Should pension funds invest in renewable energy?

Anish Butani: Renewable energy has emerged as a credible sub-sector in the infrastructure asset class over the past few years. The key attraction for investors are the index-linked government subsidies, along with the requirement for major utilities to purchase green energy.

The UK has been successful in teasing out that private sector investment

Anish Butani, bfinance

Government policies across western Europe have succeeded in encouraging investment in renewable technologies, and the cost of production has fallen markedly, to the extent that some renewable energy sources – such as onshore wind in the UK – are starting to see subsidies for new projects fall away.

Some infrastructure funds are starting to look for the ‘next big thing’ in the sector that may attract subsidies, with a lot of players looking at areas such as energy storage or batteries. The challenge for these newer areas is attracting long-term debt financing to encourage equity participation.

Gerald Wellesley: There has certainly been more about solar recently, and of course the dynamics of the solar industry are amazing. All these bullish estimates seem to be exceeded every time in terms of the capacity of its growth and the efficiency it can produce and so forth. Do you think that is a sector that should be included? Do you think it is going to be viable for pension funds to be investing in that?

Butani: The past few years have seen the emergence of renewable energy funds that have been investing in projects such as solar energy, onshore wind, offshore wind. The long-term nature of government subsidies for these projects, as well as long-term ‘off-take’ agreements with utilities, have made these projects attractive for lenders to get behind and support.

We are seeing things such as rooftop solar, where investors are doing deals with property owners across multiple sites.

The interesting thing now for renewable energy is around the subsidy environment, where I think the UK has proved to be a pioneer; it has been successful in teasing out that private sector investment.

We are almost at an inflection point now in terms of subsidies. Brownfield renewable energy assets developed under the old subsidy regime will remain very attractive.

However, pension funds will need to be aware of the risks involved in investing in greenfield projects under newer pricing regimes, which are likely to attract a lot of interest from utilities that have different strategic objectives when investing in renewable energy. So point of entry is critical for pension fund investors.

Barry Fowler: The aggregation point is an interesting one. We have built up a portfolio of something like 24,000 domestic and commercial solar panels. But you have to be very patient, you have to try to build a strategy that allows you to efficiently pool together small portfolios of assets, and then you can start to apply efficiencies of scale in terms of running them overall.

The real appeal of that part of the sector is that the underlying cash flows are again heavily government-subsidy oriented, certainly the historical assets that we have been able to acquire. That regime is largely behind us now, but the efficiency of the panels is starting to improve to the point where investments can start to be justified without requiring the underlying subsidies.

Wellesley: I have read that some of these new projects are competitive with coal, for example, so really you do not need a subsidy under those circumstances.

Vassos Vassou: How do you place a value on that portfolio of investments?

Fowler: Firstly, by looking at the income yield that is generated, and then looking at the resale value of the underlying assets. There is a secondary market, and it is very much available for them.

Vassou: As a trustee, what you are worried about is what happens when something goes wrong with your scheme and you need to realise that money. So you need to have a feel for what that is worth and how quickly you can realise it, and also how it behaves in terms of its own value relative to the scheme’s liabilities.

The cash flows from renewable energy investments can be sliced and diced to a degree

Barry Fowler, Aviva Investors

Fowler: The cash flows generated by such investments can be very stable and considered to be quite bond-like in their nature. Therefore the value of a lot of these schemes has considerably increased in the past few years as the general environment under quantitative easing has pushed most asset values upwards.

There is an inherent attraction in long-term assets and I would imagine there would be a secondary market available if you did require liquidity at short notice.

The cash flows can be sliced and diced to a degree as well. A scheme that is looking for a cash flow-driven investment could hold the assets on an ungeared basis and generate a very stable and steady cash return over the period of the holding; or you could invest in the equity, and therefore be subject to a more variable cash flow; or you can invest in the debt, which should drive the most stable level of returns overall. It depends on your risk appetite and what your overall objectives are.

Danny Vassiliades: People are very comfortable with equity-based structures and bond-based structures, but the behaviour is different. Perhaps what is more important in the decision is actually the amount of leverage, because leverage is ultimately what can cause liquidity issues when you want to get your money out. A long-term investor like a pension fund wants the characteristics of the particular asset, it does not want the financial engineering over it.

Some will want equity-based structures, some will want bond-based structures, but ultimately there are plenty of pooled fund structures in the pension fund world, which means most pension funds can get there quite easily.