Clean energy funds, once a favorite in the investment trust landscape, are poised for a resurgence as lower interest rates reignite investor interest.
After years of high premiums and booming demand due to environmental, social and governance (ESG) concerns, the sector is facing headwinds from rising tariffs and falling electricity prices. However, with the Bank of England recently cutting interest rates for the first time in over four years and further cuts expected in 2024, optimism is returning.
According to the Association of Investment Trusts, clean energy funds traded at significant premiums to their net asset value (NAV) as recently as 2020. For example, Greencoat UK Wind, the largest clean energy investment fund, raised over £1 billion in equity in 2020 and 2021, almost a third of its market value. But today the fund and its peers are trading at discounts, reflecting the broader market’s retreat from the £15.5 billion sector amid higher interest rates and weaker energy prices.
James Wallace, an analyst at Winterflood, believes recent interest rate cuts could help narrow these haircuts, although it could take some time for the impact to be fully felt. “We believe these rate cuts will at least somewhat narrow that gap in terms of discounts due to the lower return requirements that these investors demand,” he said. However, Wallace warned that significant cuts — perhaps up to 75 basis points — could be needed to have a meaningful impact on valuations.
Still, the question remains whether green energy funds can regain the high premiums of the past without returning to the ultra-low interest rates of pre-2020. Ben Newell, analyst at Investec, noted: “It is possible for these companies to trade at or near net asset value, but unless you have the prices we saw before 2020, they will not trade at premiums of 10 to 10 “Traded at 20 percent.” to the book value.”
The challenges are not just limited to interest rates. London’s emerging battery storage sector, which includes funds such as Gresham House Energy Storage and Gore Street Energy Storage Fund, is under scrutiny for volatile cash flows, with share prices trading between 45 and 55 percent below their net asset value. In contrast to wind or solar systems, revenue from battery storage depends on fluctuating wholesale electricity prices, which brings with it additional risk that investors have previously been reluctant to accept.
Paul Mason, chief investment officer at Harmony Energy, highlighted the unpredictability of battery asset revenues as a key factor in the current market discount. The recent decline in energy prices has added even more pressure on these funds and led to some funds such as Harmony and Gresham canceling their dividends for the year. Reflecting on the lesson learned, Max Slade of Harmony Energy explained: “We learned that taking an asset class with an (unpredictable) trader turnover profile and trying to promise a fixed dividend level is not always viable.”
Additionally, waning enthusiasm for ESG strategies during the economic downturn is impacting green infrastructure funds. Last year, ESG funds saw significant withdrawals from UK investors, although inflows have improved this year. “During a cost of living crisis and when the economy is a little slower, there can be a little more focus on the economy and generating returns,” Wallace noted.
The recent fall in share prices below net asset value has prevented renewable energy investment funds from raising new equity, limiting a key source of funding for future projects. Renewables Infrastructure Group (Trig), one of the industry’s largest trusts, has responded with careful balance sheet management, including selling assets worth £210 million to reduce debt and fund new developments.
As the UK government sets ambitious targets for expanding wind and solar capacity by the end of the decade, the role of private capital remains crucial. However, as Gore Street Capital CEO Alex O’Cinneide pointed out, restricting access to capital poses a significant challenge: “There’s a very big question about what that means in terms of a new government and in terms of the recovery. “-Our renewable energy infrastructure shows that a key avenue for private capital to invest in renewable energy in the UK is fundamentally closed.”
With the sector expected to recover, all eyes will be on further interest rate adjustments and their potential to revive investor confidence in the green energy space.
