SMALL CAP IDEA: Falling interest rates boost renewable infrastructure
Last month, the Bank of England provided much-needed relief to borrowers by cutting the base rate for the first time since March 2020, cutting it from 5.25 percent, a 16-year high, to 5 percent.
With the latest inflation figures coming in lower than expected, the chances of a second cut in September are diminishing.
For retail investors, this could mean a new boost for the stock market, as lower interest rates make bonds and savings accounts somewhat less attractive. But while a rising tide lifts all boats, some stocks will sail more smoothly than others.
Investors can gain exposure to renewable infrastructure such as solar farms through London-listed investment funds
One sector that could particularly benefit from changing interest rates is renewable infrastructure investment funds.
Historically, these trusts rise as interest rates fall.
According to research commissioned by Foresight Group, which Forward-looking Solar Fund (FSFL) this trend has been going on for at least ten years.
“This inverse relationship appears to hold for all listed renewables, but there is a particularly strong correlation with the investment funds,” said Ross Driver of Foresight Solar.
For those keeping an eye on the green revolution, this is promising news. In fact, it is one of many positive things that could rekindle interest in the sector.
The Labour government, backed by a strong majority in parliament, appears intent on supporting the renewable energy sector and investors are breathing a sigh of relief at the prospect of political stability.
The government’s revised budget for this year’s Contracts for Difference (CfD) auction and proposed changes to the planning regime indicate the wind is finally blowing in the right direction.
The optimism is reinforced by rising electricity price forecasts, which offer opportunities for higher revenues and improved cash flows for renewable energy projects.
After the tumultuous period following the Russian invasion of Ukraine, European countries have redoubled their efforts to achieve energy independence. This has led to more favourable prospects for long-term planning in the renewable sector.
This renewed optimism is a welcome change after a challenging period of macroeconomic headwinds.
The high inflation that emerged after the pandemic caused central banks around the world, including the Bank of England, to raise interest rates.
The BoE in particular has raised its base rate 14 times since December 2021. These aggressive cuts, the most intense in 40 years, have dented investor appetite for renewable investment funds, effectively closing equity markets to new issuance and stifling the growth of these funds.
“The transition to a low-carbon economy is one of the greatest investment opportunities of our generation. The window of opportunity is opening again,” says Foresight’s Driver.
“I don’t think it’s going to be plain sailing from here. There will probably be some bumps in the road, but overall the direction is looking more positive now.”
Against this backdrop, renewable infrastructure investment funds appear attractive based on the current discounts at which their shares trade relative to the companies’ net asset value (NAV).
This discount can be as much as 40 percent. As capital returns to equity markets, you would expect this gap to narrow, with share prices benefiting from a rise. However, as Driver points out, it is unlikely to be a straight line of progress.
For those seeking both income and growth, the Foresight Solar Fund is worth a closer look. At current prices, it offers a forecast dividend yield of 8.5 percent.
NextEnergy Solar Fund is another notable fund, with a hefty expected return of 10 percent, making it one of the biggest payers in the FTSE 350.
In addition, NextEnergy recently received the green light to launch a £20m share buyback programme, further increasing its appeal.
But the list doesn’t stop there. Bluefield Solar, UK Wind, The Renewables Infrastructure Group (TRIG) and John Laing Environmental Assets (JLEN) are also worth considering.
When screening for my ISA, all six trusts scored well on important criteria: they are asset-backed, provide income and have growth potential.
Of course, it’s important to remember that none of these investments offer a guarantee of success.
Although the downturn does not seem particularly significant at current levels, renewable energy investment funds are not without risk.
But thanks to the combination of political support, improving market conditions and attractive valuations, they could offer an interesting opportunity for those looking to invest in the green energy transition.
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