Renewable energy opportunities
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, meanwhile, harvest bountiful and increasing dividends.
Sentiment versus fundamentals
Higher interest rates and gilt yields competing for the attention of income-seeking investors, while higher discount rates 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 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 energy security considerations following Ukraine are seeing new oil and gas projects being approved. News that the 1.4-gigawatt Norfolk Boreas offshore project and two New Jersey wind projects have been shelved on grounds of high construction costs and poor profitability, the latter involving a $4bn 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 like 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 many companies’ strong revenue correlation with inflation will temper concerns over time about higher discount rates impacting asset values. Already, what asset sales there have been has seen book values achieved – and more. Meanwhile, the inflation-assisted cashflow 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 buy-back 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% when inflation was 6.1% the month before Ukraine 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 their 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 Q1 2024 despite Central Banks talking their book.
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