The race to replace traditional, fossil fuel-led power generation with cleaner renewable sources of energy could offer up some of the most lucrative long-term investment opportunities and help generate income for years to come, according to Gravis Capital Partners’ Will Argent.
While technological disruption across the board is grabbing much of investors’ attention in mainstream sectors, the energy sector is undergoing a similar revolution.
In the US, where this change has been more pronounced, wind and solar energy production is growing faster than any other source of electricity. Moreover, falling prices are making these sources more competitive with fossil fuel-driven electricity.
According to a study by asset manager Lazard, over the lifetime of a power facility, wind and solar are now cheaper than electricity generated by coal, nuclear power, and natural gas—even with government subsidies taken out.
“In the US, the vast majority of decisions about renewable energy installations were taken on economic, viability grounds, rather than any kind of policy drive,” said Argent, who manages the £22.9m VT Gravis Clean Energy Income fund.
“The sector is now moving away from its dependence on subsidies and various government support towards being economically viable in its own right.
“Indeed, the energy sector is experiencing the most dramatic transformation since its creation a century ago,” the portfolio manager said, highlighting the chart below, which depicts the increase in renewable energy consumption in recent years.
Source: BP Statistical Review of World Energy
Progress in energy storage is expediting this shift to clean energy, he added.
“Energy storage presents an interesting opportunity for investors, said Argent. “Being able to store the energy produced from renewable sources is critical owing to the nature of wind and solar power production being intermittent.
“Battery storage capacity is an important growth area required to harness the increased renewable energy capacity in the UK and elsewhere.”
As such, investors interested in clean energy have a number of options, Argent said.
It is now possible to invest in clean energy through funds that will provide exposure to broader themes, including the supply chain and companies that manufacture the equipment.
“This option offers huge potential upside, but equally chances for great losses,” he said. “It would all depend on the vagaries of market movements.
An investor thinking about investing in a fund, should ask, ‘Are the objectives of the fund in line with my own investment goals?’, Argent cautioned.
The VT Gravis Clean Energy Income manager also urged investors to consider the potential political risk. Even though the sector is increasingly self-sustaining, government support remains key.
“In the UK, a lot of companies in this sector benefit from subsidies that were in place at the time the assets they own were commissioned,” he explained. “So, political risk is something to be aware of.
“While we believe no UK government will take actions to disincentivise in the green agenda, one can never say never'” said Argent (pictured).
Consumption of renewable energy has skyrocketed in recent years, as the chart below shows.
This has led to greater awareness of the field, even though many investors interested in renewable energy tend to have a greater interest in environmental, social & governance (ESG) issues.
Source: BP Statistical Review of World Energy
Nevertheless, Argent said the fund is not specifically an ESG strategy.
Gravis, whose logo is a tortoise, runs investment strategies that are “slow and steady, alongside low volatility,” the fund manager said, adding: “We don’t really run high-growth strategies here, rather we’re looking for capital preservation.”
His selection process is a mix of quantitative and qualitative analysis. Given the focus of the portfolio, the universe shrinks down quite quickly, he said.
“We’re screening out energy companies that are exposed to fossil fuels, coal and nuclear,” added Argent.
The fund would, however, invest in natural gas, which is a fossil fuel, as long as the company’s main focus was clean energy.
“For example, if a company has a portfolio of 10 per cent wind farms and 90 per cent natural gas, we won’t invest in it,” Argent said. “But switch that around to 90 per cent clean energy and 10 per cent natural gas, it would qualify.”
The fund manager justified the inclusion of natural gas because “it’s far cleaner than coal, and safer than nuclear, and is a transition fuel that is likely to be with us for a long time to come”.
He added: “Solar and wind are intermittent power generators that often need to be complemented, and gas allows to maintain the base load of power needed.”
The Gravis manager said that could change as battery storage continues to expand, “but for the time being we’re going to need natural gas’ ability to put on power very quickly.”
The fund holds a lot of close-ended companies to access the theme.
“We look at the net asset value [NAV], which acts as a strong reference point that you can use as a starting point to appraise value and compare companies operating in the same field,” he said.
As an income fund yield is also very important, although the ability of companies to add to their portfolios of assets and grow over time is also a consideration.
On the qualitative side, the investment team is agnostic across the different types of renewable technologies—hydroelectric, wind, or solar, for example.
“We focus more on the cashflow profile,” said Argent. “The internal rate of return that you can get from a company at the time; this is highly relevant in the case of the UK closed-ended companies.”
Argent said investors sometimes tend to focus too much on the fact that these companies trade at a premium to their net asset value.
However, the manager said he digs deeper and asks, ‘What is my implied return from the current share price?’ and ‘Is this conducive to me meeting the fund’s objectives?’.
The fund is a diversified portfolio of global companies involved in the operation, funding, construction, generation, and supply of clean energy. It has a low turnover and many of its holdings have been in the portfolio since its December 2017 launch.
Among the top holdings are US firm Pattern Energy Group, which owns a number of onshore wind assets; Canadian company TransAlta Renewables; and, UK investment company John Laing Environmental Assets.
Performance of fund versus sector since launch
Source: FE Analytics
Since launch, the VT Gravis Clean Energy Income fund has made a total return of 26.45 per cent against 12.56 per cent for the average IA Global peer. It has an ongoing charges figure (OCF) of 0.80 per cent and a trailing 12-month net yield of 3.73 per cent.