- Renewable energy trusts have high yields and government support
- UK projects appear expensive and look vulnerable to falling power prices
- Trusts trade at a large premium but the sector still yields over 4 per cent
Boris Johnson's announcement this week of a 10-point plan for a self-styled green industrial revolution shows that there is no shortage of government support for the renewable energy sector. The prime minister's commitment to "build back greener" includes £160m to be invested across the UK to increase our offshore wind capacity and create thousands of new jobs.
These measures have been devised to accelerate progress towards a wider goal of reaching net zero emissions by 2050. More specifically, the government is investing so that offshore wind will produce more than enough electricity to power every home in the country by 2030, based on current electricity usage, raising the government’s previous 30 gigawatt (GW) target to 40GW. Commitments to reduce carbon emissions are likely to be amplified next year when the UK hosts the UN’s COP26 climate conference, which will act as a global stock take of progress on reducing emissions.
All of these spending pledges mean that many assets held by renewable energy infrastructure trusts, such as solar and wind farms, are partially subsidised through government schemes such as the Renewable Obligations Certificate regime. This gives some security to the revenue streams of renewable energy infrastructure trusts. With an average net yield of 4.3 per cent for Winterflood’s Renewable Energy Infrastructure trust sector, this is nothing to be scoffed at.
“Operational infrastructure projects, including renewable infrastructure, have very sought-after characteristics in the current environment of low yields and economic uncertainty, and the potential for a sharp rise in inflation at some point on the back of so much stimulus adds another string to their bow,” says Jason Hollands, managing director at Tilney.
The sector does have resilient fundamentals. Underlying projects are typically on contracts of over 20 years so there is very low sensitivity to the economic cycle, revenue is dependable, and an element of inflation-proofing is normally factored into contracts of the assets held.
Ryan Hughes, head of active portfolios at AJ Bell, adds: “Over the last few years, renewable energy as an investment has become a lot more popular with a number of trusts coming to market giving investors a wider choice. However, the area is without doubt specialist in nature with different types of trust in the sector, ranging from solar power to energy storage.”
What are the risks?
Because of the surge in demand for renewable energy investment and for reliable income holdings, many of these trusts' shares are now trading at large premiums to the value of their net assets. The trusts in Winterflood’s renewable energy infrastructure sector were trading at an average premium of 12.5 per cent on 16 November, with premiums ranging from 3 to 29 per cent. Even on such lofty valuations the yields available still look attractive, but high prices may cause investors to think twice about when and how to buy in.
“Many investors might baulk at this, but then you can still get an average yield of about 5 per cent, which is very secure, so a cautious income seeker may feel the premium is worth paying,” says Mr Hollands.
However, he adds: “Where we invest in these, we typically do so through new shares issues rather than the secondary market. These are quite regular both from existing vehicles as they line up new assets to purchase, and new trust launches as the sector continues to expand.”
New entrants are still emerging. For example, infrastructure investor Downing is currently seeking to raise up to £200m in an initial public offering (IPO) for the Downing Renewables & Infrastructure Trust. This gives investors the opportunity to invest in the fund at its net asset value, before the shares likely moves to a premium. The Big Theme of 23 October looks at the key considerations for investors who want to participate in trust IPOs.
When existing funds issue new shares, they are typically issued at a substantial discount to the current share price. Bluefield Solar Income Fund (BSIF), for example, is seeking to raise £45m via an issue of shares at 124p, with the proceeds used to repay the drawn balance on its revolving credit facility. According to research from Numis Securities, the placing price represents a premium of 8.3 per cent to the last published net asset value as at 30 September (after deducting the FY20/21 fourth interim dividend paid on 28 October 2020) and a discount of approximately 7.1 per cent to the closing share price on 13 November. The placing was due to close at 5pm on 19 November, with new shares admitted to trade on 24 November.
Power price movements are another major risk for investors. “Ultimately, the level of dividends targeted by these trusts, and their overall attraction, will depend on where power markets settle over time,” says Rob Morgan, pensions and investments analyst at Charles Stanley. 2020 has been a volatile year for power prices and this has been a headwind for renewable energy infrastructure trusts, but Mr Morgan thinks further aggressive downwards adjustments seem to be unlikely, at least in the short term. Trusts in the sector have different levels of exposure to moves in the power price.
New developments, new risks
While an important source of income, renewable energy infrastructure may remain a small part of many portfolios.
“Over the long run, it seems inevitable that the demand for renewable energy will increase and therefore as a long-term investment it may have some merit, but this feels very much part of the periphery of a portfolio as it stands today rather than the core,” says Mr Hughes.
As such, a typical allocation for a medium risk investment portfolio to renewable energy infrastructure might be about 5 per cent. But either way, it can be worth monitoring new developments and risks in this space.
While experts don’t expect much growth in payouts for renewable energy infrastructure trusts, they broadly agree that they should be maintained. Tellingly, Foresight Solar has this year ceased targeting dividend growth that matches inflation, instead targeting a payment that grows "progressively".
Investors should also be aware of the different approaches on offer. In a recent report, broker Stifel highlighted that the sector is becoming more complex with more moving parts, including funds diversifying their asset mix to include construction and more funds investing in overseas projects. Stifel says this shift “reflects UK pricing becoming too high for funds to invest”. As more funds have launched, there has been greater competition for assets. Of the 14 trusts in Winterflood's renewable energy infrastructure sector, only seven of them have existed for more than three years.
Stifel adds that many renewable energy infrastructure funds are now using significant leverage or investing in assets with project level leverage, which makes the trusts more risky investments.
While the diversification of projects across geographies and assets reduces risk and potentially provides higher returns, Stifel warns: “Shifts away from the original investment proposition are in many cases only happening because returns in the traditional investments (eg, UK solar) are now too low for these funds to invest in them. Moving into different geographies may raise issues such as foreign exchange volatility and different operational models.”
Also, many of the newer investments tend to have lower subsidies and higher power price exposure and a number of funds are now moving into unsubsidised projects. This strategy may not suit all investors given some of them were attracted by the 'dependability' of subsidy income when they initially invested.
For investors looking to access this space, Mr Hughes recommends looking at the largest and most established in the sector, The Renewables Infrastructure Group (TRIG). “It has a strong pedigree, was launched over seven years ago and has a market cap of well over £2bn, which should encourage investors that they are not simply following the latest fashionable investment idea,” Mr Hughes says.
The trust invests across a range of diversified assets with exposure to more than 70 different energy projects with 1.7GW of capacity covering solar, wind and battery storage, making it a diverse holding. The trust has a clear income focus with a target dividend and currently yields around 5 per cent, making it attractive for income seekers. The downside is the trust was trading at a premium to net assets of 19.9 per cent on 16 November, considerably higher than its 12-month average of 15.8 per cent.
For investors looking for more targeted exposure to wind energy, Mr Hollands recommends Greencoat UK Wind (UKW), which invests in operating UK wind farms. The fund is a constituent of the FTSE 250 and has a market capitalisation of approximately £2.5bn. The fund recently traded at a premium to net assets of 11.8 per cent, with a yield of 5.3 per cent. According to Stifel, Greencoat UK Wind is now the only renewable energy infrastructure trust that still has a policy of paying dividends linked to inflation, as measured by the Retail Price Index.
As its name implies, the fund only invests in projects in the UK, with its highest exposure in Scotland at 58 per cent of the portfolio value. The fund has two offshore wind projects in its portfolio and at the end of June these accounted for 5 per cent of the portfolio. The amount invested offshore is capped at 40 per cent of gross asset value at the time of acquisition. The portfolio contains 36 operating wind farms and the portfolio energy generation was 2 per cent above budget for the first six months of the year.
Of the solar funds, Iain Scouller, managing director at Stifel, recommends Foresight Solar Fund (FSFL) and NextEnergy Solar Fund (NESF) at present, on valuation grounds. Foresight Solar Fund has net assets of £515m, trades at a premium of 10.3 per cent and yields 6.6 per cent as at 16 November. The fund’s objective is to provide investors with a sustainable and progressive quarterly dividend. The majority of the fund’s assets are in the UK, but it has four projects in Australia and in September this year the fund announced the acquisition of its first Spanish solar project.
NextEnergy Solar Fund is a similar size with net assets of £578m, and it currently yields 6.5 per cent, trading at a premium of 8.1 per cent. The fund received approval in September to raise the limit for investments in Organisation for Economic Co-operation and Development countries other than the UK from 15 per cent to 30 per cent of assets. At the end of June 2020, the fund had 12.2 per cent of invested capital in Italy and the rest in the UK. The fund’s annual report published in March noted significant progress in the fund’s objective of reaching 150 megawatts of subsidy-free assets in the portfolio by the end of the current financial year. In August 2019, the fund became the first listed solar investment company to develop, build and energise a subsidy-free asset in the UK.
|Discrete performance: annual share price total return (%)*||Discrete performance: annual NAV total return (%)*|
|Trust||Net assets (£m)||Price premium||Yield||16/11/15 - 16||16/11/16 - 17||16/11/17 - 18||16/11/18 - 19||16/11/19 - 20||16/11/15 - 16||16/11/16 - 17||16/11/17 - 18||16/11/18 - 19||16/11/19 - 20|
|Bluefield Solar Income Fund||417||14.7||6.1||6.7||13.3||13.8||20.3||0.7||8.7||7.4||12.6||11.8||5.1|
|Foresight Solar Fund||515||10.3||6.6||9.3||7.5||10.1||16.5||-8.2||10.8||6.9||11.2||7.8||-6.3|
|Greencoat UK Wind||2,405||11.7||5.3||8||13.6||12||17.4||-1.6||9||8.1||11.7||12.3||4.1|
|Next Energy Solar Fund||578||8.1||6.5||10.3||7.2||10.4||15.8||-6.4||7.6||11.3||6.4||12.5||-7|
|Renewables Infrastructure Group||1,607||19.3||5.1||12.9||5.3||13.9||19.7||10.7||3.5||12.4||14.1||13.2||4.2|
Source: Winterflood *AIC, 16 November