Why renewable investment trust doom and gloom is overdone

Renewable energy and environmental investment trusts have been hit by a perfect storm. Higher inflation, interest and discount rates have impacted market sentiment generally, but particularly so renewable energy. Sector-specific headwinds have added to concerns.

Company discounts have widened significantly – many now being at or near all-time highs. Yet there are reasons to believe the gloom has been overdone. Good opportunities abound for long-term investors who can, in the meantime, harvest bountiful and increasing dividends.

Sentiment versus fundamentals

Higher interest rates and gilt yields are competing for the attention of income-seeking investors, while higher discount rates that chip away at estimated asset values are hurting. The mantra ‘higher for longer’ has cast a long shadow – especially as the sector was previously considered a defensive asset. This is even though the theoretical erosion of net asset values (NAVs) courtesy of higher discount rates has been largely marginal, certainly when compared to share price declines.

Sentiment has not been helped by governments appearing to temper their net-zero policies in the face of growing electorate scepticism about costs. This is at a time when energy security considerations following Ukraine are seeing new oil and gas projects being approved. News that the 1.4-gigawatt Norfolk Boreas offshore wind farm and two New Jersey wind projects have been shelved on grounds of high construction costs and poor profitability, the latter involving a $4bn (£3.3bn) impairment, have hardly been reassuring.

To add to the woe, there are specific investment trust headwinds involving cost disclosure. An overzealous interpretation of regulations by the various authorities has resulted in companies having to roll up their corporate costs (administrative, finance, etc) with their fund managers’ charges when declaring an overall figure, even though share prices reflect such information. Trusts managing costly assets such as renewable energy assets look especially expensive, and so are being shunned by wealth managers and platform providers alike.

Yet I suggest sentiment is unduly bearish. For example, it is underestimating the extent to which many companies’ strong revenue correlation with inflation will temper concerns over time about higher discount rates impacting asset values. Already, the asset sales there have been have seen book values achieved – and more. Meanwhile, the inflation-assisted cash flow very much remains real – and sustainable. It is currently helping to fund investment, increased dividends (which are making for attractive yields) and the smattering of share buybacks.

And while governments may be tinkering somewhat with the pace of their climate change policies, the momentum behind the net-zero agenda cannot be halted. The evidence that we need to adopt more environmentally friendly policies is unquestionable, as previous columns have alluded to. There will be bumps in the road. Projects or policies will be abandoned or diluted. But this is a journey an increasingly large body of opinion recognises needs to be travelled – as is perhaps best illustrated by the Inflation Reduction Act in the US.

As for the investment trust cost disclosure issue, Baroness Sharon Bowles, Baroness Ros Altmann and myself are working together with others, both above and below the radar screen, to obtain a speedy and just outcome. It is accepted within the corridors of power, including by the chancellor and economic secretary, that the double counting of costs is hurting the industry, does not happen in other countries, and is hindering investment in sectors such as renewable energy and infrastructure. A constructive dialogue is taking place.

Sector-specific criticism

If there is a sector criticism it is companies themselves are not being proactive enough in addressing the extent of discounts. The few asset disposals seen are confirming valuations at book value or modest premiums. Price weakness is in part down to supply and demand. The sector has raised large amounts of capital in recent decades. Meanwhile, cash and especially low-coupon gilts have encouraged multi-asset fund redemptions. A static supply and falling demand preys on prices.

Yet investors have seen little by way of asset disposals to help fund meaningful share buyback programmes (including tender offers) and the return of capital to shareholders. Boards and managers, particularly of the larger companies, could do more in the interests of shareholders. Confirmation of book values being achieved would by itself help reassure sentiment. Otherwise, takeovers are the only catalysts. While straws in the wind suggest hope, more self-help is needed.

Peak interest rates

Help may also be on hand courtesy of the growing perception that interest rates are close to peaking. This monthly column has long suggested interest rates were being kept low for too long, and inflation would ensue (‘Preparing for inflation’, 12 March 2021). Interest rates at 0.5 per cent when inflation was 6.1 per cent the month before the Ukraine invasion illustrates a wider central bank problem. That column and others since have explained why inflation will remain stickier and more volatile than hitherto.

However, just as the central banks were behind the curve in combatting inflation, they now risk overshooting in trying to bring it down. As expected, inflation will moderate in the short-term as ‘one-off’ variables fall away. But they are ignoring the lessons of history by underestimating the time-lag when assessing the impact of rate rises on the economy. The focus on historic information rather than current indicators, such as the housing market, is not helping. Interest rate policy is being steered through the rear-view mirror.

Furthermore, the importance of the money supply figures is being downplayed despite evidence to suggest peaks and troughs have influenced inflation in the past. The Bank has not even included them in itd monetary policy reports. The figures suggest a downward path. And this, of course, is allied to central banks’ current policy of quantitative tightening which many see as a ‘leap into the dark’. Certainly, in this country, rates have peaked and may start falling as early as the first quarter of 2024 despite central banks talking their book.

Portfolio purchases

The two portfolios covered in this monthly column are two of 10 live investment trust portfolios managed in real time on the website www.johnbaronportfolios.co.uk. They pursue a range of risk-adjusted strategies and income levels. The following companies have been introduced or added to some of the portfolios and are helping them sustain attractive yields – for example, the Dividend portfolio is yielding 7.5 per cent, the Green and Green Isa portfolios yield 6.7 per cent and 5.1 per cent, respectively, while the Autumn portfolio yields 4.6 per cent.

The Renewables Infrastructure Group (TRIG) seeks to generate sustainable returns from a diversified portfolio of renewable infrastructure assets, mostly wind and solar energy in the UK and Europe. The company has also been investing recently in battery storage assets. The portfolio is well diversified across proven technologies, weather patterns, regulatory regimes and power markets, and continues to perform well. The company stands on a 20 per cent discount, is growing the dividend and yields 7 per cent.

JLEN Environmental Assets Group (JLEN) invests in a diversified portfolio of environmental infrastructure projects and aims to provide investors with a sustainable and progressive dividend. The company benefits from being one of the more diversified in its sector – a recent breakdown noted 28 per cent of assets are invested in wind turbines, 25 per cent in waste/bioenergy, 19 per cent in anaerobic digestion plants, 15 per cent in solar and 13 per cent in low carbon transport, hydro-electric, battery storage and hydrogen. This diversification helps to reduce volatility.

Recent results suggest solid progress on most fronts. In line with the company’s progressive dividend policy, a target of 7.57p has been set for the year to 31 March 2024 – an increase of 6 per cent over the previous year. This represents a yield of 8.6 per cent at time of purchase. As the chairman pointed out in the last set of results, the predictability of these future flows is enhanced by the actions the manager has taken to fix contract prices while power prices were elevated. A near-historically wide discount of 27 per cent adds to the investment case.

SDCL Energy Efficiency Income Trust (SEIT) is the first UK listed company to invest exclusively in the energy-efficiency sector. Recognising that most energy is lost in the energy system, at enormous cost to the economy, the company targets energy efficiency investments which reduce wastage in the supply, demand and distribution of energy – thereby helping to reduce company costs. Servicing over 50,000 buildings across its portfolio, its investments span a broad range of energy services in North America, Europe, the UK and other markets.

The chairman recently commented on the outlook: “The company is well positioned ... Energy efficient technology is a critical part of the energy transition because its implementation is typically much quicker and cheaper compared with the time and cost to develop new sources of energy generation.” Meanwhile, the dividend is fully covered and the 4 per cent increase to 6.24p for the year to March 2024 equates to a yield of 10 per cent. An experienced management and discount of nearly 40 per cent all suggest the market is being harsh.

Gore Street Energy Storage Fund (GSF) presents an interesting opportunity. Renewable power is becoming an increasingly important part of the UK’s generating mix (c.40 per cent at the last count and sometimes more) but there is a big problem: intermittency. Patterns of energy demand in the UK are largely predictable, but the weather is not. Energy storage facilities constantly harvest power from the wind or sun and then release it to the grid when needed – thus ‘smoothing out’ the variability in demand and supply.

GSF is currently standing on a discount of 40 per cent while yielding 10.5 per cent. Concerned about the level of the share price, the board and manager recently put out a statement. It stated they are not aware of any portfolio-specific factors that have led to the recent sharp decline. The company’s assets across five international energy markets not only reduce volatility and provide diversification but continue to perform strongly and this is supporting the dividend. Meanwhile, the company is well capitalised without any outstanding debt.

Octopus Renewables Infrastructure Trust (ORIT) seeks to provide an attractive level of income with some capital growth, courtesy of a diversified portfolio of mostly onshore wind and solar assets, with offshore wind and battery storage making up the balance. The management has made a reassuring start since coming to market. The company is targeting a dividend of 5.79p for the current year – an increase of 10.5 per cent in line with inflation (CPI) – which presently equates to a yield of 6.3 per cent. Meanwhile, it is standing on a 15 per cent discount.

Relative newcomers to the sector, if somewhat smaller in size, again offer enticing prospects. One example is Triple Point Energy Transition (TENT). The company helps businesses become more energy efficient while reducing their costs. It made a somewhat pedestrian start when first coming to market but momentum has been building of late, and an expanded remit may help matters further. A dividend equating to a 10 per cent yield and discount of 45 per cent again leaves little to chance.

*The MSCI PIMFA Growth and Income benchmarks are cited (total return)