This week I have a new addition for the income portfolios (see below). The brand new Gravis Clean Energy fund (it launches this week) invests in a wide range of funds and bonds that invest in renewable technologies, notably wind power and solar. Gravis isn’t just of interest to “green” investors – renewables is in effect a subset of the broader infrastructure theme, with which it shares many desirable features: government-supported cash flows, some inflation protection, and a relatively predictable flow of revenues based on operating assets.
Gravis already runs a range of popular infrastructure-themed investment trusts, and the advisory business behind this particular fund also runs the VT Gravis UK Infrastructure Income fund, which is just under two years old and has already grown to over £240m in assets. (We’ll take a look at this fund again next year, but you can probably guess why it has been such a hit with investors – it boasts an annual income yield of over 5.2%.)
The new Clean Energy fund is run on almost exactly the same principles as the infrastructure fund, although the target yield is a bit lower at 4.5% per year. It’s basically a fund of funds – it buys into existing investment trusts, plus a smattering of direct bond holdings (in this case, green bonds). Funds of funds aren’t usually especially cheap (you are layering fund of fund fees on top of the original direct investment), but the charges for this fund are capped at 0.8% a year, not unreasonable given the specialist knowledge required for investing in this niche.
The Clean Energy fund will invest in investment trusts already well known to UK investors, as well as the more exotic world of (primarily US-based) yieldcos, which I explain below. The launch portfolio will consist of around 31 securities, with US stocks comprising around 32% of the holdings, British assets around 30%, and Spain on around 11%. Wind-based assets will form the largest part of the portfolio at 39% of holdings, followed by solar assets at 33%, with a long tail of broader renewables-based businesses, including some involved in smart meters and battery technology.
It’s a diverse range of investments, but all are linked by a tight focus on income-producing cash flows, which means the fund managers are overwhelmingly investing in assets that are already operational rather than riskier development projects. In order to hit that 4.5% target yield, as well as cover the annual management charge, plus some capital growth, the funds’ managers are seeking underlying assets that probably produce returns closer to 6%-7% a year. Probably around a quarter of the assets also have strong inflation backing, which implies that dividends might even increase a tad if prices continue to rise over the next year or so.
There are risks. Firstly, governments might change their minds about the level of subsidies on offer – this has already happened in Spain, for example. Secondly, the seemingly stable cash flows are also affected by fluctuating wholesale energy prices.
Technological change, especially in solar, is helping to drive down renewable energy costs to not-far-off market levels. That’s great for solar operators with deep pockets, but it’s potentially bad news for fixed-cost legacy broad power generators (the utility stocks now at serious risk of being “disrupted”) who will start to lobby against unfair competition from renewables (as is already happening in California).
Overall, however, this is a solid-looking fund with a decent yield target, that could fit into either our balanced or our adventurous portfolio.
What are yieldcos?
Perhaps the most mundane risk of investing in Gravis’s Clean Energy fund is overpaying for its income-producing assets. That’s certainly the case in the US yieldco sector – and the Gravis fund’s biggest holding is a yieldco called 8Point3, which occupies 7% of the portfolio. This niche features renewable assets packaged into special-purpose vehicles, which are then listed on the US stockmarket. Investors like these vehicles because they provide them with a tax-free income through dividends – a bit like the master limited partnerships that are so popular with US private investors.
Yields hit as much as 7% per year, and at one stage there were lots of new initial public offerings driving up prices. But these new issues dried up as yieldco sponsors – usually big power firms or infrastructure investors looking to offload operational assets – started worrying about negative coverage by analysts of individual yieldcos. Too many were promising increasing dividend yields just as interest rates were starting to climb – and higher debt costs are likely to hit investors’ returns. But the market has stabilised and returns look good – many quality firms are offering returns of 5%-6.5% per year. UK investors can invest directly in yieldcos, but note the currency risk (you’re buying a US dollar asset with sterling) and you may be subject to US dividend withholding taxes.
The story so far…
A couple of months ago we first outlined plans to pull together two model portfolios, both with the goal of generating a robust, growing income. The first is a balanced or defensive portfolio, targeting a blended yield of around 4.5% a year. The second is a more adventurous sibling, targeting a slightly higher yield of 5.5%, which involves taking a little extra risk as a result. Last month, we highlighted our first idea – an investment trust called CQS New City High Yield (LSE: NCYF), which we thought could fit into either portfolio. Clearly, both portfolios are riskier than investing in UK gilts, for example, and bear in mind that these investments will go up and down in value – they are not a substitute for cash.