Investing to beat inflation at 5.5 per cent is tough – trying to beat the 7 per cent it is forecast to reach by the Bank of England adds the temptation for some unwise decisions.
The extra risk needed to get extra reward brings greater volatility and the possibility that a shift in sentiment can send prices sinking fast.
This has been highlighted by the beating meted out to some tech star shares in the US, after growth that would be seen as stellar for most companies was judged pedestrian and disappointed shoot-the-lights-out investors.
Chasing down high inflation with growth shares brings a risk that isn’t suited to all, so sometimes it’s better to settle for dividend investments that can at least into inflation even if they can’t match it.
One area of the income investing world that has attracted keen interest in recent years is renewable energy – a sector that offers both decent yields and a tailwind.
A dividend from natural sources: Renewable energy investment trusts offer an average yield of 5.55% but many trade at a premium – are they worth investing in?
This shift to renewables is held partially responsible for some of the energy element of the inflation spike we are currently seeing.
Teething problems from the drive to go green are likely to continue and renewable energy investors should bear that in mind when weighing up the potential for energy costs to do unexpected things – for example, what would a sudden fall in price forecasts do to their investment.
Nonetheless, the transition to green energy has had a huge weight of government support put behind it and it’s hard to see a scenario where that won’t continue and step up as countries and companies seek to meet their net zero pledges. Hence the tailwind.
So for investors interested in renewable energy, what’s on offer?
Arguably the best method of investing in such real assets, or stocks exposed to them, is through an investment trust. Their structure of a limited number of shares means that they won’t be forced buyers or sellers if investors rush in or out, whereas investment funds can be.
The Association of Investment Companies has a Renewable Energy Infrastructure sector, which has a current average yield of 5.55 per cent.
That just beats the current rate of inflation and the average trust in the sector has posted a total return (share price and dividends combined) of 6.38 per cent over the past year and 46.14 per cent over the past three years.
But – and it’s a big but – there are some things you need to watch out for here.
Firstly, many of these renewable energy trusts trade at hefty share price to net asset value premiums. The sector average is 7.06 per cent.
In simple terms this means you pay 7 per cent more for a share than the stake in the trust’s assets it is entitled to.
Yet, that’s not the case for all. If you look at just those renewable energy trusts paying a dividend (see the table at the bottom), which is what we are after when looking through an income investing lens, things vary substantially.
A few trade at a discount, some have a premium of under 1 per cent, and others trade at 10 per cent-plus.
It’s always worth looking at individual trusts and how their premium or discount compares to their own longer term averages, which you can do on the AIC website, and what the reasons why may be.
For example, some of the big guns in the sector trade on bumper premiums, Greencoat UK Wind at 6.1 per cent, Renewables Infrastructure Group aka Trig at 13.15 per cent, and Greencoat Renewables at 10.94 per cent.
Yet, those premiums are all lower than they’ve been for much of the past three years.
In contrast, the top-yielding trust, NextEnergy Solar, has a 7.05 per cent yield, but trades at a 2.26 per cent discount. It’s only exposed to one renewable energy area, but has expanded its reach from beyond just the UK to up to 30 per cent invested in other OECD countries and gets some of its income from inflation-linked subsidies and some from selling power.
One of the issues with renewable energy trusts is their value is based on what investors think their future power generation is worth.
Investment trust specialist Mick Gilligan, of Killik, sounds a note of caution here. He says: ‘Although power prices are on the increase right now, longer term prices may reduce as more renewable generation and battery storage is added to the grid.
‘My preference is for battery storage rather than energy generation. I like Gresham House Energy Storage.’
This is an emerging and popular investment area but again storage trusts are on big premiums.
Another interesting option that made Bestinvest’s latest best funds list is SDCL Energy Efficiency Income Trust, it has a 4.95 per cent yield and one year return of 10.9 per cent, but again trades at a 7.86 per cent premium.
The trust invests in projects in the UK, Europe and US that deliver cheaper, cleaner and more reliable energy; from roof-top solar panels for commercial and industrial firms, to more efficient lighting and energy storage. It holds a stake in Bio Town in the US, turning cattle manure and food waste into energy.
A trust outside the renewable energy sector that Gilligan likes – and I hold in my portfolio – is Impax Environmental Markets, which invests in companies with products and services that seek to mitigate or combat climate change.
It’s a growth-oriented trust and has been hit by the recent sell-off, so total return has fallen 8.05 per cent over one year, but over three and five years investors are up 65.2 per cent and 111 per cent, respectively.
As with any investments, the warnings are don’t just buy any of the trusts mentioned here, do your own research, beware overpaying, and don’t over expose yourself to this one niche sector.
However, it’s an interesting and different investment area at a time when inflation is hitting our wealth and might be worth a look.
|Total assets (m)||Discount/ premium (%)||1 year total return||5 year total return||10 year total return||Ongoing charge ex perf fee||5 year dividend growth (%) p.a.||Dividend yield (%)|
|Foresight Solar Fund||654.44||-6.42||5.5||27.46||N/A||1.18||2.52||6.95|
|Bluefield Solar Income Fund||576.12||5.05||-3.36||54.32||N/A||1.14||1.99||6.66|
|JLEN Environmental Assets Group||671.56||4.22||-2.84||33.55||N/A||1.29||2.23||6.43|
|Gore Street Energy Storage||358.7||11.58||14.35||N/A||N/A||2.26||N/A||6.03|
|Triple Point Energy Efficiency Infrastructure||95.23||-1.28||-5.91||N/A||N/A||1.07||N/A||5.85|
|US Solar Fund||312.39||1.98||-6.7||N/A||N/A||1.49||N/A||5.74|
|Greencoat UK Wind||4,014.63||6.11||12.48||55.76||N/A||1.03||2.52||5.48|
|Renewables Infrastructure Group||2,572.76||13.15||5.49||56.78||N/A||0.91||1.58||5.26|
|Gresham House Energy Storage||493.97||17.89||24.3||N/A||N/A||1.26||N/A||5.26|
|Octopus Renewables Infrastructure||581.37||2.42||-2.62||N/A||N/A||1.15||N/A||4.97|
|SDCL Energy Efficiency Income||950.58||7.86||10.87||N/A||N/A||1.13||N/A||4.95|
|Downing Renewables & Infrastructure||141.32||0.58||8.09||N/A||N/A||N/A||N/A||4.82|
|Aquila European Renewables Income||420.72||0.78||0.05||N/A||N/A||1.4||N/A||4.81|
|VH Global Sustainable Energy Opportunities||312.99||7.12||5.75||N/A||N/A||N/A||N/A||4.65|
|Ecofin US Renewables Infrastructure||126.1||0.16||-0.15||N/A||N/A||N/A||N/A||3.17|
|Source: AIC using Morningstar data 16 February 2022|
The investment trust expert’s pick
Mick Gilligan, of Killik, prefers energy storage to renewable energy generators and his pick in the sector is Gresham House Energy Storage (GRID).
He says: ‘I am not so keen on the wind and solar plays as their NAVs are valued using long term power price forecasts, which are very difficult to predict.
‘GRID acquires or constructs Battery Energy Storage Systems (BESSs). It then generates revenues from several sources, primarily: Frequency Response (i.e., providing power into the grid at short notice), Trading (buying power from the grid when cheap and selling back into the grid at a higher price) and the Capacity Market (selling power on longer term contracts).
‘The trust now has a 30 per cent share of the UK BESS market and so has achieved scale quite quickly. The UK’s increasing reliance on renewable energy and increasing electrification raises the demand for balanced power transmission and distribution and increases short term power price volatility. This is a very good backdrop for GRID.’
For investors considering the sector, Gilligan flags the following things to be wary of.
He says: ‘In terms of things investors need to watch out for I would highlight 1) long term power price uncertainty and 2) the negative impact of higher interest rates.
‘Many trusts trade at premiums due to the market valuing their income generation more highly than is assumed by the NAV. For example, renewable infrastructure plays like Greencoat UK wind and Bluefield Solar Income apply discount rates to their cashflow to arrive at their NAVs.
‘In the same way that £100 today is worth £105 or £110 in a year’s time (if you compound it at 5 per cent or 10 per cent), £100 in a year’s time is worth £95 today if you discount it at 5 per cent or £91 today if you discount it at 10 per cent.
‘So, if the market is willing to apply a lower discount rate than the trusts themselves, this results in a higher present day value (i.e. a premium to NAV).
‘This willingness to apply a lower discount rate seems to have increased as interest rates have fallen and there are fewer alternative sources of income.’