The unexpected spill at BP's oil well in the Gulf of Mexico and the subsequent suspension of its dividend has highlighted how even large established players in the energy sector can be subject to significant operational risk. Add to that the slower growth profile of oil majors, and you could be tempted to look at other areas of the sector.
Alternative energy is one area growing globally, thanks to environmental concerns and government action. China, for example, recently published plans to reduce its carbon intensity by 40 to 45 per cent by 2020, which it will achieve via massive investment in clean energy.
Back in the UK, the Comprehensive Spending Review showed that one area which still enjoys some government support is the "new green economy," with Chancellor George Osborne announcing, amongst others, an investment of £200m in off-shore wind technology and manufacturing at port sites.
Fund managers add that stock valuations of alternative energy companies are attractive following share price falls during the bear market.
Modest exposure
Alternative energy is a specialist area, and as such the number of investments available to private investors is not wide, making it difficult to create a diversified portfolio. Many of the technologies are also early stage and unproven, making this a long term investment of at least ten years. Don't expect immendiate returns; your money could be moving sideways for a while.
Alternative energy is also highly correlated to mainstream energy in that it tends to rise and fall in line with the oil price. When the oil price is high, alternative energy does well as people look to alternatives. When it falls, the economics of alternative energy look less compelling and share prices fall in response. As with other energy plays, this area is subject to regulation and often dependent on subsidies - introducing a significant chunk of political risk.
Listed energy plays are also correlated to market movements and some of the companies are smaller and so more volatile. For these reasons, advisers suggest you do not allocate more than five per cent of your overall portfolio to clean energy.
Share boost
While the number of UK listed alternative energy shares is not great there are some options, generally among the smaller more speculative end of the market. Examples include small cap Dialight, which makes LED applications and Aim-traded fuel cell company Ceres Power Holdings.
You could also invest in a company whose activities include alternative and clean energy, but has a wider focus. UK-listed utilities such as Centrica and Scottish & Southern Energy have some involvement in alternative energy, and while these large utilities do not promise the potential growth of some start-ups they do offer the potential for dividends. Alternative energy may even become a larger part of their business over time if there is a shift to this area as anticipated.
These companies are much less volatile, so could be a good addition alongside more speculative investments lowering the overall volatility of your portfolio.
Investment trust options
The limited choice of UK-traded green energy companies means that a fund, which can look overseas, may be a better way to access the sector.
Bruce Jenkyn-Jones, fund manager at Impax Asset Management says it is also important to diversify across the different areas of alternative energy and hold businesses which are not correlated to each other. The areas include wind, solar, geothermal, hydropower, marine energy and biomass.
Tim Cockerill, head of collectives research at wealth managers Ashcourt Rowan Asset Management, suggests BlackRock New Energy Investment Trust, currently on a discount of more than 17 per cent to net asset value (NAV). Prior to the financial crisis, it traded at NAV or a small premium, with the fund popular because of high oil prices. If alternative energy becomes more popular the discount could narrow so this is a good opportunity.
Mr Cockerill also favours Impax Environmental investment trust, though this does not purely focus on alternative energy, including companies involved with energy efficiency, water treatment and waste technology. Impax Asset Management also runs the Asian Environmental Markets investment trust, of which more than 40 per cent is invested in China and Hong Kong. This trust is running at a premium to NAV of nearly four per cent due to the popularity of the shares.
Another option with exposure to the east, is the Premier Renewable Energy Fund, a split-capital investment trust with more than a fifth of its assets invested in China. However, this fund is small with a market cap of just over £8m, meaning its shares could be less liquid, while smaller funds tend to be less cost efficient to run.
While these investment trusts are not a pure play on renewable energy they are potentially less risky because they are more diverse. "Alternative energy could be a very good investment over the long-term, perhaps over a ten to 20 year period," says Mr Cockerill. "When these business become more viable some will be very profitable, but in the meantime you should diversify to see you through periods where alternative energy is not doing so well."
There are also a larger number of wider environmental and green funds to choose from. Ones with an allocation to alternative energy include Jupiter Green investment trust, which is at a discount of nearly 22 per cent to NAV, much wider than its historic average of 15.1 per cent, and which has at times traded near NAV.
Environmental investment trusts
| Investment trust | Disc/Prem to NAV (%) | Disc range (%) | Mkt val (£) |
|---|---|---|---|
| BlackRock New Energy | -16.8 | -6.1 to -19.2 | 98m |
| Impax Asian Environmental | 4 | 6.2 to -3.8 | 145m |
| Impax Environmental | -10.1 | -1.7 to -12 | 377m |
| Jupiter Green IT | -22.4 | -7.4 to -22.5 | 32m |
| Ludgate Environmental | -10.57* | NA | 50.35m |
| Premier Renewable Energy Fund | -17.36* | NA | 8.2m* |
Source: Winterflood Investment Trusts, *Investors Chronicle as at 21 October 2010.
Other options
If you're looking for open-ended fund options to up your alternative energy exposure, there are a number of options, including the IM WHEB Sustainability Fund, Henderson Industries of the Future, Jupiter Ecology Fund and the Allianz RCM Global EcoTrends Fund, and the CF 7IM Sustainable Balance Fund. These funds all tend to have a broader focus, however offshore there are open-ended options such as the Guinness Alternative Energy and Pictet Clean Energy funds, which have a purer focus on alternative energy.
Exchange-traded funds (ETFs) tracking clean energy indices include the iShares S&P Global Clean Energy, Powershares Global Clean Energy and ETFX Alternative Energy Fund. These have lower fees and are well diversified, however Mr Cockerill argues that as alternative energy is a specialist and immature market an active manager could add value here.
There are a number of venture capital trusts (VCTs) which invest in alternative energy. These offer a pure exposure to areas including wind power, solar power and anaerobic digestion, with a number of VCTs investing in solar power expected to come to market this year.
Although they offer attractive tax breaks, VCTs are higher risk funds focused on early stage unlisted companies, so consider if these fit your risk profile. "My observation with VCTs is that if the tax breaks were not running they are not a good investment because they are very concentrated, specialised and invest in small and immature companies," says Mr Cockerill. "If you include these as part of your alternative energy portfolio, keep exposure modest, and be very clear on what it is you are investing in."
