Sir Keir Starmer has rolled back his previous pledge to spend £28bn to accelerate the UK’s new zero ambitions. He is not alone. The UK government has already pared back commitments to electric vehicles and heat pumps. Around the world cash-strapped governments are balking at the cost of green measures.
This is just one of the reasons that it has been such a dismal run for sustainable investment. Eight of the bottom 10 funds in the Global sector over one year are all clean energy funds. Speciality solar funds have fared the worst, but all clean energy transition funds have struggled. It is a similar picture in the investment trust sector. Funds in the renewable energy sector have dropped an average of 25.3% over the past 12 months (source: Trustnet, to 15 February 2024). It was also a difficult year for ‘environmental’ funds, including Impax Environmental Markets and Jupiter Green.
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Jake Moeller, associate director, responsible investment at Square Mile Consulting, outlines some of the other problems that sector has had to face: “The shift to a higher interest rate regime and increasing inflation has acted as a significant headwind in sustainable asset performance. Sustainable companies, typically, have a long-term, growth bias due to the nature of the product or service they provide. Green energy, for instance, has been particularly susceptible to high inflation due to the rising costs of materials in their supply chains. Additionally, green energy projects require a significant amount of capital, which, in conjunction with high interest rates, has made financing large projects less profitable.”
There have also been problems of market sentiment, which has moved away from sustainable strategies after a surge in popularity during the pandemic.
Jason Hollands, managing director, corporate affairs at Evelyn Partners, says: “Investors have become wary of some of the claims being made by fund companies after greenwashing scandals”.
HSBC, for example, saw a recent ad campaign pulled by the UK’s advertising watchdog, having showcased a tree-planting scheme and its net-zero plan without acknowledging that it also finances fossil fuel projects.
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Another problem has been the sector performance. Energy has been the best performing equity sector globally in the three years to the end of 2023, with shares in oil and gas companies particularly strong as economies reopened after Covid, and in the wake of Russia’s invasion of Ukraine. Funds that did not invest in fossil fuels missed those gains. Defence has been another strong area, as countries have raised spending in response to heightened geopolitical risks. This is another area largely closed to ‘green’ funds.
Moeller says: “As a result of geopolitical uncertainty, energy security, and the aforementioned hikes in interest rates, investors appear to be preferring defensive, value oriented stocks to their sustainable alternatives.”
As such, ESG and sustainable funds have generally fared better with a less ‘purist’ approach. If they have held energy companies, but engaged with them, or swerved some of the major renewable energy groups, such as flagging Orsted, they have generally fared better. Over three years, the MSCI World ESG leaders is up 9.42% annually, versus 8.58% (to 31 January 2024) for the broader MSCI World index. The MSCI World ESG Screened is also ahead, albeit by just 0.2%. Importantly, both indices still include technology giants such as Microsoft, Nvidia and Alphabet, which has helped support performance.
Can the outlook for clean energy improve from here? The wavering commitments from governments and some push-back on the net zero agenda by investors in the US should not be over-interpreted. A recent ESG survey from Cerulli showed 68% of US institutional investors are integrating material ESG issues into their investment decision-making process. Masja Zandbergen, head of ESG integration at Robeco, points out that this is being done almost exclusively for financial reasons, adding: “It is about better pricing of externalities.”
Nevertheless, Alex Monk, portfolio manager, global resource equities at Schroders, says there are still some risks around the US election and the withdrawal of support for the green energy transition. He adds: “Although support to energy transition sectors is unlikely to be removed in its entirety, the leading runners for the Republican nomination have talked about repealing aspects of the policy, making the risk of a reduction in support a credible threat. Regardless of the ultimate outcome, we would at least expect those names that currently benefit most from the policy to experience volatility as the election looms.”
It is not yet clear whether companies have worked through their operational problems. As recently as early February, the world’s largest wind farm developer, Ørsted, suspended its dividend and slashed targets for developing renewables. The Danish group also said it would cut up to 800 jobs and withdraw from offshore wind markets in Norway, Spain and Portugal. Chief executive Mads Nipper said the company needed a ‘reset’.
Solar companies continue to struggle with the impact of cheap imports from China, though there have been improvements in the solar supply chain that are easing the pressures on developers. There are also signs of encouraging M&A, with BP paying £254m to take full control of solar joint venture Lightsource at the end of November.
Monk adds: “Our 2024 outlook indicates a much stronger fundamental earnings landscape for energy transition equities compared to 2023. Although we can’t predict when the cyclical earnings headwinds that affected the sector last year will subside, our analysis and discussions with companies and industry participants point to an improvement in earnings throughout 2024 and into 2025.” However, they still see vulnerability in specific sectors, such as hydrogen.
Even without clear signs of an improvement, there has been a significant fall in the valuations for many clean energy companies. Many had become extremely expensive. The iShares Clean Energy ETF has become a proxy for the sector as a whole. It saw its share price more than triple in the period between March 2020 and January 2021. Inevitably, there was an adjustment, as there is with any over-hyped technology. SolarEdge, for example, has seen its p/e ratio drop from 166x at the end of 2022, to just 19x today.
The interest rate factor is still likely to be important. These areas – solar, wind, battery storage – are infrastructure assets. The upside is that they have strong, inflation-linked cash flows; the downside is that they will be sensitive to rate rises. Sentiment has improved as interest rate expectations have shifted.
Hollands adds: “When you invest in funds that take a selective approach to areas they will and won’t invest in, there are bound to be periods when performance varies from wider markets.”
These growth themes are inevitably subject to volatility. While more volatility is plausible, the clean energy sector appears to be in a better place today than 12 months ago.
