There are plenty of factors which have contributed to the mediocre performance of UK equities over the last few years, both unavoidable and self-inflicted. However, the rationale behind the ongoing sell-off across the renewable energy infrastructure sector, as well as its scale, is one which we struggle to understand. Prior to the pandemic, most if not all funds were trading on premiums – some in excess of 20% – and while some of these may have been overdone, the median discount for the sector is now 28.5%, which looks every bit as excessive.

Certainly, during the worst of 2023’s inflation episode and the rapid tightening of monetary policy, there was a clear case for the sector to de-rate. Higher risk-free rates dampened the appeal of renewable energy assets that had traditionally boasted significant yield premiums, while falling spreads were compounded further by the rise in financing costs. The market started to fret about the ability of some of these companies to service their high debt burdens, driving some discounts to over 50%. While one could argue that the selling went beyond the fundamental impact of higher rates, the use of leverage to juice returns on illiquid assets is inherently riskier in a higher interest rate environment and it was inevitable that this would dampen demand for these strategies.

However, this is the exception, not the rule of a traditionally defensive sector which has a proven track record of generating stable, highly visible returns thanks to a range of long-term contracts, price fixing strategies, and energy subsidies. Historically, these characteristics have driven significant outperformance over the market during periods of high inflation and falling growth, as was the case in the UK over the second half of 2023 and remains a concern through 2024.

Take the Bluefield Solar Income Fund (BSIF), for example. Over its 2023 financial year, the company’s operational performance was as good as it has ever been in the 10-plus years the fund has been operating. Thanks to the success of its power price hedging strategy and inflation linked contracts, the company was a net beneficiary of rising prices. Total funds available for distribution reached an all-time high, driving the dividend towards 9%, which was covered by more than 2x by the company’s earnings

It’s a similar story for Foresight Environmental Infrastructure Group (FGEN, and formerly JLEN Environmental Assets Group). The company has capitalised on price fixes and inflation linkages to drive record cash flows, underpinning its dividend while also funding share buybacks and allowing it to build out its attractive pipeline. Both BSIF and FGEN have maintained prudent, long term debt structures, meaning rising rates have had a very limited impact on debt servicing costs, and while increases in the discount rate have had a negative impact, these have been more than offset by the company’s inflation linked contracts.

Unfortunately, stubborn and irrational discounts have meant BSIF and FGEN have been starved of the capital needed to optimise their growth. Despite this, the two have been able to deliver NAV total returns of 10% and 12% respectively over the last three years, even as their share prices have continued to fall.

Other strong performers such as Downing Renewables and Infrastructure (DORE) and Greencoat UK Wind (UKW) have suffered from a similar fate, leaving managers across the sector searching for ways to raise capital to continue their momentum. An excellent example of this has been BSIFs recently announced partnership with GLIL Infrastructure, which has allowed the company to make strong progress on its capital allocation objectives and continue to develop its pipeline to drive future growth.

It remains frustrating, however, that such measures are necessary given the fundamental execution of these funds in recent years and their track record of performance over a long period of time.

It was hoped that a change in interest rates would act as a catalyst for a re-rating of the sector, however so far, the reaction has been modest. Costs disclosure reforms are also expected to take time to have an effect. Positively, the ongoing execution of these trusts and the weight of earnings will eventually flow through to share prices, and we expect that the impact of falling interest rates (which came down another 25 basis points this week) will be recognised sooner rather than later.  The long-term structural changes we are seeing to the UK power market, will provide further support for earnings, and as BSIF manager James Armstrong noted, the regulatory outlook for renewables in the UK is as good as he has ever seen following the Labour government’s announcements around the expansion of renewable energy.

There’s no doubt that the last few years have been a frustrating time, however investors should remain confident that negative sentiment surrounding the sector will not persist forever.

Renewables – don’t let the sun go down on me