Have environmental and renewable energy investment companies just been given the green light?

Following the Bank of England’s decision to cut interest rates for the first time since March 2020 and Labour’s landslide victory in the UK General Election could the stars be aligning for London’s environmental and renewable energy investment companies?

Have environmental and renewable energy investment companies just been given the green light?
Following the Bank of England’s decision to cut interest rates for the first time since March 2020 and Labour’s landslide victory in the UK General Election could the stars be aligning for London’s environmental and renewable energy investment companies?

By
Frank Buhagiar
07 Aug, 2024

It’s been a tough few years for those London-listed investment companies that have a somewhat green hue. Whether heralding from the Association of Investment Companies’ (AIC) three-fund environmental sector or the 20+ funds in the renewable energy space, all have seen their share prices regularly trade at stubbornly high discounts to net asset value. As recently as 30 June 2024, the average discount in the renewable energy subsector stood at -24.6%. The three environmental funds’ average discount was around half that level, but was still in double digits.

Hard to square those steep discounts with the scale of the global environmental emergency and the collective effort being made to tackle it. As the United Nations Sustainable Development Goal 13 states “To address climate change, we have to vastly raise our ambition at all levels. Much is happening around the world – investments in renewable energy have soared. But more needs to be done. The world must transform its energy, industry, transport, food, agriculture and forestry systems to ensure that we can limit global temperature rise to well below 2°C, maybe even 1.5°C.”

As the above paragraph from the UN suggests, action is being taken. In the US, the Inflation Reduction Act (IRA), which became law in August 2022, and the Bipartisan Infrastructure Law, which was enacted in November 2021, are helping to channel billions of federal dollars towards the development of clean energy. The numbers are eye-catching. Originally, estimated at US$391 billion over ten years, the cost of the IRA, including tax credits, loans and loan guarantees, is now forecast to exceed US$1 trillion. And according to Goldman Sachs, the IRA is already having an impact. “A total of 280 clean energy projects have been announced across 44 US states in the IRA’s first year, representing $282 billion of investment.”

Closer to home, the UK has set itself the target to reach net zero by 2050. The deployment of clean power generation clearly key here and 100% zero-carbon generation is being targeted by 2035. Step up all those renewable energy investment companies and their wind, solar, hydro, biomass and battery storage assets. Progress is being made. According to the National Grid, “2020 marked the first year in the UK’s history that electricity came predominantly from renewable energy, with 43% of our power coming from a mix of wind, solar, bioenergy and hydroelectric sources.” The National Grid goes on to add that in 2023 wind power accounted for 29.4% of the UK’s total electricity generation; biomass energy (the burning of renewable organic materials) contributed 5% to the renewable mix; solar power 4.9%; and hydropower, including tidal, 1.8%.

The UK has come a long way – renewables accounted for just 2% of all electrical generation in the UK as at end of 1991 and just 14.6% in 2013. But, as impressive as the above numbers are, there’s still clearly a way to go before zero-carbon generation hits 100%. Plenty of room for growth then for both renewable energy infrastructure companies and those funds, such as Impax Environmental (IEM) and Jupiter Green (JGC), that invest in clean energy and other environmental technologies and solutions.

And yet, the share prices of these funds continue to languish at discounts to net assets, thereby cutting off a vital source of funding, particularly for renewable funds. Indeed, unable to issue new shares to raise funds, renewable companies have had to adopt and announce capital allocation strategies. These are largely centred around reducing debt levels, returning capital to shareholders via buy backs, securing strategic partners and selling assets.

In black and white

The environment may well be a structural growth story underpinned by government backing and targets, but it is one that, based on prevailing discounts, has been largely shunned by investors in recent years. As for why this has been the case, over to the latest Annual Report from CT Global Managed Portfolio Trust (CMPI/CMPG), a fund which invests in other investment companies, including renewables, “A common theme amongst the underperformers in the Income Portfolio was widening share price discounts, much of which was the result of rising interest rates and importantly higher discount rates which are used to value future cash flows and assets for many alternative investment companies. The renewable energy infrastructure sector has been particularly affected”.

There it is in black and white – higher interest rates a major contributor to those wide discounts. As Jupiter Green’s Jon Wallace recently explained in an update recorded with doceo fund manager video update, “interest rates affect not just the rate at which a company will pay to finance itself but also ultimately the discount rate in the market place that’s applied to the long-term growth and structural growth for businesses.” Higher discount rates lead to lower valuations for the assets held by renewable funds and also for the growth stocks that environmental funds invest in.

But, if higher interest rates are to blame for the steep discounts, it follows that lower interest rates are key to an improvement in sentiment. CMPI/CMPG Chairman, David Warnock, agrees “Investors have been disappointed by the ‘higher for longer’ approach to combat sticky inflation. It may require actual cuts to be delivered for sentiment to improve”.

Welcome news

If that’s the case, then the 25-basis point cut in UK interest rates to 5% announced by the Bank of England on 01 August 2024, the first cut since March 2020, ought to be welcomed with open arms. And while the Governor of the Bank of England cautioned the market not to expect a flurry of further cuts in the coming months, he did nevertheless describe it as “an important moment in time”. Certainly, in the investment company space – a change in the direction of travel for interest rates should help narrow discounts and, eventually, reopen a much-needed source of funding.

That first cut in UK interest rates, not the only positive change for the environmental and renewables AIC sectors. So too, the more stable political backdrop in the UK, following the landslide victory for the Labour Party which, during the campaign, pledged to make Britain a clean energy superpower: “The climate and nature crisis is the greatest long-term global challenge that we face. The clean energy transition represents a huge opportunity to generate growth, tackle the cost-of-living crisis and make Britain energy independent once again. That is why clean energy by 2030 is Labour’s second mission.”

Back to Jon Wallace’s video update,

“Given the change in the UK Government and also the scale of the victory for the Labour administration, there is now an opportunity to add back some of the commitments around addressing climate change. In principle, that’s about decarbonising power systems. The commitment around onshore and offshore energy, in particular wind energy, is notably a positive for us.” As at 30 June 2024, Jupiter Green had 18% of its assets invested in clean energy. The election result is presumably a positive too for renewable energy companies such as Greencoat UK Wind (UKW) and The Renewables Infrastructure Group (TRIG).

On the up

Add the more favourable political backdrop and the first cut in UK interest rates to the global structural growth story that is the transition to net zero and the stars could well be aligning for London’s environmentally focused investment companies. And based on a recent narrowing in discounts, it would appear the market agrees. As the table below shows, current discounts in the environmental sector have bounced off their year highs (or lows depending on one’s perspective):

Fund

Current discount

52-week high discount

Impax Environmental (IEM)

-8.6%

-12.6%

Jupiter Green (JGC)

-18.0%

-33.4%

Menhaden Resource Efficiency (MHN)

-38.5%

-41.9%

Interestingly, all three funds’ discounts set their year-highs in May. Round about the time Rishi Sunak called the General Election, despite trailing heavily in the polls to Labour, and round about the time it was reported that inflation had fallen back to the Bank of England’s target rate of 2%, thereby opening up the possibility of a first rate cut. Market sensing change was in the air perhaps. It’s a similar story with the renewables sector. Earlier in the year when higher for longer was the prevailing interest-rate narrative, renewables regularly contributed the most names to Doceo’s Discount Watch List of funds trading at year-high discounts. For weeks now, no renewables have featured on the list.

So, it seems with share prices bouncing off the bottom and discounts narrowing, the environmental and renewables sectors may well have just been given the green light investors have been waiting for. And with discounts still on the steep side and with much work to do to put the world on a more sustainable path, there’s arguably a lot more to come from both sectors.