For those who want their investments to support the transition to net zero, renewable energy infrastructure is an obvious choice.
Access to this asset class has been made much easier over the past 10 years, with the launch of more than 20 London-listed investment companies involved in renewable energy generation, energy efficiency or battery storage.
For a while, these investment companies occupied a sweet spot for wealth managers, providing an attractive level of income and impeccable ESG credentials. Fundraising for the Renewable Energy Infrastructure sector boomed to reach a record £3.4bn in 2021, with six IPOs launched in that year.
You already know what happened next. War, inflation and higher interest rates made the yields on these companies less appealing as their valuations plunged. Demand fell rapidly, with fundraising dropping to £1.5bn in 2022 and just £50m so far this year.
Discounts to NAV – a real-time popularity gauge for investment companies – reflect this shift in sentiment. The average investment company in the AIC Renewable Energy Infrastructure sector has plummeted from a premium of 19% in the heady days of August 2020, to a discount of 25% today. These discounts make it near-impossible to raise new money.
So where does that leave the sector? Can it recover and attract demand again?
Dependable dividends
The fundamentals of most investment companies in the sector, especially the larger, well-established ones, are healthy. For the most part, dividends are growing and are well covered. Greencoat UK Wind, for example, has maintained its policy of increasing dividends in line with RPI inflation and reported robust dividend cover of 2.1 times cash generation in its latest half-year results. Other companies have managed nominal, if not real dividend increases, and outright cuts have been few.
There is also strong underlying support for the renewable sector. In our annual ESG Attitudes Tracker, we asked both private and professional investors about the appeal of investment companies investing in renewable energy infrastructure.
In 2021, 87% of intermediaries (advisers and wealth managers) found the sector appealing for clients concerned about ESG. Two years later, this percentage was unchanged at 87%.
For private investors, the appeal of renewable energy infrastructure has drifted downwards slightly, from 76% to 72% – but this still leaves more than two-thirds of investors (at least in theory) as potential buyers for these companies.
So why are they languishing on such large discounts? It may be that investors are adopting a ‘wait and see’ approach. In the latest UK Investment Trust Study by Research in Finance, infrastructure was the top sector in which the wealth managers surveyed were looking to invest more over the next six months (fieldwork was conducted in May and June). The same research shows that wide discounts are a big part of the appeal.
Winds of change
Matthew Hose, equity analyst at Jefferies, sees a number of possible catalysts for a turnaround in sentiment. Most obviously, a sustained fall in gilt yields would cause a reduction in the discount rates used to value underlying renewable assets, boosting their values, as well as improving confidence. There is also the potential for M&A in the sector, which could ignite investor interest.
More fundamentally, Hose believes renewable energy infrastructure companies need to add another string to their bow. “They have been really good bond proxies – they now need to move towards growth while maintaining their dividends. They’ll do that by selling existing operational projects and recycling the capital into development projects with higher returns.”
There are two benefits to this approach. Development projects will support decarbonisation targets and the move to net zero. They will also help investment companies in the sector move to a “growth and income” approach, which could lead to higher total returns as well as regular dividends, Hose adds.
Beyond subsidies
Longer term, renewable energy infrastructure companies are moving towards a subsidy-free future, and stable funding for decarbonisation is essential. According to the UK’s National Infrastructure Commission, the private sector needs to invest £20bn-£35bn a year between 2025 and 2050 to reach net zero.
Investment companies – with their proven ability to invest in this sector – should be a key part of the solution. They are robust and adaptable, with a structure perfectly suited to multi-decade investment in illiquid assets.
The sharp change in the macroeconomic environment has clearly hurt the renewables sector, but the underlying investment case remains as clear as ever. For investors concerned about sustainability, these assets offer environmental benefits so obvious a child could grasp them – the perfect antidote to greenwashing. If they can successfully pivot towards growth, they may be able to find a new sweet spot between financial returns and environmental impact.