The world in which we live is undoubtedly a low return world. Yields have been pushed down relentlessly by loose monetary policy, with 10-year German government bund yields turning negative for the first time in June. Meanwhile, the prospects for equities look mixed, with muted global growth and lacklustre corporate earnings.
This is a challenge for multi-asset investors, whose role is to find asset classes that can deliver returns at all points in the cycle. But as traditional asset classes have struggled, opportunities have opened up in alternative, non-traditional asset classes that come with a range of different and uncorrelated return drivers. While specialist expertise may be required to understand the risks and rewards, their diverse nature helps to immunise them against becoming crowded trades.
Perhaps the best known alternative investment of the past few years has been infrastructure. While we do invest in conventional infrastructure, we also invest in listed renewable energy vehicles, which offer additional investment capacity and an alternative to infrastructure funds trading at unappealing premiums to their NAVs.
Our renewables exposure comes through Greencoat UK Wind (onshore wind with one offshore farm) and the Renewables Infrastructure Group, or TRIG, a mixture of onshore wind and solar photovoltaic. These technologies are mature, well-tested and have long operational history. As a result they are lower risk than investments in projects based on more experimental technology, such as wave or tidal energy. In general, we view our renewable energy exposure as a compliment to our existing infrastructure assets, as they display many of the same characteristics that we find in traditional infrastructure.
One of the attractions behind renewables is that they are relatively straightforward to value. An operational wind or solar farm generates a revenue stream over the lifetime of the wind turbines or solar panels, with revenue underpinned by renewable energy subsidies. These subsidies are virtually guaranteed for existing projects, so while a future regime shift might affect assets yet to be built, it would be unlikely to impact existing renewable power projects. With relatively predictable revenues and costs, and fixed-rate long-term debt, these assets should generate a fairly predictable rate of return.
Of course, this is a very simplified case for renewables. Revenues are not just dependent on subsidies but are also partly a function of wholesale power prices. Declines in demand for power, as occurs in a recession, or increases in low-cost supply (such as when natural gas prices are low) will impact prices.
However, because energy companies tend to secure supply on long lead times, prices received by renewable power generators tend to be contractually fixed over the short to medium term. So while lower power prices present headwinds, these projects are relatively well insulated.
“One of the attractions is that renewables are relatively straightforward to value”
As alternative investments, portfolios of renewable power projects do come with their own idiosyncratic risks. Most obviously, there is the risk that your assets fail to generate power and hence the revenue you’re relying on. That’s most likely to happen when maintenance and physical management is poor. This is why we work only with managers who have extensive expertise and operational know-how.
For individual projects there is obviously the risk that in any given year wind-speeds may disappoint. In general, however, what you lose one year can be made up the year after. Having a geographically diversified portfolio and keeping leverage at prudent levels can mitigate this risk.
While the merits of traditional asset classes may be opaque at the moment, there are opportunities for multi-asset investors. For those looking for a reasonably predictable, long-term income stream, with some inflation protection, renewables have a lot to offer.
James Bateman is head of portfolio management at Fidelity Solutions