on climate risk; to develop through the Investor Network on Climate Risk (INCR) an ideal climate risk policy for institutional investors; to adopt a reliable and generally accepted global standard for disclosure of climate risk; and to promote information sharing among the growing number of institutional investors and organizations around the world concerned about climate risk.

In addition, with regard to fund managers, the Call to Action commits the signatories to require and validate that relevant investment managers, seeking to manage their fund assets, describe the resources, expertise, and process that they use to assess the risks associated with climate change. It also requires the INCR to publish an annual scorecard indicating how mutual funds vote on climate change shareholder resolutions. Lastly, the Call to Action encourages companies to report on how they are addressing climate change and calls on the US Securities and Exchange Commission to require that companies disclose the risks associated with climate change in their SEC filings.

The efforts of groups like CDP, IIGCC, CERES, and INCR are important to effecting change at the investor level because, ultimately, it is the investor community that will have the greatest impact on corporate governance in the area of climate change and the assessment of climate risk. The World Economic Forum held a series of three roundtable discussions in 2003 and 2004 to look into why SRI did not play a larger role in the investments of the mainstream financial community. The World Economic Forum’s Global Corporate Citizenship Initiative (GCCI) and the London-based think tank, AccountAbility, issued a report summarizing the findings of the roundtables in early 2005. The following comment summarizes the challenge faced by investment managers when they take into account issues like climate risk that may not be perceived as financial factors by their investors:

Thus, the commitment of investors to use climate risk analysis as a tool in their investments becomes critical to the use of climate risk analysis as a tool by investment managers and analysts. The commitment by the investors that participated in the second INCR sponsored investment summit is a significant step toward achieving this goal. Coupled with the increased participation of corporate respondents to CDP3, the foundation is being laid for demand by institutional investors in investment products that use climate risk analysis as a primary factor, along with good investment fundamentals, to achieve returns.

Clean technologies, including wind and solar energy, fuel cells, advanced materials, industrial process controls, and water filtration have grown rapidly over the past several years, becoming a bourgeoning investment ground for both venture capital and hedge funds. In fact, whereas these emerging technologies represented a mere 1 percent of total North American investments five years ago, they now comprise roughly 5 to 7 percent of total venture capital investment. The rapid proliferation of "green" technologies and renewed investor interest is being driven by global economic demand. These technologies are now being integrated in fast-growing established industries that, in many cases, are experiencing double-digit growth rates. For example, automation technologies that improve energy efficiency are currently a US$2 to 5 billion dollar market. In the case of wind power generation, the global market was just US$5 billion in 2000 and is projected to grow by ten times by 2012. Likewise, the global solar market is expected to grow from US$3.5 billion to US$28 billion during the same time period. In addition to technological advances that are improving industrial processes and energy generation, sustained growth in clean technologies is also being supported by resource constraints and years of underinvestment. For example, the EPA estimates that US$3 billion is spent annually on repairing the US’ aging water infrastructure, which has led to the rapid proliferation of private water companies acquiring municipal water systems. In addition, the US has not spent the necessary capital to refurbish and modernize its national power grid, leading to billions of dollars in losses due to power fluctuations and outages. Finally, commodities, particularly oil and natural gas, have risen markedly in price since 2004, while also being characterized by increased volatility. Consequently, both producers and end-users of power are adopting new technologies that can improve efficiency, manage risk, and reduce waste. Electric and gas utilities are developing wind power generation programs to offset the volatility of oil and gas inputs. Finally, as new technological advancements have been adopted by industry, resulting economies of scale have driven down prices for alternative and renewable forms of energy. A few forms, such as wind and hydroelectricity, have become cost competitive with their mainstream carbon-based counterparts. These factors, along with rising geopolitical costs, a growing climate burden, increased health expenditures, the declining quality of the world’s oil supply, and insufficient refining capacity, are coalescing in importance. Consequently, alternative and renewable forms of energy, and investments in them, are becoming increasingly profitable.

The recent global prominence of wind as an alternative and renewable energy source has its genesis in Europe where, in the 1990s, the increase of wind power generation grew from opposition to nuclear power after Chernobyl, concerns over oil supply during the first Gulf War, and the general assessment that, given its weather patterns, northern Europe was much better suited to harness wind energy than solar power.

Of all of the alternative energies currently being developed, wind currently has the most attractive economics and, by extension, represents the most immediate and viable alternative to traditional fuels. The economics of the industry have changed dramatically over the last twenty years with advanced technologies and increased production volumes resulting in a 90 percent reduction in unit costs. Despite this progress, the global wind industry is still in its infancy. Future electricity output will dwarf current production volumes based on the industry’s rapid growth rates. According to the American Wind Energy Association’s (AWEA) 2003 Global Market Report, global wind power generating capacity quadrupled during the five-year period from 1997 until 2002, growing from 7,600MW to an estimated 31,128 MW.

According to the Global Wind Energy Council (GWEC), that figure has since risen to 47.317MW in 2004 and, although it does not represent a 32 percent increase in production seen annually in the late 1990s, it still represents a healthy increase of 20 percent in total installed generating capacity from 2003. The countries with the highest wind power usage are Germany, Spain, the United States, Denmark and India. These are followed by Italy, Japan, Holland and the U.K, which are at or approaching the 1000MW level. In the US, wind power currently accounts for less than 1 percent of total electricity production but generation capacity has been expanding at similar annual average rates of 20 percent. AWEA estimates that by 2020, given consistent government support, wind could provide up to 6 percent of US electricity, an amount equivalent to current hydroelectric production.

There are many reasons for wind power’s emergence as a viable alternative energy source. The first is pure economics. Depending on the size of the windmill employed, the number of mills at a given location and the site’s average wind speed, new state-of-the-art wind plants can generate electricity for less than 5 cents/kWh (including the Production Tax Credit in the US). That makes it competitive with coal and natural gas-fired power plants and cheaper than nuclear energy. As competitive as current rates are, with organizations like the National Renewable Energy Laboratory (NREL), a division of the US Department of Energy, working with members of industry to develop next generation products, prices are expected to drop even further. Moreover, the long-term economics of wind power are no less compelling. After initial capital costs have been fully amortized, wind energy becomes extremely inexpensive with no fuel and pollution costs, and minimal operating and maintenance expense. The reliability of wind turbines is much higher than most traditional energy sources with only about 1 to 2 percent average downtime per year; and like hydroelectricity that utilizes nature’s kinetic energy to directly run a turbine, the energy source lasts forever and generates zero emissions.

In addition to low long-term cost and high reliability, there are several other factors that make wind power an attractive form of energy. It takes much less time to construct a wind farm than a conventional power plant and turbines can be added piecemeal allowing for energy output to be increased incrementally. The fabrication and maintenance of wind farms also generates 27 percent more jobs than conventional coal technology and twenty times more jobs than natural gas. This makes it potentially attractive to the general public as an industry that is not only environmentally sustainable, but one that makes economic and political sense as well. Finally, wind energy is an enormous potential resource. In the US alone, theoretical wind power is estimated at about 3,000 quads per year (one quad is equal to one quadrillion BTUs, an amount equal to 170 million barrels of oil) or 30 times the nation’s annual energy consumption. The US Department of Energy estimates that only about 120 quads of that total are exploitable, but even this small fraction of recoverable wind represents 20 percent more energy than total annual current US consumption. Since only a tiny fraction of this vast reservoir has been tapped thus far, as the industry expands rapidly over the next several years, wind energy is expected to be the cheapest energy resource by 2010. Additionally, as the global market has developed, marquee-manufacturing companies such as General Electric, Siemens and Mitsubishi Heavy Industries have all entered the wind turbine market. In fact, GE announced in June 2005 that revenue from wind turbine sales in 2005 would exceed US$2 billion and that the company sees wind power as the fastest growing sector in the energy industry. Traditional energy companies are also entering the market. Royal Dutch/Shell Group is leading an international consortium to develop the London Array, a US$2.7 billion wind farm consisting of 270 turbines in the Thames River estuary. The project could produce as much as 1000 megawatts and, according to Shell, supply London with up to 25 percent of its residential electricity while simultaneously reducing carbon dioxide emissions by up to 1.9 million tons per year.

Solar

The solar energy markets are becoming a more attractive sector of energy production with conventional energy prices rising, concerns of global warming and excessive pollution, and solar energy prices decreasing due to technological advances. Global demand for energy will most likely keep oil, gas and coal prices high and concerns regarding the environment will increase the incentive to use efficient alternatives such as solar.

The majority of electricity is produced from coal, natural gas, and oil. When these natural resources are taken through the process of combustion to produce electricity, pollutants such as carbon dioxide, sulfur dioxide and nitrogen oxide are released into the atmosphere, creating acid rain and smog. Carbon emissions, a significant portion of greenhouse gases and a major contributor to future global warming, are 6 billion tons per year. Clean energy sources such as solar can help reduce the emission of these pollutants, while meeting increasing energy demands.

Solar cells convert energy from sunlight, a renewable resource, into electricity. The Earth receives more energy from the sun in an hour, than the world uses in a year, making this resource extremely untapped. This untapped energy will be crucial to produce as conventional energy prices rise and the appealing production of solar energy becomes more popular. The electricity from solar panels is produced using no moving parts, produces no pollution, and creates no noise, making it very reliable and practically maintenance-free.

While subsidies are largely responsible for fueling the solar market, there will soon be growth without government subsidies. Solar cell installations have been increasing at a rapid pace. Energy from solar cells only accounts for 0.1 percent of global energy demand, allowing for even a small increase in market penetration to lead to rapid increases in solar industry growth rates. Global warming risks, coupled with energy security and price concerns, which are very unlikely to disappear in the near future, create the opportunity for the solar power market to gain a larger position in the power pool. Some industry experts estimate renewable sources of energy, such as solar, can supply half of the world’s demand for energy in the next 50 years.

In 2004, the 24 publicly traded solar equities returned nearly 185 percent as a group. Currently, the number of publicly traded solar companies is up to 29 and continues to expand as demand for solar electricity is much higher than solar manufacturers can meet at current production. While there are five major players in the photovoltaic market which account for approximately 60 percent of the market share, smaller pure play solar companies such as Evergreen Solar are showing promising growth with approximately 250 percent revenue growth over the past few years.

The current market for solar power is US$7 billion per year and growing at an annual rate of over 30 percent, which is expected to last until at least 2010. Improving solar cell efficiency, manufacturing technology improvements, and economies of scale have all contributed to declining costs, allowing many solar companies to achieve profits for the first time in 2004. Cost reductions have been over 5 percent annually, causing margins to expand well through 2007. Analysts estimate the solar market has a realistic potential to increase from US$7bn in 2004 to US$30bn in 2010, while during the same time period increasing profits from US$0.8bn to US$3bn.

Hydroelectric power is the global leader of energy production for renewable sources of energy. Nearly 20 percent of the world’s electricity is produced by hydropower in over 150 countries. Canada is the world leader of hydropower production at 13 percent of the world’s output, with a capability of twice that amount being developed.

There are many benefits to hydroelectric power. After dam construction, it is virtually free of cost and there is no pollution or waste production. Furthermore, it is very reliable and peaks in demand can be accommodated by reserves of water stored above the dam. Finally, the level of energy production can be easily raised or lowered, and electricity can be generated at a constant rate.

Hydroelectric power produces more electricity than any other alternative energy source. Hydropower is an emissions-free, renewable and reliable energy source that serves our environmental and energy policy objectives. With zero air-emissions, hydropower helps in the fight for cleaner air. Hydropower's fuel—water—is essentially infinite and is not depleted in the production of energy. This helps to preserve a nation's independence from supply disruptions overseas. And, as a source of energy, hydropower excels at preserving the stability and reliability of the electrical grid, due to its unique operating characteristics.

Geothermal energy uses heat from within the earth to produce energy through the use of wells, which are drilled into geothermal reservoirs to bring hot water or steam to the surface. The steam then drives a turbine-generator to produce electricity in geothermal plants.

Geothermal energy production emits no nitrogen oxides, no sulfur dioxide and much less CO₂ than fossil fuel energy production. Since no NO_x or SO₂ is emitted, acid rain in the area of energy production is reduced, as is the impact of climate change from the reduction in CO₂.

Geothermal energy production makes sense economically as well as environmentally. The cost of producing geothermal energy is competitive with that of some fossil fuel facilities. Real levelized costs, or the average cost of power production over the life of a power plant, are currently 4.5 to 7 cents per KWh. These costs are very competitive with conventional power sources, as can be seen in the table below. The combination of economical energy production and minimal environmental impact makes geothermal a very attractive source of energy.

According to the US Department of Energy, costs per KWh will drop to 3 cents, making geothermal energy even more economically competitive with traditional fossil fuels energy and should result in 10,000 additional MW of new capacity by US firms in the net decade.

Bioenergy is renewable energy that is produced from organic matter. Biomass fuels include wood and forest and mill residues, animal waste, grains, agricultural crops, and aquatic plants. These materials can be used as fuel to heat water into steam or can be processed into liquids and gases for energy production. With lower production costs and better technology, bioenergy could increase by four and a half times by 2020. Biomass energy is expected to grow faster than any other alternative energy source, rising by 80 percent and reaching 65.7 billion kWh in 2020.

There are many advantages to using biomass as a form of producing power. Biomass can be easily grown or collected, used and replaced so that resources are not depleted from one generation to the next. On the other hand, fossil fuels such as natural gas and coal require millions of years to be produced. The lengthy time required for the production of these fossil fuels depletes natural resources for thousands of generations. Traditional fossil fuels are found in specific locations, unlike biofuels, which are readily available across the Earth. There is therefore a greater self-sufficiency with bioenergy capability on a local, regional and national level. Self-sufficiency does not only promote a healthier internal economy, but is more beneficial to the environment.

Energy production from biomass is much more environmentally friendly than other conventional forms of energy. Carbon dioxide levels in the atmosphere have doubled from 150 ppm to 330 ppm since the industrial revolution and are expected to double again by 2050. Biomass keeps the carbon cycle stable by releasing the same amount of CO₂ as was absorbed through photosynthesis of the plants.

In 1990, Congress passed amendments to the 1970 Clean Air Act with the goal of reducing pollutant emissions such as sulfur dioxide (SO₂), one of the primary causes of acid rain and ground level ozone (smog). The amendments included the creation of a "cap-and-trade" market for SO₂ aimed at restricting and, over time, reducing emissions. Under this system, power plants were granted emission allowances that were "capped" at certain levels and would need to be reduced over the next several years. These allowances could be bought or sold if a plant needed to pollute above or below its allotment.

Though some are dubious about the environmental benefits of the cap and trade system, SO₂ emissions have fallen by 35 percent nationwide from their 1980 levels, according to the Environmental Protection Agency (EPA). Skeptics state that the fall in emissions is due mostly to the "cap" portion of the program. The EPA has continually lowered granted allowances, which have fallen from 15.7 million tons in 1995 to 11.2 million tons in 2000, and will drop to 8.9 million tons in 2010. Furthermore, in March 2005, the EPA finalized the Clean Air Interstate Rule (CAIR), which requires SO2 emissions to be reduced by 57 percent or 5.4 million tons down from 2003 levels by 2015.

However, Denny Ellerman, head of the Center for Energy and Environmental Policy Research at MIT, says of SO₂ trading, "Without dispute, it works. Cap-and-trade programs are proving to be an unprecedented solution for environmental regulation—not to mention a nice business for financial firms." Indeed, the "trade" portion of the program provides financial incentive for plants to reduce their emissions so they can sell unused allowances, placing emphasis on developing new "cleaner, greener" technologies.

Currently over 2000 US factories and power plants participate in the SO₂ cap-and-trade market, which totals about US$7 billion annually. It is a reasonably mature and liquid market, averaging about six trades a day on Amerex with 40 percent volatility. In fact, financial powerhouse Morgan Stanley is now the largest SO₂ emissions trader in the market. In 2003, SO₂ prices averaged about US$250 per ton, but surged to US$650 per ton after CAIR was announced in March of 2005. At the end of August, prices had reached about US$850 per ton. SO₂ prices are expected to reach over US$1000 per ton in 2015 during the strictest period of emission allowances.

Until recently, the complexity of the cash market has kept many potential investors away. In June 2005, however, NYMEX announced that it would launch futures contracts for SO₂, as well as for nitrogen oxide (NO_X). The ability to use NYMEX’s clearing system means that emissions transactions are no longer limited to cash transactions, and being able to trade on an exchange will likely make current traders more active and lure new participants like hedge funds into the game. Since this market is not widely understood, information asymmetries could provide significant profit opportunities for knowledgeable players.

Recently, a new emissions market has emerged, that of carbon dioxide (CO₂) emissions trading. Carbon dioxide and other greenhouse gases such as methane, nitrous oxide (N₂0), sulfur hexafluoride, hydrofluorocarbons, and perfluorocarbons, trap and absorb radiation and cause warming of the earth’s atmosphere. The trading of CO₂ emissions has gained traction recently mainly due to the Kyoto Protocol, which took effect on February 16, 2005. The Kyoto Protocol aims to reduce greenhouse gas emissions by 5.2 percent from 1990 levels by 2012, and was signed by every industrialized country except the United States, Australia and Monaco.

Skeptics see little effectiveness for the protocol since the US produces anywhere from 25-35 percent of the world’s greenhouse gas emissions. However, though the US has rejected Kyoto as a federal program, 28 states have already proposed or implemented initiatives to reduce greenhouse gases. In fact, on August 24, 2005, nine states in the Northeast, including New York, New Jersey and Connecticut, came to a preliminary agreement to cap and reduce greenhouse gases. In 2003, these nine states formed the Regional Greenhouse Gas Initiative to explore the cap-and-trade option as a means of reducing emissions. The plan would cap CO₂ emissions at 150 million tons per year, with plans for reductions in 2015. The New York Times indicated that the agreement is likely to be ratified by the participating states, and this would create tremendous opportunity for carbon trading in the US market.

As part of Kyoto, the European Union created a market for CO₂ rights. The market capitalization of those rights valued at recent prices totaled €64 billion. If the ascent of SO₂ prices is any indication, CO₂ prices could skyrocket. The nascent CO₂ rights market is forecast to reach US$5 billion in 2005, and "has the potential to become the biggest financial market in the world," according to Neil Eckert, chairman of the European Climate Exchange in London. The price of CO₂ rights has more than quadrupled this year, from about €6 per ton in January to a record of €29.50 on July 7, 2005. Current prices are at about €23.

Already, the burgeoning market in the EU has attracted many investors. So far there are at least 10 funds that have begun trading in the carbon market, and industry giants like Morgan Stanley, Merrill Lynch, Goldman Sachs, and Citadel have all ventured into the European CO₂ rights market. Investors can enter the carbon markets in a number of strategies. Some will buy and hold the rights, while others will seek to benefit from the information asymmetries and wide arbitrage opportunities throughout the world. Some investors may analyze the effects on the costs and share price of power plants, and the trickle down effects if plants pass costs onto consumers. Any way the market is played, there is tremendous profit potential.

The water industry consists of a diverse global universe of participants involved in the collection, transportation, treatment, monitoring and analysis of water and wastewater for various enterprises. As one of the most important inputs to global agriculture and manufacturing, particularly in developing economies such as China, which are less efficient in its use, there is a growing imbalance between supply and demand for clean water. However, the demand for water is still highly inelastic, making it less susceptible to the vagaries of economic cycles as are many other types of commodities.

This inelasticity of demand along with regular dividend increases, has led to excellent investment opportunities and returns within the water industry, particularly in the US. In fact, an equally weighted basket of publicly traded US water utility stocks had an annualized return of 15.77 percent from 1999-2003 compared to the S&P 500, which returned 12.96 percent. That return was calculated using only companies in existence at the end of 2003 and would have been even higher had it incorporated all of the utilities acquired over the same time period.

Notwithstanding the favorable economics caused by a growing supply and demand imbalance and consistent and predictable dividend increases, the secular investment case for investing in water utilities is furthered by the trend towards privatization and consolidation. In the US, one of the most advanced nations in the world, the water infrastructure is so antiquated and decrepit that the EPA estimates that it will take up to US$1 trillion to upgrade, an order of magnitude similar to defense spending or the estimated need to overhaul Social Security. In addition, the industry is extremely fragmented with approximately 53,000 community water systems serving 260 million people, half of which are owned by local municipalities that service about 85 percent of the population. However, whether they are privately owned or not, the vast majority of community water systems in the US are very small, with 75 percent serving less than 3300 customers. Typically, this means they do not have access to the enormous amounts of capital necessary to upgrade their aging and neglected infrastructure. Assuming they can consolidate with another municipality to form a geographically contiguous system, a small municipal utility will become part of a much larger entity that may be able to issue municipal or revenue bonds or possibly raise special project financing. However, when all potential financing possibilities have been exhausted and consolidation is not possible, a small community system in dire need of overhauling its water system will often allow itself to be acquired by a much larger publicly traded utility. As few homeowners exercise their ownership stake of the local system, larger utilities are often able to acquire these municipalities at excellent valuations, often well below the replacement value of the acquired systems, allowing for significant returns on investment despite the reconstruction costs associated with system upgrades. Furthermore, these publicly owned utilities are the only industry players that have access to sufficient capital and the management expertise to operate well-organized systems and are benefiting not only from accretive acquisitions but also lucrative management contracts with larger municipalities. As these utilities currently only service about 8 percent of the total US water market, the future investment opportunities are enormous.

There is still yet another source of investment returns when considering US water utilities and that is the potential for merger and acquisition activity amongst the utilities themselves. For example in 1999, Philadelphia Suburban purchased Consumers and later in 2000, California Waters merged with Dominguez Services. Some of these public companies have become such attractive investments that they are also grabbing the attention of international suitors, as evidenced by French conglomerate Suez’s acquisition of United Water Resources and German company RWE’s purchase of AWK. Some of the premiums paid in these transactions have been up to three times book value making these water utilities, when also considering their steady dividend payouts, extremely rewarding investments for long-term stockholders.

Although water utilities have generally been lucrative investments, and while they are the most readily observable participants in the industry, they are merely the end delivery mechanism to consumers and represent just a fraction of the global water industrial complex. The broader universe is also comprised of companies that manufacture pumps, pipes, filters and valves as well as firms involved in the testing, engineering, instrumentation and building of water systems. Since every water utility must provide uninterrupted service to its customers, they are in turn stable patrons of the water industrials, providing them with a steady, non-cyclical demand.

In the wake of the deregulation of the power industry, the weather derivatives market was developed as a means for the formerly monopolistic utilities to manage weather risk in the face of the emergence of the wholesale market. Initially, the participants in the weather derivatives market involved large energy trading companies, but this soon expanded to include re-insurers, financial institutions, and end user industries affected by weather.

Weather derivatives are essentially options on the weather. A utility or other entity that wishes to hedge against weather that may adversely affect its operations can enter into an agreement with another party that will pay the utility for moves in temperature in exchange for a premium. For example, if a gas utility wishes to hedge against a warm winter, during which consumers would not use as much gas to heat their homes, it can purchase an option from a counterparty that will pay it a specified amount for every degree the temperature is over a certain predetermined level. Weather risk is not limited to the utility industry. The agricultural industry is obviously significantly impacted by weather, and even the retail industry, for coat manufacturers for example, can be harmed by unexpected climate conditions. In fact, the US Treasury has stated that 70 percent of US companies are impacted by the weather, and the US Department of Commerce estimates that a third of the US economy, about US$3.8 trillion, is subject to weather risk.

The weather risk markets have seen significant growth in the recent past. The notional value of these types of contracts increased US$400 million compared from 2003 to 2004, a 10 percent increase on the total notional value of US$4.6 billion, an all time high. Furthermore, the number of contracts tripled over the same time period. John Polasek, president of the Weather Risk Management Association, says, "The 10 percent increase in notional value…is quantitative proof that the market for weather risk management instruments is poised for continued growth and expansion. In an era of heightened fiscal responsibility, more and more businesses are realizing the importance of protecting their profits and revenues from the risks of adverse weather."

Another instrument intended to mitigate risks caused by the natural environment are catastrophe bonds (or cat bonds), which cover extreme events such as hurricanes, typhoons, and earthquakes. There are even cat bonds to guard against terrorist attacks. These types of bonds gained popularity after Hurricane Andrew in 1992 and have been profitable investments for many investors.

A cat bond differs from a weather derivative in that, instead of acting like an option, it is actually a fixed income instrument, generally issued by insurance companies. Investors purchase the cat bond and receive a coupon related to its risk premium, in this case the probability that a catastrophe of a specific type and magnitude will occur in a specified place and time period. If a catastrophe occurs at a certain level, an investor might lose the coupon, and if the event exceeds a certain level, the investor stands to lose some, or all, of the principle as well. What makes these investments so attractive is that catastrophic events of the magnitude and specificity needed to trigger losses occur very rarely. In fact, since 1997, none of the 59 cat bonds issued had hit its trigger. In 2005, however, Hurricane Katrina did cause the loss of principal on one bond, a special purpose vehicle called Kamp Re.

In 2004, there were more than US$4 billion of catastrophe bonds outstanding, and demand is outstripping supply, according to Guy Carpenter, a reinsurance broker. Not only is there ample growth potential in both weather derivatives and catastrophe bonds, there is also zero correlation to equity, bond, currency, and all other financial markets. This combination presents a very appealing investment opportunity.

The impact of greenhouse gas emissions on climate changes is virtually indisputable. The ratification of the Kyoto Protocol, the increased awareness of climate risk by corporations, the work of the Carbon Disclosure Project and CERES, and the launch of carbon trading both in Europe (mandatory) and the US (voluntary) all lead institutional investors to the knowledge that this is an area that must be considered in terms investment analysis and risk. The participation of over 150 investors in CDP3 representing assets of US$21 trillion and the Call to Action by the 28 investors at the INCR Conference on Climate Risk prove that investors are serious about considering climate risk in their investment decisions.

As we have shown, the opportunities for investment in clean technologies, including wind and solar energy, fuel cells, advanced materials, industrial process controls, and water filtration, is growing. The nascent carbon trading market in Europe has traded over 38 million tons of carbon in its first five months. The CEO of General Electric, Jeffrey Immelt, has stated that he wants GE to be thought of not as a "global company," but rather as an environmentally friendly company. In fact, GE has coined the "ecomagination" and is using it as part of a new advertising campaign to re-position GE as friendly to the environment.

PGS Global Green Fund provides the opportunity for institutional investors to gain exposure to a select list of managers that are focused on climate risk and the opportunities that climate change presents.

¹Socially Responsible Industry Trends in the United States

2 ibid

3 ibid

¹²Carbon Disclosure Project website

¹³CDP 3