When Martin Gross-kopf scours the investment universe for the $141.9-million Acuity Clean Environment Equity Fund, he looks for companies that provide innovative products or solutions to meet the planet’s growing environmental needs. It has paid off. The performance of the one-of-a-kind fund in Canada has excelled in the past five years.

“We’ve seen a real acceleration of opportunities for clean technology in the past few years,” says Grosskopf, 41, associate portfolio manager at Toronto-based Acuity Investment Management Inc. “People are more aware of climate change and that means politicians are getting interested in the issue. The regulations and incentives for alternative power have dramatically improved compared with a few years ago.”

The fund, launched in December 1991, differs from others devoted to socially responsible investing because of its narrower, environmental focus.

Everyone is aware of the commodities boom that has driven the economy, Grosskopf says, but few think about the constraints on the consumption of those commodities. “Every time we burn a lump of coal in a power plant,” he says, “we have emissions. We face issues on how to control what’s being pumped into the environment. There are companies that are going to provide the solutions.

“It’s all about the need to control the manner in which we consume these commodities,” he adds. “That’s the unifying theme [of the fund]. These companies are not only alleviating the problems but making good money at the same time.”

Although many environmental companies have been around for some time, it has taken years to commercialize their technologies. They are only starting to produce results.

“It hasn’t hurt that crude oil is above US$100 a barrel,” says Grosskopf, a growth manager. “Investors are focused not only on conventional technology, but also on alternatives.”

Thanks to a change in market sentiment and selective stock picking, the fund has generated strong results. For the 12 months ended June 30, it returned 2% vs a loss of 8.8% for the median fund in the Canadian-focused small-/mid-cap equity category. For the three- and five-year periods ended June 30, the fund had an average annual compound return of 13.8% and 15.7%, respectively, vs 6.7% and 10.3% for the median fund. It has a three-star Morningstar rating.

Despite the high rating, analysts’ opinions are mixed.

Ranga Chand, who heads Ottawa-based Chand Carmichael & Co. Ltd. , considers the fund a “heavy-hitter” (by definition, a fund that delivers above-average rates of return with below-average risk).

Still, he counsels that advisors should not use the fund for short-term plays. “It’s preferably a 10-year investment,” he says, noting that although the fund never lost money over any 10-year period, it had a bad patch when it lost 10.5% compounded in the five years ended March 2003.

“It’s a focused fund, appealing to people who support environmental solutions,” Chand says. “But given its history, you should expect volatility and definitely take a long-term horizon.”

Dan Hallett, president of Windsor, Ont.-based Dan Hallett & Associates Inc. , also acknowledges that the fund has lately outperformed, like many in the Acuity family. “As a firm, it has been on a strong run, as it’s focused on smaller companies, income trusts and resources, which have all done well. It has been Acuity’s kind of environment and its funds have prospered. This fund is no exception.”

But Hallett does not feel comfortable with the fund’s growth style. And he is critical of its 2.89% management expense ratio, almost 30 basis points higher than the median fund in the category. The fund’s 115% turnover in 2007 is also too high for his comfort.

One contributor to the fund’s performance is ARISE Technologies Corp. A leader in solar technology, the Waterloo, Ont.-based firm has established a plant in Germany that manufactures photovoltaic cells to generate electricity.

“Germany is the leader in solar implementation. It provided some incentives for companies such as ARISE to put in production facilities,” says Grosskopf. “It has gone from being a marginal player in the solar space to becoming a legitimate company with tremendous growth opportunities.”

Acquired in late 2006, the share price has risen to a recent $1.20 from around $0.40 at the time of purchase. “The stock is getting some attention, reflecting the growth it has in front of it,” he says.

@page_break@Grosskopf has no stated price target, but believes it has further upside: “It’s an industry that is emerging very rapidly. You will attract some momentum investors. These stocks are reflective of very high growth rates and people trade in and out of them.”

Another key holding is GLV Inc. (formerly Groupe Laperriere & Verrault Ltd.) The firm used to have three divisions: mining tools, pulp and paper machinery, and waste water and drinking water systems. It sold the mining equipment division last year and is now concentrating on the latter two businesses.

“We got a very good multiple on the mining business. Then the company became more of a pure play on water and waste water,” says Grosskopf. “The growth rates are quite attractive in that sector. Generally, there is a higher multiple than for other capital goods industries.”

GLV’s shares trade at around 17 times 12-month earnings. That multiple is backed by a high earnings growth rate, which Grosskopf estimates at 50% for the next few years. He acquired the stock at around $10.50 a share in 2003. It recently traded at $13.07 a share.

There is further upside, he says, based on two catalysts. “We anticipate GLV will continue to make headway in terms of organic growth,” Grosskopf says, noting that the firm offers a suite of technology solutions and equipment, unlike its competitors, which specialize in one solution. “It also has a history of buying underperforming companies, turning them around and generating good margins.”

Grosskopf tends to take a thematic approach to investing. The first theme looks at alternative energy and power solutions and focuses on wind and solar energy firms, conventional oil and gas companies that employ innovative technology and less obvious companies that supply so-called “smart meter” technology. He likes Calgary-based Canadian Hydro Developers Inc., which has a diversified portfolio of power generators (using wind, biomass and water) and is Canada’s largest wind farm developer.

“It’s one of the only ones that is mature enough to have good cash flow,” he says. “But its 15%-20% growth rate is much higher than at the utility level.”

Acquired in 2005 at $4 share, it recently traded at $5.33 a share.

The second theme focuses on waste management and pollution control technology. This lends itself to firms such as oil field waste recycler Newalta Income Fund and Foster Wheeler Ltd., a U.S. engineering firm that builds coal plants.

The third theme focuses on water treatment and waste-water technology; the fourth on solutions for environmental health and safety issues. A representative holding in the latter area includes HSE Integrated Inc., which provides monitoring equipment and training in emergency response to the oil and gas industry.

“As we push our infrastructure in terms of capacity,” Grosskopf says, “we have to deal with older plants and there’s more need for these services.”

The weightings for each theme depend on the opportunities. Currently, about 40% of the fund is in alternative energy, followed by 30% in waste management and pollution control equipment. The remaining 30% is split between water and waste-water technology and environmental health and safety issues.

Grosskopf likes to broaden the universe of investments by investigating a company’s supply chain for other opportunities. That leads to carbon fibre manufacturers, which supply material for wind turbines, or firms that supply silicon for photovoltaic energy panels. He is also willing to seek overseas opportunities; thus, the fund has about 50% foreign content unhedged against currency swings.

Praxair Inc., for example, is a top holding. One of the world’s largest suppliers of industrial gases, the Danbury, Conn.-based firm has a growing hydrogen business that is benefitting from strong demand in the oil refinery industry, which is required to remove sulfur from crude oil and meet regulatory standards.

“It has a very good growth rate in the hydrogen business, as it ramps up production for refineries,” he says. This business segment has a 20%-40% growth rate. The company also provides carbon dioxide for industrial processes and the oil and gas industry (to improve the viscosity of oil). Acquired in 2004 at around US$40 a share, the stock recently traded at US$91.76 a share.

“The opportunities still look very strong, and the company pays a growing dividend,” says Grosskopf. “Even in a recessionary environment in the U.S., the company is still growing dramatically in other areas of the world.”

A Toronto native, Grosskopf has a background in environmental management. He graduated from the University of Toronto in 1990 with a Bachelor of Arts in anthropology, then attended Toronto’s York University, from which he earned a Masters of Environmental Studies in 1993. On graduation, he worked as environmental consultant at Acres Ltd., a private engineering firm in Toronto.

“I did a lot of in-house work for the resources industries,” Grosskopf says. He was seconded by a steel mill for six months and helped it deal with environmental mitigation issues. “Later on, I could use my knowledge from an investment standpoint.” He also completed an MBA at York University.

Joining Acuity in 2000 was a natural fit as Acuity provided an opportunity to apply his technical knowledge. “It was the only firm focused on environmental technology,” he says. “I always felt there were a lot of opportunities to invest in clean technologies.”

Like other Acuity funds, it is managed on a team basis. Most ideas come from Grosskopf and research associate Rachel Davies. They also get insights on new technologies in the oil and gas industry from Hugh McCauley, Acuity’s lead equity manager. Ian Ihnatowycz, company founder and chief investment officer, acts as chief strategist.

The fund has had its ups and downs in its 16½-year history. In the mid- to late 1990s, it prospered, as there was strong interest in environmental companies. The bursting of the tech bubble in 2001-02 brought that to an end and the fund hit a rough patch. The fund has rebounded since then, partly because of the strategic shift toward environmental solutions for the resources industries.

“Once we made those changes,” he says, “the fund began to turn around.”

Grosskopf has become more cautious lately, raising cash to around 9%. He has also increased the exposure to liquid, large-cap names such as Suncor Energy Inc. “There will be opportunities down the road to add to existing names,” he says. “In that sense, we are being more defensive — at least in the short term.”

In the long term, he remains upbeat: “All we can do is own companies that we believe will be winners over three to five years.” IE