The second in a series of articles investigating growth sectors, developing technologies and niche themes that adventurous private investors can back in their Isas – and how they might do so. The first, on open-ended funds in the environmental sector, is here.
The UK’s energy mix is in the process of transitioning from coal and gas towards renewables and has been for some time. During the first quarter of 2020, 47 per cent of the UK’s electricity generation came from wind and solar.
When all sources of renewables are included, such as biomass and hydro, the forecast is for around 80 per cent of our power to come from renewables by 2040.
These commitments mean that underlying energy projects, such as solar and wind farms, held by renewable infrastructure vehicles are in effect partially subsidised through Government schemes such as the Renewable Obligations Certificate.
Investment trusts (see explainer box at end) are a popular way, among professional and retail investors alike, to gain exposure to specialist sectors. And they are a vehicle well-suited to infrastructure projects.
The UK Government last month released details of its 10-point plan for a Green Industrial Revolution, including stepping up offshore wind production to power every home, working with the hydrogen industry to generate 5GW of low carbon hydrogen by 2030, advancing nuclear energy and backing the manufacturing of and accelerating the transition to electric vehicles.
Chris Hulatt, co-founder of Octopus Group – who explained recently to This is Money the other day why renewable energy trusts present an opportunity for investors seeking income – says that ‘ultimately it’s about liquidity’.
‘Open-ended funds are well suited to things like equities or bonds which are traded daily, as this means that if an investor wants to withdraw their money, the fund manager can sell those equities very easily and return the money,’ he explains.
‘Renewable energy assets are quite different, as they can’t be bought and sold quickly, or in small amounts. That’s why closed ended investment trusts are the perfect vehicle as they raise capital to purchase the assets and then issue a fixed number of shares.’
Renewables also suit investment trusts’ reputation for being able to maintain income payouts. As most of the costs are fixed and borne at set-up, once they are running such projects can produce a steady stream of income as they are paid for their energy by the grid.
Chris Salih, research analyst at FundCalibre, says in a world of zero per cent interest rates on cash and corporate bonds at two per cent, ‘these vehicles typically pay north of 5 per cent, depending on what price you pay for them’.
Tim Cockerill, Investment Director at Rowan Dartington, says the attractions for investors are: ‘a high income from a stable source, often quasi government, and a physical asset base’. He observes that none have cut dividends this year. But they are not without risks.
‘On the capital growth side I think it’s best to expect only modest appreciation because these vehicles are about income and having defensive characteristics compared with equities,’ he adds.
Chris Hulatt, co-founder of Octopus Group
Government subsidies are also at the mercy of politics. But analysts tend to agree that the UK’s carbon emissions commitments enjoy political consensus so the jeopardy is limited.
Trusts are also being launched in the more nascent but growing energy efficiency and storage sub-sector. The cost of wind and solar power continues to fall but a challenge is delivering it when needed – and without losing too much power.
As newer technologies such as biomass and battery storage see their base cost fall they will become more prominent.
Finally, there are also investment trusts with a broader environmental remit that could also benefit from the secular transformation to green business practices.
Similar to those identified in our previous piece dedicated to open-ended funds, these trusts look to invest in companies engaged in a variety of environmentally focussed sub-sectors and technologies. These, in contrast to the renewables trusts, will generally be geared more towards growth than income.
Looking towards next year, James de Sausmarez, Director and Head of Investment Trusts at Janus Henderson, says that interest in environmental issues is growing rapidly ‘and I anticipate growth in investment trusts with a demonstrable ESG angle’.
Investors must remember that while the underlying assets of an investment trust might not always be equities, the trusts themselves do trade as shares and can get hit by wider sentiment.
There are many ESG-badged funds, but fewer that are directly investing in green industries and technologies.
Many of these trusts almost halved in value in March which stock markets plunged on the back of the pandemic.
Ongoing charges – the fee that comes out of your annual returns – are almost all above 1 per cent, which by many investors is deemed expensive. Those who baulk at this are likely to look towards tracker funds and ETFs – which will be the subject of our next piece.
THE TOP PERFORMING ENVIRONMENTALLY-FOCUSED INVESTMENT TRUSTS
As the familiar investment industry proviso goes, past performance is no guarantee of future returns. But in terms of seeing what’s out there, it’s certainly a start.
We asked the Association of Investment Companies – the umbrella organisation for investment trusts – to crunch the numbers on the best performing funds in two of its sub-sectors (Environmental and Renewable Energy Infrastructure) over the last three years.
|INVESTMENT COMPANY||SECTOR||1 YEAR SHARE PRICE TOTAL RETURN (%)||3 YEAR SHARE PRICE TOTAL RETURN (%)||5 YEAR SHARE PRICE TOTAL RETURN (%)||PREMIUM / DISCOUNT (%)||YIELD (%)||ONGOING CHARGE (%)|
|1||Impax Environmental Markets||Environmental||34.1||72.8||185.1||8.3||0.7||1.02|
|3||Renewables Infrastructure Group||Renewable Energy Infrastructure||3.5||44.3||76.7||15.9||5.3||0.97|
|5||Bluefield Solar Income Fund||Renewable Energy Infrastructure||-2.7||35.3||71.5||12.9||6.2||1.11|
|6||JLEN Environmental Assets Group||Renewable Energy Infrastructure||-0.8||30.7||52.6||19.2||5.9||1.26|
|7||Greencoat UK Wind||Renewable Energy Infrastructure||-9.2||27.2||60.6||8.8||5.5||1.0|
|8||Greencoat Renewables||Renewable Energy Infrastructure||3.2||26.2||N/A||13.4||5.3||1.18|
|9||NextEnergy Solar||Renewable Energy Infrastructure||-8.5||18.0||46.0||8.3||6.7||1.16|
|10||Foresight Solar Fund||Renewable Energy Infrastructure||-9.8||16.5||36.3||6.5||6.9||1.15|
|Source: AIC/Morningstar. Returns are correct as of end 08/12/2020|
The more growth-orientated ‘environmental’ trusts sit towards the top of the table, which is ordered by three-year total returns. Meanwhile the renewables trusts boast much higher yields which will compound as the years go on.
Also there’s quite a bit of volatility in returns over time, with the Menhaden Capital trust showing well over three years but much more poorly over one and five years, which in part explains its hefty discount.
The other two environmental trusts have been given a shot in the arm this year by the new focus on sustainability sparked by the Covid crisis.
Impax Environmental Markets targets long-term capital growth by investing in companies offering solutions to environmental challenges. Having launched in 2002, the trust has an 18-year track record but has seen its performance go from strength to strength since 2016.
It also invests in several companies making manufacturing and supply chains more energy efficient, which will be key in a post-pandemic world. Learn more about the trust here.
The long-standing Jupiter Green shifted towards smaller and unlisted companies and emerging markets in the light of Covid. It has moved from discount into premium territory over the last year but over the last ten years its performance has been overshadowed by rival Impax.
THE RENEWABLES TRUSTS
Premiums for these can be – like the yields – hefty.
Peter Walls who runs the Unicorn Mastertrust says that the prevailing high premium ratings for many of the trusts are due to a combination of ‘attractive yields in the continuing low yield, dividend-cutting, income hungry environment’, and their ESG credentials – ‘because ESG is selling well’.
Tim Cockerill says the premiums are not surprising ‘given the direction of travel for power generation, ultra-low interest rates and a demand for these assets because of their high yield and ESG having gone mainstream… they are in some ways the ultimate ESG investment’.
Wind and solar are the two leading renewables, but the more nascent sectors of biomass and energy efficiency will create future investment opportunities.
Peter Walls reckons the leadings trusts in each area – namely solar, wind, energy storage and efficiency – are respectively Bluefield Solar, Greencoat Wind, Gresham House Energy Storage and SDCL Energy Efficiency Income. The latter two are too young to feature in our table.
Digging a bit deeper, Cockerill says it is important to understand the difference between the trusts within the renewables sector both in terms of the reliability of the income they pay and their asset mix – ‘what dominates, is it wind, solar or is there a spread?’
‘JLEN Environmental Assets is the most widely diversified of the sector, wind generation is 36 per cent of the portfolio for example, it’s yielding 5.7 per cent but on a 19 per cent premium which is steep,’ he explains.
‘The Renewable Infrastructure Group is on a 16 per cent premium and yields 5.1 per cent: it is nearly 75 per cent invested in wind, so quite different from JLEN. From an income perspective TRIG currently has 80 per cent of its income coming from fixed tariffs – which could be construed as being preferable for the income investor – whilst JLEN has 48 per cent.’
Hollands warns that these steady-eddy investments might be less exciting for those hoping for explosive growth from the shift to a low carbon economy.
‘The main challenge for investors is that the demand for such assets means that listed renewable infrastructure companies trade on hefty premiums to their net asset values. In fact the average renewable infrastructure company listed on the UK market is trading on a 13.6 per cent premium.
‘Many investors might baulk at this, but then you are still getting an average yield of over 5 per cent, which is very secure, and so cautious income seeker may feel the premium is worth paying.’
SHOULD INVESTORS BE PUT OFF BY BIG PREMIUMS?
Double-figure premiums can deter the retail investor who fears ‘over paying’ for their investment.
Cockerill says that – as with any company share – it depends if the characteristics of the investment are meeting specific needs in your portfolio: ‘Diversification is important by asset class, region and fund. If income is required and / or defensive assets then they are worth considering.’
It is also worth waiting for a dip in premiums, which can fluctuate – so opportunities could arise to buy in.
Trusts in the renewables sector are a favourite with institutional investors and fund managers seeking exposure to the sector and income – and their buying weight can sometimes distort prices and premiums of the trusts in the short term for retail investors.
Chris Salih, research analyst at FundCalibre, observes that trust share prices can move from their NAV quite significantly within weeks or months, so investors can get in there premiums do dip below recent averages.
He notes that Greencoat UK Wind and Foresight Solar are trading at lower premiums than for most of the year.
‘JLEN Environmental Assets Group is a great trust but its premium at the moment is so high that it’s the equivalent of giving up four years’ worth of its income,’ says Salih.
Andrew Rees, Investment Manager at EQ Investors, also says that it might be worth just biding one’s time: ‘It is important to note that a number of new investment companies in the renewable infrastructure sector are looking to come to market so it as the supply grows, it is certainly possible that the sector’s premiums could reduce.’
NEW TRUSTS ON THE BLOCK
The table excludes a lot of trusts that have been around for less than three years. It has been a hot sector recently, with new launches (or IPOs) including Aquila European Renewables, US Solar and Octopus Renewables.
Peter Walls observes that one possible approach for the adventurous – and well-researched – investor is to buy new and secondary issues, as premiums will be smaller.
He notes that there are forthcoming issues for: Downing Renewables & Infrastructure, Ecofin US Renewables and Victory Hill Global Sustainable Energy Opportunities.
‘Meanwhile recent or live secondary issues include Bluefield Solar, Gresham House Energy Storage and Gore Street Energy Storage,’ he adds.
Salih also mentions Downing as a much-anticipated float: ‘What you are getting in that instance is no premium, but the ‘con’ is that it won’t have a high first year yield as it won’t invest all the IPO money in assets over night.
‘Ecofin US Renewables Infrastructure Trust is another example: with this US trust investors would also have some currency risk though.’
Hollands adds that new shares issues are also quite regular from existing vehicles as they line up new assets to purchase.
ANDREW REES, EQ INVESTORS
Greencoat UK Wind: It has a strong track record in delivering a consistent dividend that is uncorrelated to equity or bond markets. UKW itself invests in both onshore and offshore wind farms and is a constituent of the FTSE 250. We like the simplicity of its investment strategy in comparison to other infrastructure funds as it allows us to model the cash flows and to get more comfortable with the different risks inherent to investing in renewable energy.
We also believe in the long-term structural theme driving the growth in renewable electricity generation and welcome Boris Johnson’s announcement of all UK homes being powered by wind energy by 2030. This policy tailwind will continue to create an attractive opportunity set for Greencoat’s management team going forward. The company trades at double digit premium on average but may issue up to a maximum of 750 million new shares over the next twelve months.
Impax Environmental Markets: It is the UK’s largest dedicated environmentally focused investment trust, investing in companies offering solutions to themes such as clean energy and energy efficiency, water treatment and pollution control, waste technology and natural resource management, and sustainable food. IEM invests in small and mid-cap companies that have more than 50 per cent of revenues linked to these themes which helps to maintain purity of exposure to each theme.
Since the financial crisis, the trust had traded at a consistent discount until mid-2018 when its strategy begun to be more highly sought after by investors and has since traded at a premium. The Trust has been issuing shares consistently when trading at a premium to satisfy investor demand.
JASON HOLLANDS, TILNEY
Octopus Renewables Infrastructure: Octopus is a newer vehicle which listed last year and is building a portfolio of both operational renewable energy assets and investing in projects to construct wind and solar farms. The trust will invest in projects in the UK, Europe and Australia and currently owns assets in the UK, Sweden and Southern Spain.
Greencoat UK Wind: A more mature vehicle, focused on the UK, trading on an 8.4 per cent premium but yielding 5.3 per cent.
INVESTMENT TRUSTS EXPLAINED
Investment trusts are funds that are structured as companies and listed and traded on the stock exchange. The oldest were founded in the 19th Century to raise funds for global projects from British investors, and some have been paying and increasing dividends for several decades.
They are also called ‘closed-end’ funds because the manager does not have to increase or decrease his holdings as money from investors flows in and out of the fund. The number of shares in circulation will remain unchanged unless more are issued.
So unlike open-ended funds they are not subject to indefinite or sudden inflows or outflows of capital, and are many experts’ preferred vehicle for long-term investing.
Trusts often perform better than their open-ended or OEIC counterparts, over the longer term particularly, a confirmed by independent research. James de Sausmarez at Janus Henderson Investors identifies three more key benefits attached to investment trusts.
‘As they are companies with a closed-end structure, it means the fund manager can take a longer-term view of investments and borrow money to invest with the aim of achieving a greater return than the cost of that debt,’ he says.
Second, investment trusts can deliver steady and rising income through the cycle as they can retain up to 15 per cent of income in a good year, hold it in a revenue reserve, and use it in a difficult year.
And finally he concludes, ‘investment trusts have independent boards of directors, whose responsibilities include always acting in the best interests of shareholders by holding the fund manager to account and ensuring a competitive fee basis’.
However, ITs are – as listed shares – subject to wider market sentiment and can therefore suffer in stock market sell-offs. Also the fact that they can borrow to fund investments – while sometimes a boon – can add to their risk profile.
Finally some trade on ‘premiums’. This means that their popularity with investors boosts the share price and takes a trust’s market capitalisation above the value of the underlying assets held by the fund.
Retail investors can therefore feel they are ‘over paying’ for their investment.
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