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THEMATIC INVESTING An alternative to benchmarks?

In today’s financial markets there is perhaps too much information, too much choice, too much opportunity, and unfortunately too many pitfalls. Cutting through all the conflicting opinion and advice can be hard work and requires a lot of discipline.

For this reason, it is important to regularly take a step back and survey the bigger picture – to analyse the longer-term trend rather than the deviations around it.

In the first of our series of papers on thematic investing, we take a look at some of the limitations of benchmarks, and discuss why a thematic approach to equity investing may be better suited to some investors.

ARE BENCHMARKS THE RIGHT ‘FILTER’ FOR YOUR PORTFOLIO?

There are nearly 15,000 investable stocks in the world - far more than any individual, or even team, can possibly evaluate efficiently. The way that investors typically ‘filter’ the universe of stocks to a more manageable number is to first identify a benchmark, and then try and beat it. Whilst identifying a benchmark may present a quick, easy, and low-cost way to gain exposure to a particular group of stocks, it’s important that investors are aware of some of the limitations associated with this approach. As most benchmarks are capitalisation-weighted, there are a number of implications investors should be mindful of:

The biggest stocks aren’t always the best

Market capitalisation weighted benchmarks have a bias towards large stocks, and will generally have a limited exposure to value and small stocks – two traits that have shown strong outperformance in returns over time.

Beware of short-termism

As a security increases in value, a market capitalisation-weighted benchmark will hold more of the stock. This means that if

the security becomes overpriced and falls in value again, the benchmark will be holding the largest amount of that security right before the price begins to fall. This can lead an investment manager to adopt a momentum-based style of investing where they respond to ‘cyclical’ economic indicators such as manufacturing surveys, loan growth, retail sales etc. This data can be high frequency and volatile, and can often result in ‘over-trading’ and short-termism.

Do geography or sector benchmarks really give you what you’re looking for?

Most benchmarks are created according to geography – i.e. where the stock is listed (such as the S&P500 Index in the US or the S&P/ASX200 Index in Australia) or the sector under which the stock is classified (such as infrastructure or real estate investment trusts). However, a company listed in the US doesn’t necessarily give you any better or worse prospects than one listed in Europe. For example, Pfizer (listed in US) and Roche (listed in Switzerland) are both highly competitive leaders in the pharmaceutical industry and equally generate 40% of their revenue from the US and 60% from the rest of the world. A thematic investment approach would focus on assessing the fundamental merits of both companies, in context of their exposure to global healthcare spend.

About the authorAndy joined AMP Capital in February 2012 as a Portfolio Manager/Analyst within the Fundamental Equities team, and has more than 12 years’ investment experience in Europe and Asia Pacific as a senior buy and sell side equity analyst and strategist. Andy holds a Bachelor of Science in Economics (first class honours) from Kings College London, and is a CFA charterholder.

IN THIS PAPER WE DISCUSS… > How most benchmarks are capitalisation-weighted and arbitrarily constructed, which can create limitations for some investors

> Why an alternative approach to filtering investment opportunities may be to identify stocks highly exposed to secular investment drivers

> Some preferred themes which exhibit high exposure to our secular investment drivers

ANDY GARDNER Fundamental Equities

insightpaper

NOVEMBER 2014

Investing according to a geographic benchmark does not focus on the company merits or its exposure, but only considers the size of the company in context of their weighting in a regional index (Pfizer has a market cap of $192 billion and accounts for 1% of S&P500, while Roche has a $230 billion market cap and accounts for 2% of EuroSTOXX).

THE GROWING TREND TOWARDS THEMATIC INVESTING

An alternative approach to filtering investment opportunities may not be to choose a particular geography or sector, but to identify stocks which are highly exposed to secular investment themes.

Just as globalisation and technology have brought about interconnectivity through trade and service flows, and longer and more complex supply chains, there is clear evidence to suggest that investment themes transcend borders and sectors in the same way that they drive corporate strategy. For example, company executives in the US are as equally concerned about online security as executives in China, with cybercrime estimated to cost the global economy around US$400 billion per year1.

Many of the world’s challenges, such as education, aged care, and waste management, are undeniable. This is because they relate to secular forces such as population growth and productivity; as such, they are expected to grow at rates well in excess of GDP. This realisation is supporting the growing trend towards thematic investing – an approach which identifies companies that are exposed to themes which offer solutions to the challenges of a rapidly transforming world.

RECONNECTING WITH THE REAL WORLD

The products available to investors are arguably becoming increasingly shorter-term in nature and disconnected from the real world. Author and former Head of US Equity Research at Fidelity Management, Katherine Collins, suggests the primary beneficial function of investing has become overshadowed by ever more extended iterations of ‘finance’ - all the secondary activity that’s related to those primary functions and initial exchanges2.

As a result, we now have a greater amount of synthetic financial products, securitisation on top of securitisation, funds of funds, high frequency trading, and exotic derivatives being just a few. When we move deeper into the specialised mechanics of finance, we often end up in the realm of speculation, and lose sight of the primary role of investing.

Accompanying this trend, portfolios are becoming less ‘human’ and more mechanised. The many tools we have created in the past few decades to assist our decision making have now become the primary drivers of the decisions themselves. For example, the rise of modern portfolio theory has given birth to many theoretical and formulaic philosophies and processes, with one of the consequences being the recent fashion for risk parity and minimum volatility focused funds. While these funds certainly have a purpose and an important role to play in the overall mix of investment options, our concern is that the means is increasingly becoming the end. As Yogi Berra said about the dislocation of theory and practice, “In theory there is no difference between theory and practice, but in practice there is”.3

Instead of aiming for resilient, flexible, optimised portfolios, we seek to constrain them into ever smaller Style Boxes™4, and control them by increasing the layers of systems, tools and processing (and cost) between the underlying investment and the investor. But through constraining, controlling and focusing on the short-term, we inhibit flexibility and adaptability and hence lose resilience in the long term. As great academic and investment thinkers from Hyman Minsky5 to Howard Marks6 have discussed in detail, the current trend to believe in the absence of risk or at least the ability to suppress it, is in fact the riskiest thing of all.

Thematic investing is not risk free but it is more connected with the real world than the world on our screens. It is focused on aligning with the longer-term trend rather than speculating on the deviations around it. It aims to be simple rather than complex and flexible and adaptive rather than rigid. The outcome is that investment portfolios are more variable in their construct but less fragile and more resilient to changes over time.

1 Net Losses: Estimating the Global Cost of Cybercrime, Centre for Strategic and International Studies, June 2014.2 The Nature of Investing, Resilient Investment Strategies through Biomimicry, Katherine Collins, 20143 http://en.m.wikiquote.org/wiki/Yogi_Berra4 Fact Sheet: The Morningstar Style Box™, 2004 accessed on 18 September 2014 via http://morningstar.vk.se/Static/MorningstarStyleBoxFactSheet2004.pdf 5 Stabilizing an Unstable Economy, Hyman P. Minsky, 20086 Oaktree Capital memo dated 3 September 2014 accessed on 18 September 2014 via http://www.oaktreecapital.com/memo.aspx

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SUITABLE FOR LONG-TERM INVESTORS

Thematic investing is perhaps best suited to investors with a longer-term investment horizon as well as those who are seeking exposure to an international portfolio of stocks. The long-term nature of thematic investing enables investors to take advantage of two opportunities:

> Identify secular growth themes which will compound at rates in excess of the average over the long-term

> Identifying attractively valued quality companies that use these growth themes and generate additional value on top by producing high returns above their cost of capital, and continuing to reinvest those returns for many years

We believe that thematic investing enables a fresh perspective for thinking about risk and return, and as the approach is not constrained to a benchmark, it has the flexibility to go where most funds can’t. This will prove particularly useful in a world where the average rate of return on most asset classes is expected to be constrained (see The medium-term return potential for major assets - still constrained by Shane Oliver, 6 August 2014). Given that many of the world’s economic growth challenges can impact average returns, and thematic investing benefits from solving many of the world’s growth challenges, we have found this type of investing to exhibit lower beta and lower correlation to equities than traditional benchmark focused approaches. Given these attributes, we consider thematic investing to be an attractive option for investors who also like traditional growth strategies such as emerging markets and small caps.

SO, WHICH THEMES SHOULD AN INVESTOR CHOOSE?

Inspiration for themes can be drawn from almost anywhere, including disciplines not traditionally associated with investment. These can include culture, history and politics, as well as social and natural sciences. The goal for investors should be to choose themes which have the greatest potential for reward per unit of risk. Our favoured solution is to rank themes according to the degree of exposure they have to our five secular investment drivers: demographics, productivity, environmental, social and governance.

Why the importance of demographics and productivity?

Rooted in endogenous growth theory, a groundbreaking school of thought originally pioneered by great economic thinkers such as Kenneth Arrow , is the assumption that investment in human capital, innovation, and knowledge are the key contributors to economic growth. The growing divergences in the dependency ratio (i.e. retirees versus working population) across a number of countries is expected to drive major changes in future global patterns of consumption and healthcare. Compare African countries, with their relatively ‘youthful’ profile, to US ‘baby boomers’, and to the effects of the ‘one child policy’ in China. Given the challenges presented by demographic changes, we believe that substantial increases in productivity (e.g. technology and education) will be necessary to help us work smarter and produce more efficiently.

Secular changes in demographics and productivity can create huge long-term opportunities and challenges. The ‘reward’ to an investor is to identify which specific companies will benefit most by taking advantage of the opportunity – or which ones will find a solution to the challenge. The earlier this can be identified, the greater the potential reward to the investor.

Why environmental, social and governance?

In a world undergoing rapid demographic and technological shifts, sustainability factors are also extremely important. Environmental, social and governance (ESG) analysis is growing increasingly relevant as industries are impacted by the re-pricing of intangible factors such as weak regulation, underpaid labour and pollution. Indeed, intangible assets continue to rise as a percentage of companies’ market capitalisation. For example, the move to address climate change and energy security has provided a tailwind to lower emission intensive fossil fuels such as natural gas and liquefied natural gas (LNG), but has been a headwind for the coal sector. It is our belief that industries and companies that act responsibly, ethically and transparently have – and will continue to display – a better understanding of risk management, and are likely to avoid costly disasters. As such, identifying and understanding ‘intangible drivers’ can lead to more informed investment decisions and can avoid value destruction.

Once the potential reward from a particular theme has been identified, ESG analysis is used to evaluate the ’upside risk’ and ‘downside risk’ to our forecasts. So, is the secular change of benefit to society or the environment? How will governments respond? Will they introduce or change regulation?

Understanding regulatory change is perhaps the single most important factor when assessing risk to long-term secular themes, and ESG analysis is key to evaluating this potential change.

Demographics and productivity – we need to work smarter

Demographics

Source: OECD Statistics

Wor

kin

g ag

e p

opu

lati

on

(mill

ion

peo

ple

age

d 1

5 to

65

year

s) 1,400

1970

Africa

2000

Europe

20301950

Australia

1980

China

2010

Japan

20401960

USA

1990

India

2020 2050

1,000

400

1,200

600

800

200

-

“The goal for investors should be to choose themes which have the

greatest potential for reward per unit of risk.”

7 Arrow, Kenneth J., The Economic Implications of Learning by Doing (1962)

3

Source: The Internet of Things and the future of manufacturing, McKinsey, June 2013

Technology

USD

tri

llion

s p

er a

nn

um

Estimated benefits to the world from known new technologies

12

Renewable

energy

3D

printin

g

Autonom

ous

vehicles

Inte

rnet

of Thin

gs

Frack

ing

Energy

stora

ge

Advance

d

robotic

s

Autom

ation

knowledge

Advance

d

mate

rials

Genomics

Cloud

Tech

nology

Mobile

Inte

rnet

8

3

10

6

2

0

Low estimate High estimate

Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) makes no representation or warranty as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Certain information in this article has been obtained from sources that we consider to be reliable and is based on present circumstances, market conditions and beliefs. We have not independently verified this information and cannot assure you that it is accurate or complete. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital. © Copyright 2014 AMP Capital Investors Limited. All rights reserved.

Contact usIf you would like to know more about how AMP Capital can help you, please visit ampcapital.com

FINAL THOUGHTS

In this paper we have explored some of the limitations with investing in benchmarks. While the benchmark approach will be appropriate for many investors, for others, particularly those who can benefit from a longer-term investment horizon, a thematic approach may be better suited. For these investors, we propose an optimal investment framework is to first create an investment universe of stocks according to key secular investment drivers. Once the investment universe has been created, companies can be individually analysed to determine which ones can take advantage of opportunities (or provide solutions to challenges) faced by various themes.

In the second part of our Thematic Investing series we look further into this issue, and discuss how constructing an equity portfolio around themes may support improved investment returns.

WHERE WE SEE VALUE

While many themes are already playing out in the market, the market’s attention is mostly focused on short-term cyclical economic data and beating a benchmark. Humans exhibit a general tendency to underestimate long-term impacts and overestimate short-term impacts on asset markets and economies. As a result of this behavioural trait we have found that the market typically undervalues secular growth by not focusing on the power of compounding growth at rates in excess of the average over the long-term. In addition, the market also fails to give due recognition to those companies that use growth opportunity and generate additional value on top by maintaining a disciplined approach to capital allocation (return on capital and return of capital). These are the two major opportunities for investors with a longer-term horizon. We will explore these opportunities in greater detail in our second paper in this series.

We believe the following themes (which exhibit high exposure to our five secular investment drivers) provide some of the best opportunities for investors over the long-term: education; energy revolution; ageing demographics; obesity, health and wellness; technology change; and urbanisation. We delve into more detail to explain our reasoning for these preferred themes in the attached appendix.

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We believe the following themes exhibit high exposure to our five secular investment drivers (demographics, productivity, environmental, social and governance).

EDUCATION

Education is one of the most pressing socio-economic challenges today. It is a major component of well-being and a key measure of economic development and quality of life. It contributes to poverty alleviation, gender equality, health, and environmental sustainability. However, barriers to school enrolment and completion mean that, globally, there an estimated 793 million illiterate adults (two-thirds of which are women) and close to 100 million children who are not in school8.

Education spending is already very large (accounting for around 5% of global GDP). According to the United Nations, every dollar invested in education is estimated to generate US$10-15 in economic returns, and expenditure is expected to continue to grow by at least 7-8% to 2017. Factors driving this growth include higher enrolment targets, demographic opportunities (booming population of 5-17 year olds in emerging markets), more women in education, the increase in the middle-income bracket in

emerging markets (disposable spending on education in China, India and Brazil is just 10-13%), increasing global mobility, and a growing realisation of employment, earnings and economic development needs and opportunities. It is estimated that, over their lifetime, developed market graduates earn more than US$1 million compared to early school leavers. Growth in the private sector is expected to be at least double the overall 7-8% spend as governments increasingly seek public-private partnerships to tackle the education challenge. For example, e-learning expenditure is expected to continue growing at 20-25% compound annual growth rate over the next decade. An interesting (but not well known) fact is that education is Australia’s third largest export after iron ore and coal, but it is growing at a more consistent rate. According to Oxford Economics, by 2020, an additional 50,000 international students per annum will study higher education in Australia – the highest absolute growth of any country in the world.

APPENDIX Our preferred themes

Sub themes

> Education technology

> Publishing and content

> K-12 and childcare

> Post-secondary, colleges and university

Source: IBIS Capital

8 EFA Global Monitoring Report 2013/4

=Global education v.s. e-Learning expenditure forecasts 2012-2017

Global education expenditure breakdown by sector 2012

Corporate & Government learning

Glo

bal

Ed

uca

tion

Exp

end

itu

re ($

tn)

e-Learning expenditure: 23.0% 2012-2017 CAGR

education expenditure: 7.4% 2012-2017 CAGR

K-12 Other

10.0

8.0

6.0

4.0

2.0

0

Post secondary

2017

34%

50%

8%

8%

20152012

2012

i

Sub themes

> Alternative energy (wind, solar, hydro, fuel cells, biofuels)

> Clean technology

> Energy efficiency

> Battery technology

> Auto efficiency

> LEDs and lighting

> Fighting pollution

Source: BP

Litr

es p

er 1

00km

*

Renewables share of power Fuel economy of new cars40% 20

EU EU

1990 19752005 19952020 20152035 2035

US US

China China

30% 15

20% 10

10% 5

0% 0

ENERGY REVOLUTION

Economic, environmental and political drivers are now combining to support rapid uptake in alternative energy. Renewable energy will constitute the vast majority of new capacity added over the coming decades as the likes of solar and wind are now cost competitive on an unsubsidised basis in many locations around world. This is to the extent that even Shell and BP (oil companies) project they will dominate the global energy mix by the middle to end of the century. Despite this, renewable companies account for less than 0.1% of global market capitalisation today.

As it will take some time for renewable technologies to achieve the necessary scale and infrastructure to challenge fossil fuel, the short to medium-term focus will be on solutions increasing the efficiency of existing uses (cars, batteries, lighting, buildings). Historical energy savings from efficiency have exceeded the output from any other single fuel source, and if the trend continues at its

current pace, efficiency gains could halve the energy needed to power the world by 2035. Global investments in efficiency have ranged from $130 billion to $300 billion per annum in recent years. By 2035, we expect up to $14 trillion in investments – or $550 billion plus in annual spending – both to meet growth in demand and make the transition to a lower-carbon economy. There is significant ‘low hanging fruit’ potential given that 80% of energy is lost along the value chain, every dollar spent means $2-4 in lifetime cost savings, and two-thirds of the economic potential to improve energy efficiency remains untapped.

Furthermore, the rapid improvements in energy storage and battery technology will be the major keystone to unlocking the potential of renewables (such as solar PV) and energy efficiency (such as electric cars).

ii

Sub themes

> Ageing demographic spend

> Aged care

> Financial planners

> Dividends and yield

> Medical tourism

Source: Center for Medicare & Medicaid Services (National Health Statistics)

AGEING DEMOGRAPHIC

We are living through a period of population ageing that is ‘without parallel in the history of humanity’ according to the United Nations. Globally, the number of ‘older persons’ (aged 60 and above) is soon expected to exceed the number of children (aged under 5) for the first time in the history of the world. By 2050, one in three people in developed countries will be aged 60 and over, up from around one in five today. Further, these forecasts may prove optimistic. Over the past 50 years, every forecast of how long people will live has fallen short. Despite fears that obesity and global warming would reverse the trend; life expectancy in rich countries has grown steadily, by about 2.5 years a decade, or 15 minutes every hour. Falling birth rates mean that some countries are heading towards a potentially catastrophic decline in population. We believe that all aspects of society and the economy need to be viewed through the lens of this demographic transformation.

The spending habit of this cohort increases demand for a wide range of products and services, such as healthcare (drugs, hearing aids, orthopaedics, eye care, beauty products), aged care, and specialist travel. The US longevity sector alone is currently estimated at US$7.1 trillion, making it the world’s third largest economy. This section of the economy is expected to account for over 50% of US and Japanese GDP by the 2030s9.In a world where we expect constrained investment returns, an increasing proportion of the population retiring, and funding shortfalls in many pension plans, good quality companies with high and sustainable cash-flow yields and a policy of paying out profits to shareholders are likely to continue to perform well. Longevity risk will be one of the most significant challenges facing retirement systems over the next 50 years, with global annuity and pension-related exposure estimated to be as high as US$15-25 trillion. Many countries could be facing additional costs of up to 50% of 2010 GDP by 205010.

Spending on health care per person Population of the world aged 60 years or more

USD

Age

0$5,000

$10,000$15,000$20,000$25,000$30,000$35,000$40,000

0-18 19-44 45-64 65+ 85+ 1950

8%

2000

10%

2050

21%

9 Oxford Economics, NLIRI 10 International Monetary Fund

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Sub themes

> Obesity

> Immunotherapy

> Medical technology

> Generics

> DNA/genetics

> Biotech

> Weight management and nutrition

> Sports apparel and equipment

Source: AMP Capital

Past and projected future overweight rates in selected O.E.C.D. countries

Prop

orti

on o

verw

eigh

t

Years

80%

50%

70%

40%

60%

30%

20%1968 20001996 2016201219921984 1988198019761972 20082004 20242020

England

Spain

Switzerland

Mexico

Australia

Italy

Korea

USA

Canada

France

OBESITY, HEALTH AND WELLNESS

The obesity epidemic may be the most pressing health challenge facing the world today because of both its direct impacts and ripple effects on chronic diseases, such as diabetes. More people across the world now die from overweight / obesity related illness than from starvation. In the US, almost one-fifth of all deaths are associated with being overweight or obese. This means that a large proportion of health care spending is a direct or indirect consequence of obesity, with total health care costs more than 40% higher for obese patients than normal-weight patients. The annual cost of obesity-related illness in the US alone is estimated at US$190 billion, or nearly 21% of the country’s annual medical spending. By 2030, 50-60% of the population in many countries, including the US, UK, and Australia are on target to be classified as obese. The World Health Organisation estimates that 44% of the global diabetes burden, 23% of the heart disease burden and between 7% and 41% of certain cancer burdens are attributable

to being overweight and obesity. Food and beverage companies are going to have to increasingly focus on the quality of their portfolios given the rising spectre of fat and sugar taxes. For example, Mexico, who have the world’s highest obesity rate at 33% (including the most number of obese children, 14% of which have diabetes) and who consume 163 litres of soda per capita, per year, has become the standard bearer for sugar taxes, taxing sugary drinks at 10% per litre.

More broadly, the rapidly rising demand for and cost of providing healthcare is spawning innovation in areas such as DNA to use an individual’s genetic makeup to better tailor medical treatment. Further, immunotherapy is likely to become the treatment backbone in the majority of cancers over the next 10 years. More varied trends include patients travelling abroad for treatment to rationalise healthcare spending, and better use of IT infrastructure to improve quality, safety and efficiency.

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Sub themes

> Cybersecurity

> Internet of things

> Mobile payments

> Cloud computing

> Factory automation

> E-commerce

> 3D printing

> Big data

> Software services

> Social media

> Patents/IP

> Networks

Source: Gartner (November 2013), AMP Capital

11 The Digital Universe of Opportunities: Rich Data and the Increasing Value of the Internet of Things, IDC, April 2014 12 World Economic Forum, accessed on 18 September 2014 via http://www.weforum.org/issues/partnering-cyber-resilience-pcr

TECHNOLOGICAL CHANGE

Technological development is accelerating at a rapid pace as academic research and commercial enterprise become increasingly intertwined. Themes such as mobile connectivity, cloud computing, ‘smart city’ development and big data, are just a few strands in a multiplying web of developments that have wide-ranging commercial benefits. The number of everyday items that will be connected to the internet (cars, clothes, parking meters, home thermostats etc.) is expected to pass 30 billion devices by 202011.

Technology is also revolutionising traditional production processes. 3D printing has the potential to rewrite the rules of localised manufacturing and be as significant to the industrial sector as lean manufacturing. Automation is driving a substitution from labour to machines given rising wages in emerging markets and the need for productivity gains and safety improvements to meet tightening regulations and consumer expectations. Technological connectivity is enabling more companies to locate operations overseas in a process known as ‘offshoring’.

There is a growing focus on long-term solutions to the ever growing and changing array of safety and security threats against people, governments, infrastructure and society, with terrorism, cyber security attacks and critical infrastructure breakdowns recognised as one of the top five global risks today12. The proliferation of internet (fixed and mobile) enabled devices, and requirement to store valuable data and content increases vulnerability in a world of multiple devices using cloud services, e-commerce, and social media. Globalisation and competition from emerging markets is also leading corporates to protect themselves against ongoing threats against intellectual property. Increasing regulation and government standards are also causing companies to expand the boundaries of safety and risk management in their efforts to address issues like workplace accidents, road deaths, the food supply chain, the degrading environment, and new diseases.

Total of connected devices, billions of units (installed base)

30

2009 2020

20

10

25

15

5

0Connect PC, smartphone, tablet IoT

v

Sub themes

> Water treatment

> Waste management

> Recycling

> Greenhouse gas (GHG) treatment

> Smart grid and storage

> Infrastructure

> Emerging consumer

> Property

> Transport

Source: AMP Capital

Total population living in megacities (millions)

700Africa

Asia

Europe

The Americas600

500

400

300

200

100

0

1950 1975 2000 2025

URBANISATION

Urbanisation has been a defining trend in economic development for millennia, but the past two decades have witnessed urbanisation at an unprecedented scale and speed. In 2008, for the first time in history, the human race became predominantly urban. 3.5 billion people now live in urban areas, covering just 0.5% of the global land surface but accounting for 70% of global GDP. By 2025, there will be 37 cities with more than 10 million people in them and only seven of them will be in the developed world13. By 2030, 500 million chinese people will be added to the ranks of middle class, and Asian household wealth may surpass the US and Europe combined.

Increased urbanisation in emerging markets raises living standards and causes a shift in the consumption habits of the population, but requires significant investment in core infrastructure. At the same time, much of the urban infrastructure in the developed world is many decades old and in need of upgrade. In both cases, innovation is required to handle environmental and social issues, like water and waste.

In 2013, the Carbon Disclosure Project received survey responses

from almost 600 companies globally with regards to water issues. The energy sector had the highest percentage of respondents who said their sector was exposed to water risk (82%), followed by materials (79%), utilities (73%) and consumer staples (69%). The United Nations estimates that each year 3.5 million deaths are related to insufficient water supply, poor sanitation and hygiene. Poor water quality causes many socio-economic costs including degradation of ecosystem services, health-related costs, increased water treatment costs and reduced property values among many others.

By 2025, waste generation is projected to increase from 1.3 billion tonnes to 2.2 billion tonnes of municipal waste per year. In low income countries, landfills and dumps are the preferred method of waste management. According to the World Bank, 72% of waste in the poorest regions globally is disposed of in one of these two ways. In contrast, less than 40% of waste is sent to landfills in OECD countries. Landfills and dumps cause numerous environmental issues. Decomposing organic waste generates various gases including methane, a potent greenhouse gas. If current waste management trends are maintained, landfills’ share

13 World Urbanization Prospects, The 2011 Revision, Economic & Social Affairs, United Nations

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