Everyone loves a good deal, and right now, one potential opportunity lies within the realm of renewable energy infrastructure funds. However, investors should be aware of the risks involved.
Traditionally, these funds focus on owning solar and wind farms. In recent years, they’ve branched out into areas like hydrogen and battery storage. This diversification allows them to generate a reliable income that usually adjusts with inflation, making these investments appealing for those seeking consistent returns.
Unfortunately, the past three years have not been favorable for this sector. Rising interest rates have made government bonds seem like a more attractive option, prompting many investors to leave these trusts.
As a result, renewable energy infrastructure funds are currently trading at an average discount of around 32%.
For some investors, this discount could signal a bargain. The long-term outlook for renewable energy has received a boost from the Labour government, which has set an ambitious clean power target for 2030, moving it up from 2035. This indicates that the net asset value for many trusts could rise in the future, though analysts are cautious about whether the government can successfully attract more private investment into the sector.
Despite these challenges, there are positive signs. Analysts believe that falling interest rates will make infrastructure assets appealing again compared to government bonds, given their yields of 6 to 8 percent relative to 4 to 4.5 percent for gilts. Additionally, an increase in power prices and the overall growth potential in renewable energy sectors bode well.
Many analysts suggest that the current sell-off in this sector has been rather indiscriminate, leading to potential bargains. Iain Scouller, an analyst at Stifel, notes, “There are a number of positives out there. Some of the valuations are quite attractive.” He recommends investing in Greencoat UK Wind for its strong dividend cover, Bluefield Solar Income for its attractive dividend yield of about 8 percent, and Octopus Renewables for its diverse portfolio across Europe, Australia, and the UK.
Elliott Hardy, an analyst at Winterflood, predicts that as interest rates decrease, discounts on these trusts will also shrink as investors return.
Although there’s been a slight uptick in interest in renewable energy infrastructure trusts, Victoria Hasler from Hargreaves Lansdown indicates that many investors still prefer to hold cash and wait for clearer signals before making moves.
Hardy emphasizes the importance of observing the proactive steps taken by boards to improve circumstances, such as share buybacks, which signal good intentions, even if they don’t immediately affect discounts.
However, some trusts are trading at large discounts for specific reasons. Many have high levels of borrowing, with NextEnergy Solar Fund showcasing a debt ratio of 93 percent to its net asset value, leading to a 29 percent discount.
Challenges persist throughout the sector. The UK has experienced less-than-favorable weather conditions, resulting in lower power generation, which has contributed to a drop in average net asset values of 3 to 5 percent this year. Power prices have been highly volatile, and there’s no certainty they will rise in the upcoming year.
Matt Hose, an analyst at Jefferies, cautions that some trusts might even face closure. Many are burdened with assets they need to sell to cover debts, yet struggle to raise new capital due to their steep discounts.
Looking ahead to the next year, there will be a series of “discontinuation votes,” where trusts must allow shareholders to vote on whether to wind down the fund if discounts exceed 10 percent. Shareholders have previously allowed trusts to continue, but they may be less lenient this time.
Hose predicts a phase of “creative destruction,” where smaller funds might disappear, while larger ones could survive and narrow their discounts.
In summary, investors will need to navigate numerous challenges in the renewable energy infrastructure sector to truly feel they’re seizing a great opportunity. The coming year will heavily rely on movement in energy prices and board actions. Scouller reminds investors, “Going into next year, a lot depends on what happens with power prices. It’s been quite a tough 2024.”