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Institutional investors turn to renewables in pursuit of stable, long-term returns

Alex Brierley

This first appeared in Clean Energy Pipeline.

The year opened with significant equity market volatility as spooked investors came to terms with the likely end of the equity market bull run. This volatility, combined with low interest rates and rising political uncertainty, has heightened investors’ appetite for diversifying strategies and cash-yielding assets that are long-term in nature.

Against this backdrop, real assets, which give investors exposure to structural trends rooted in long-term societal or demographic shifts, are particularly attractive. They can provide shelter from short-term market volatility.

One of the most prominent structural trends of our time is the race to a carbon free future. Renewable energy infrastructure is attracting investment from institutions seeking more stability from alternative assets, where the risks from short-term uncertainty are less prevalent.

Drivers into renewables

New research from Octopus of 100 global institutional investors – representing $6.8 trillion assets under management – reveals the desire among institutions to shelter from short-term market uncertainty and pursue less volatile, long-term returns. Two thirds (66%) of investors reveal diversification and low correlation to financial markets as the primary driver into renewable infrastructure. Almost half (48%) of investors surveyed identify stable cash flows as another key driver into the sector. 

The long-term nature of renewable assets is particularly attractive among pension funds, who have long-term liabilities that must be matched.

ESG is another priority among institutions allocating to the sector. Over the longer-term, ESG will become increasingly important as a driver with end investors, particularly millennials, holding institutions to account on their ESG credentials. Almost half (47%) of investors surveyed adopt ESG within portfolios as a result of end investor demand.

These drivers mean future demand for the asset class is strong. Our research reveals investors surveyed are set to almost double their portfolio allocations to renewable energy from 4.4% to 7.1% over the next five years. This represents an additional $210 billion of estimated inflows into the sector.

Challenges to overcome

However, whilst the long-term nature of renewable assets is a key driver into the sector – particularly amid current short-term uncertainty in other markets – it also raises some perceived challenges for institutions. These include energy price uncertainty, liquidity concerns and a skills shortage.

Among institutional investors surveyed, energy price risk is considered the greatest threat to renewable energy return expectations, with over half (56%) seeing this as the salient concern. Given the long-term nature of the investments, it is difficult to predict where energy prices will be in 10, 15, 20 years’ time.

Government subsidies intended to drive investment in the sector have, to an extent, mitigated concerns around energy price risk. However, as the government looks to remove these subsidies, investors will need to assess energy price uncertainty more closely.

Any investor can run any number of sensitivities to understand the return impact of electricity price movements. But understanding the risk itself, and how to mitigate that risk, is far harder and requires specialist knowledge. 

Specialist renewable energy managers are finding better ways to hedge the exposure to electricity price movements. They are educating investors on the underlying risk exposures and helping them build diversified portfolios of renewable energy assets that each react differently to factors that determine power prices – thereby increasing the stability and predictability of the assets.

Lastly, liquidity concerns (41%) and a lack of skills within organisations (35%) were both cited as barriers by respondents. These concerns can be addressed by experienced teams who focus on the commercial, technical, legal and health and safety aspects of owning large portfolios. This can help ensure the assets are best placed to suit investor requirements over the long-term.

For those seeking cash-yielding, inflation-hedged real assets in sectors uncorrelated to financial markets, renewables have a crucial role to play in portfolios. The sector is benefiting from an increased understanding of ways to mitigate perceived risks around energy prices. Furthermore, current uncertainty in traditional markets like equities and bonds, is driving institutions to diversify their allocations. Renewable energy assets offer an attractive long-term investment for those looking to lock in the most stable returns possible beyond the short-term.

For journalists in their professional capacity only. The value of an investment, and any income from it, can fall as well as rise. Investors may not get back the full amount they invest. Personal opinions may change and should not be seen as advice or a recommendation. We do not offer investment or tax advice. We recommend investors seek professional advice before deciding to invest. Issued by Octopus Investments Limited, which is authorised and regulated by the Financial Conduct Authority. Registered office: 33 Holborn, London, EC1N 2HT. Registered in England and Wales No. 03942880. Issued: February 2019.