Investors can diversify with the energy transition

Three renewable energy investment trusts to watch: The eye-watering energy bills landing on our doormats have placed a renewed focus on the need to move the UK’s power supplies away from fossil fuel sources, reducing our vulnerability to the volatile global oil and gas markets.  The record-breaking temperatures seen this summer have highlighted another reason for cutting our fossil fuel usage - to tackle climate change.s contribution to the UK’s electricity generation, which is growing relentlessly.

18 Aug 2022
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Tom White, Investment Research Manager at DIY investing platform Bestinvest

The eyewatering energy bills landing on our doormats have placed a renewed focus on the need to move the UK’s power supplies away from fossil fuel sources, reducing our vulnerability to the volatile global oil and gas markets.  The record-breaking temperatures seen this summer have highlighted another reason for cutting our fossil fuel usage - to tackle climate change.

The government is on board with the shift: Kwasi Kwarteng, the secretary of state for business, energy and industrial strategy, recently committed the UK to producing 95% of its electricity from low-carbon sources by 2030 and to fully decarbonise our electricity system by 2035.

A key part of this change will be moving to renewable energy – wind, solar, hydro and bioenergy – and an ever-growing number of specialist funds has sprung up to capitalise on this move. In this article we look to throw some light on what is known as the ‘energy transition’, and how you can make renewables a profitable part of your portfolio.

The move to renewables

The shift to renewable energy has been quietly underway for some time. Take a walk in the British countryside or along our coast and you’re likely to have spotted some of the numerous wind turbines that are springing up across our landscape and seas. Solar parks are less common, but even city-dwellers can spot solar panels on the rooftops of houses and increasingly of businesses – Tesco has begun putting solar panels on its stores as part of a commitment to generate 100% of its power from renewables by 2030.

This proliferation is reflected in the sector’s contribution to the UK’s electricity generation, which is growing relentlessly. Looking at the graph below, as recently as 2012, less than 10% of our electricity came from renewables. Today, depending on how windy or sunny it is, it’s around 40%. In 2019 power generated by renewable energy exceeded that produced from fossil fuels (gas, oil and coal) for the first time.

UK electricity generation by source

Source: Department for Business, Energy & Industrial Strategy, as at 9 June 2022.

This growth is set to continue. In 2019 the UK became the first major economy to commit to net zero emissions, and cleaner electricity is a key part of that. Wider awareness of environmental issues means that consumers and businesses are also increasingly uncomfortable with receiving their power from ‘dirty’ sources.

Renewables as investments

Renewable energy has also become increasingly attractive as an investment option. However, shares in companies such as turbine manufacturers are highly correlated to equity markets generally, and come with similar volatility. Instead we favour investing in the wind farms and solar parks themselves, using investment companies listed on the London Stock Exchange. There are a number available which we believe to be high quality. Some examples are outlined below but remember this is not advice to invest:

The Renewables Infrastructure Group. In what is a fairly new sector this is one of the rare trusts with a proven pedigree, having launched in 2013 and being managed by two leaders in the field, InfraRed Capital Partners and Renewable Energy Systems. Operating in the UK, Ireland and continental Europe, it invests primarily in wind farms but also has some exposure to solar (around 11%). Last year its portfolio generated 4,125 GWh of electricity, enough to power 1.1 million homes.

Octopus Renewables Infrastructure Trust. This is a newer vehicle having launched in 2019, but still has an experienced manager in the Octopus Renewables team which was formed in 2010. It takes a more diverse approach, with the portfolio split almost equally between wind and solar assets and spread across the UK and continental Europe. Another differentiator is that as well as operational assets, it also invests in assets in their construction phase. Though these are riskier than operational assets, they can generate higher returns.

SDCL Energy Efficiency Income Trust. This trust takes a different approach to the first two. With large amounts of energy lost between generation and end use, the managers believe the best way to reduce emissions is to reduce the demand for electricity in the first place. One way of doing this is through on-side power generation – the trust supplies combined heat and power systems to NHS hospitals and rooftop solar power to Tesco supermarkets. It also invests in projects to reduce energy demand, for instance by providing LED lighting.

The attractions of renewable energy trusts

Clearly renewable energy trusts are highly attractive from an environmental point of view, but we believe they also have a number of strong attributes as investments.

Income

Our favourite renewables products are designed to pay out high levels of income, typically around 4-5%. This appears attractive even compared to the high-yielding UK equity market and substantially higher than that available from global equities or bonds. (Source: Refinitiv Eikon 9 June 2022)

Total returns

Renewable investments have also delivered attractive returns on a total return basis, though investors should be aware that it’s those high yields that have delivered most of these gains – capital growth has been more moderate. (Source: Lipper for Investment Management)

The renewable investment companies invest in physical assets with robust underlying revenues. These revenues are often backed by governments or by contracts with utility companies, and often linked to inflation. As a result they tend to be less volatile than funds investing in equities, and even those investing in renewable energy equities. However, these are listed vehicles and investors should be aware they can still experience shorter-term share price volatility.

Diversification

Diversification – combining assets with different characteristics to improve the balance of a portfolio – is highly prized in the investment world. However, it has also become increasingly hard to come by.

With individual stock markets dominated by giant global companies their fortunes have become increasingly intertwined, so spreading your investments around the world doesn’t carry the same benefits it used to. This makes diversification an increasingly rare commodity, but renewable energy investments provide it. In other words, they march to a different beat to equities or bonds.

The risks

Of course no asset class is without downsides. Perhaps surprisingly, some key ones for renewables are environmental. The blades of wind turbines are hard to recycle and are often simply buried when they reach the end of their lifespan. However, fully recyclable turbines are undergoing testing and could present a way forward.

Another issue is the intermittency of supply. Whilst gas can be stored and then used to generate electricity as required, wind and solar output varies depending on the weather – a lack of sunshine and wind meant renewable energy supply was actually lower in 2021 than in 2020. Even when it is sunny or windy the electricity generated can exceed demand, and battery technology to store the excess power remains in its infancy.

Investors should also note that, due to the popularity of the sector, renewable energy investment companies often trade at a premium, i.e. their share prices exceed the value of their underlying assets. Periodic share placings, where they issue new equities to finance expansion, often provide an attractive entry point.

As with all investments, investors should also remember that investments go down as well as up and they may not get back the amount originally invested. Past performance of any fund is not a guide to future performance. Some ethical funds may, by definition, have a limited investment universe and this may affect performance.

In conclusion

We believe renewable energy trusts have become attractive investments. Many provide a good income, solid total returns including some protection from inflation, as well as diversification from traditional asset classes. With the demand from consumers and businesses and the commitments from governments in the UK and elsewhere, there are reasons to suggest they should continue do so. And they’re environmentally sound as well. Doing the right thing for the planet might also be the right thing for a portfolio.

Important information

Nothing in this article is intended to constitute advice or a recommendation, and you should not take any financial decision based on its content. It is based on our opinions which may change. If you are in doubt as to any course of action you should seek professional advice.

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