The fund manager’s view
Aoi Nishiyama, investment director, Climate Strategy fund, Wellington Management
The renewable energy sector presents abundant long-term opportunities as the world shifts toward a low-carbon society to mitigate the escalating impacts of climate change. Additionally, renewable energy contributes to national energy independence and enhances security, especially in the wake of Russia’s invasion of Ukraine.
However, this sector is multifaceted, with each subsector requiring thorough analysis to uncover viable investment prospects.
We hold a positive view of the utility-scale solar industry, which offers long-term potential. Structural catalysts, such as onshoring supply chains accelerated by the Inflation Reduction Act – the largest US climate bill in history – enable project developers to achieve higher, more predictable returns when purchasing products made in the US.
The act’s introduction in the US has also encouraged similar policies globally. Utility-scale solar benefits from rising energy demand driven by data centres, electric vehicles and artificial intelligence (AI), facilitating the development of an efficient and reliable clean energy grid.
In contrast, we approach residential solar more cautiously due to higher interest rates and a significant slowdown in the US and Europe. While uncertainties persist, we believe the market has reached its bottom, making valuations and growth rates increasingly attractive.
Selectively investing in high-quality companies during this period of broader sector weakness and uncertainty offers opportunities, but we remain vigilant.
The wind sector faces challenges, particularly for offshore projects affected by rising interest rates, input costs and competition. Nevertheless, we recognise wind power’s long-term significance as a critical renewable energy source.
While we continue to closely monitor the market for signs of recovery and appealing returns, we currently find other areas within the renewable energy landscape more compelling.
Decarbonisation and clean energy generation become increasingly critical as the world grapples with climate change. The diverse sub-industries and unique drivers within renewables create numerous investment prospects for research-driven, active investors.
The analyst’s view
Arita Sehgal, equity analyst, Ninety One
We have seen the best and the worst of times within renewables. While the sector has faced the headwinds of rising interest rates, elevated inflation and supply chain issues, there have also been tailwinds from decarbonisation-induced demand, advancements in tech, local policy support and a focus by nations on energy security.
The headwinds have undoubtedly been fierce. Interest rates skyrocketing in a short span of time have impacted the capital-intensive nature of renewables development. Inflation has driven up equipment costs for on- and offshore wind, squeezing the already-tight economics of these projects. This pain has been exacerbated by a slow policy response, leading to failed auctions and developer exits, notably in offshore wind.
However, there are reasons for optimism. Ninety-six per cent of newly installed utility-scale solar photovoltaics and onshore wind capacity are now generating electricity at lower costs than their fossil-fired counterparts, leading to lower consumer bills in an inflationary backdrop. Offshore wind, while facing challenges in new markets like the US, continues to be competitive in Europe.
As demand for electricity continues to grow – driven by the electrification of buildings, transportation, AI, data centres and the needs of economies such as China and India – clean energy solutions become increasingly urgent. Low-emission sources are projected to supply nearly half of global electricity generation by 2026.
This backdrop requires a disciplined approach from developers and manufacturers to succeed, however. Encouraging signs are already emerging, while easing commodity and logistics prices, the improving profitability of original equipment manufacturers and increasingly favourable renewables policy all provide additional support. In short, the opportunity in renewables continues to endure but selectivity remains key.
The fund buyer’s view
Charlotte Cuthbertson, co-manager, MIGO Opportunities Trust
We focus on investment trusts that are mispriced, with catalysts for change, particularly those which are doing a good job but trading on a wide discount. These situations seem to be plentiful in the renewables sector, which has fallen from double-digit premiums to double-digit discounts over 18 months.
Typical renewables trusts offered a 5% yield at launch, so were highly sought after when interest rates were near zero. As rates have risen, investors have turned to other assets, such as gilts, with similar yields but lower risk.
This fall in demand, with constant supply, means renewables trust share prices have fallen to the point where their dividend delivers closer to a 7% yield on the share price, and investors are better compensated for the risk compared with gilts. Every renewables trust is different, and sorting the wheat from the chaff involves a lot of legwork meeting managers.
Marketing smaller trusts is more challenging for managers based abroad. That’s the case at Aquila European, a £250m trust invested in Iberian solar assets and Scandinavian wind farms, run by a respected German manager with €18bn (£15.4bn) in assets under management.
Aquila is also attractive because its sites are valued with a 25-year life. Many in the sector believe reliability has improved, and a 40-year lifespan may now be more appropriate. When the net asset value is adjusted for another 15 years of cashflows, you get a totally different number. Aquila European looks cheap relative to its peers because it is valued more conservatively.
We also invest in Atrato Onsite Energy, which invests in solar on roofs or alongside factories and large retailers, selling the electricity back to the site. Unlike some of its peers, its revenue is nearly all contracted, so it’s less risky than those which sell power at market prices. It trades on a similar discount to other trusts without having that power price uncertainty.
The wealth manager’s view
Mollie Thornton, senior investment manager, Parmenion
Renewable energy infrastructure investing has struggled of late, with sharp falls in company values resulting from higher interest rates. This is partly a reaction to the very strong outperformance seen during the pandemic and partly owing to inflationary pressures.
While the sector fell by around 20% on average over the past year, there has been a wide range within this, with a positive return for some companies and deep drawdowns for others. This will depend on company-specific factors such as the quality of the infrastructure assets they own, type of income arising from these and levels of debt in the company.
After recent market falls, the current yield for the sector has become more attractive and now stands at around 8%. Looking ahead, there are a couple of key drivers of revenue growth from here.
First, the renewables energy market is growing strongly – 2023 was a record year with over 40% of the UK’s electricity generation from renewable power – 29% wind, 5% solar, 5% biomass and 2% hydro. Second, renewable infrastructure subsidies are inflation-linked and are set to increase by nearly 10% based on last year’s monthly RPI data.
In addition, renewable infrastructure company values will remain sensitive to interest rates, and so expected rate cuts later in the year and stabilisation in interest rates should prove positive for the sector. And the sector is currently trading at a significant discount of around 20%, so a change in sentiment could give a meaningful boost to returns.
However, 2023 is a reminder that investors need to be prepared for a degree of volatility in the asset class and be comfortable taking a medium-term view, given the complexity involved with an energy transition required at this scale.
This article first appeared in the March issue of Portfolio Adviser magazine
