Simon Gordon, Senior Director, Fund & Corporate Services, JTC Group writes that in one of its first press releases since the 4th July election, the new UK government announced an “unprecedented partnership between Great British Energy and The Crown Estate, which has the potential to leverage up to GBP60 billion of private investment into the UK’s drive for energy independence. … The company will be … backed with GBP8.3 billion of new money over this Parliament to own and invest in clean power projects in regions across the UK.
“It comes soon after the Energy Secretary has scrapped the ban on onshore wind and unblocked the production of cheap solar energy,” Gordon writes.
New solar farms and wind turbines are expensive as the press release numbers indicate. Moreover, it’s clear from the posited GBP60 billion/GBP8.3 billion ratio that the private investment sector is intended to be the major contributor to this project.
In the recent past, accurately 10 or 12 years ago, some of first structures enabling institutions to invest in renewable energy made an appearance – in the form of investment trusts. At the time, the investment case appeared impressive: most of the developed world, notably the EU, had started out on the long road to net zero, investors such as insurance companies and pension funds were attracted by the long (c.25 year) life of a trust which tended to match their liabilities, the positive ESG characteristics appealed to the institution’s stakeholders, and moreover there was the anticipated rate-of-return of something between 5 per cent and 7 per cent per annum in the pre-Covid, pre-Russia/Ukraine war period when, for example, UK government securities or gilts, were yielding next to nothing.
Initially, propelled by these considerations, some renewable energy Investment Trusts traded at a premium to net asset value but today most of the sector is suffering deep (-10 per cent, -15 per cent) discounts to NAV and this is particularly true of single-focus trusts – exclusively solar for example – more so than their diversified competitors.
It is not entirely clear what prompted this (at least temporary) reversal of fortune, but one certain factor was the rapid rise in Bank of England interest rates from 0.1 per cent in December 2021 to 5.25 per cent at the time of writing today. Suddenly investors in Trusts, like many others, found themselves able to achieve similar yields in highly liquid bonds and it may be that such liquidity was required following the cash calls arising from the disastrous Liz Truss ‘mini-budget’ of September 2022, which in turn caused some investors to move to reduce the levels of gearing in their portfolios.
Whether or not liquidity issues prompted Investment Trust investors to begin trading their holdings, risk should not have been a factor. Renewable energy Trusts are inevitably backed by long-term National Grid contracts or other quasi-governmental guarantees. While not quite gilt-edged, they are rightly perceived by most investors to be safe long-term assets whose duration, in many cases, matches an investing institution’s liability profile.
One issue that may be consequential, and this applies to all Trusts, not just those focused on renewable energy, is PRIIPS disclosures. Brought in by the Financial Conduct Authority in 2015, the aim of the Packaged Retail and Insurance Based Investment Products regulation is to encourage efficient markets by helping investors better to understand and compare the key features, risk, rewards and costs of different PRIIPs, through access to a short and consumer-friendly Key Information Document (KID).
A problem here, specifically as far as investment trusts, which are exchange-listed vehicles, are concerned is that the KID disclosure appears to reveal the presence of additional fees and charges whereas, in reality, these are baked into the share price. It has, however, been suggested that this misunderstanding, which the FCA is apparently now working to correct, has discouraged institutions whose investment criteria preclude them from accepting investment trust fee levels which PRIIPs imply.
Despite these issues, this is not a negative story. In short, the renewable energy Investment Trust sector is showing signs of recovery partially in the face of an anticipated reduction in the Bank of England base rate (following downward moves by the ECB, Sweden and Switzerland in June), and moreover because energy generation’s direction of travel in the UK, Europe, and increasingly in other parts of the world, is one way: towards net-zero and thus renewables.
According to the UK National Grid, in 2019 zero-carbon electricity production overtook fossil fuels for the first time, and on 17th August 2019, “renewable generation hit the highest share ever at 85.1 per cent (wind 39 per cent, solar 25 per cent, nuclear 20 per cent and hydro 1 per cent).”
Additionally, the National Grid tells us, “On 15 May 2023 the UK produced its trillionth kilowatt hour (kWh) of electricity generated from renewable sources – enough to power UK homes for 12 years based on average consumption. While it took 50 years to reach this milestone, based on current projections it will take just over five years to reach the next trillionth kWh.”
Probably in recognition of these facts, the discounts to NAV of renewable energy Trusts have begun to shrink, particularly for diversified funds. Some analysts are predicting an imminent re-rating in the renewables Trust sector. In other words, the market appears to be re-embracing its original financial and ESG values, although whether the premiums briefly witnessed by the first investors will reappear remains a matter of conjecture.
