By Simon Gordon, senior director, fund & corporate services, JTC Group
Despite a number of false starts, the move towards net zero carbon dioxide emissions is inexorable, certainly in Europe. At the heart of this vital transition is the generation of renewable energy which in the UK, underlined by the first speech from the new Chancellor of the Exchequer, Rachel Reeves, is largely about solar power and wind farms (with some hydroelectricity), and associated battery storage.
New solar farms and wind turbines are expensive. One estimate suggests that a 3.5 megawatt (MW) turbine costs over £3m, and the costs are met in a variety of ways including directly by government and, commonly, via institutional investment in the form of investment trusts.
The first renewable energy trusts made an appearance some 10 or 12 years ago and were a popular investment vehicle for a range of institutions – insurance companies and pension funds, for example – who were attracted by the circa 25 year life of a trust, the positive ESG characteristics which appealed to the institution’s stakeholders and, moreover, the anticipated rate-of-return of something between 5% and 7% per annum in the pre-Covid, pre-Russia/Ukraine war period when, for example, UK government securities or gilts were yielding next to nothing.
Initially propelled by these considerations, some renewable energy investment trusts traded at a premium to net asset value (NAV), but today most of the sector is suffering deep (-10%, -15%) discounts to NAV and this is particularly true of single-focus trusts – exclusively solar for example – more so than their diversified competitors.
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It is not entirely clear what prompted this (at least temporary) reversal of fortune, but one certain factor was the rapid rise in Bank of England interest rates from 0.1% in December 2021 to 5.25% at the time of writing. Suddenly, investors in trusts, like many others, found themselves able to achieve similar yields in highly liquid bonds and it may be that such liquidity was required following the cash calls arising from the disastrous Liz Truss ‘mini-budget’ of September 2022, which in turn caused some investors to move to reduce the levels of gearing in their portfolios.
Whether or not liquidity issues prompted investment trust investors to begin trading their holdings, risk should not have been a factor. Renewable energy trusts are inevitably backed by long-term National Grid contracts or other quasi-governmental guarantees. While not quite gilt-edged, they are rightly perceived by most investors to be safe long-term assets whose duration, in many cases, matches an investing institution’s liability profile.
One issue that may be consequential, and this applies to all trusts, not just those focused on renewable energy, is Packaged Retail and Insurance Based Investment Products (PRIIPs) disclosures. Brought in by the Financial Conduct Authority (FCA) in 2015, the aim of the PRIIPS regulation is to encourage efficient markets by helping investors better to understand and compare the key features, risk, rewards and costs of different PRIIPs through access to a short and consumer-friendly Key Information Document (KID).
A problem here – specifically as far as investment trusts are concerned, which are exchange-listed vehicles – is that the KID disclosure appears to reveal the presence of additional fees and charges whereas, in reality, these are baked into the share price. It has, however, been suggested that this misunderstanding, which the FCA is apparently now working to correct, has discouraged institutions whose investment criteria preclude them from accepting investment trust fee levels which PRIIPs imply.
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Despite these issues, this is not a negative story. In short, the renewable energy investment trust sector is showing signs of recovery partially in the face of an anticipated reduction in the Bank of England base rate (following downward moves by the ECB, Sweden and Switzerland in June), and, moreover, because energy generation’s direction of travel in the UK, Europe and increasingly in other parts of the world is one way: towards net-zero and thus renewables.
According to the UK National Grid, in 2019 zero-carbon electricity production overtook fossil fuels for the first time, and on 17 August 2019, “renewable generation hit the highest share ever at 85.1% (wind 39%, solar 25%, nuclear 20% and hydro 1%)”.
Additionally, the National Grid tells us: “On 15 May 2023 the UK produced its trillionth kilowatt hour (kWh) of electricity generated from renewable sources – enough to power UK homes for 12 years based on average consumption. While it took 50 years to reach this milestone, based on current projections it will take just over five years to reach the next trillionth kWh.”
Probably in recognition of these facts, the discounts to NAV of renewable energy trusts have begun to shrink, particularly for diversified funds. Some analysts are predicting an imminent re-rating in the renewables trust sector. In other words, the market appears to be re-embracing its original financial and ESG values, although whether the premiums briefly witnessed by the first investors will reappear remains a matter of conjecture.
This article was first seen in our sister publication, PA Future
