The best renewable energy funds to buy now

The outcome of Russia’s invasion of Ukraine is uncertain but one consequence is not in doubt: the drive to reduce usage of hydrocarbons will be accelerated. The need to reduce dependence on Russian, as well as Middle Eastern, oil and gas will only add to the economic incentive resulting from higher hydrocarbon prices.  

Yet investors seem oblivious to the competitive advantage offered by renewable energy. Share prices in the renewable infrastructure sector have been flat in the last three months, even as net asset values (NAV – the value of the underlying portfolio) have risen. 

Reaching for the sun with solar-energy funds

As a result, the solar energy-focused funds – Bluefield Solar Income (LSE: BSIF), NextEnergy Solar (LSE: NESF) and Foresight Solar (LSE: FSFL) – are trading on discounts to NAV. Greencoat UK Wind (LSE: UKW) trades on a 12% premium; and the more broadly-spread funds trade somewhere in between. The solar funds yield over 6%, UKW yields nearly 5%, and the other established funds around 5%. 

This looks excellent value but as Iain Scouller of broker Stifel reminds investors, higher bond yields would imply higher rates at which future cashflows are discounted and therefore lower asset values. However, he thinks the sector could cope with the ten-year gilt yield rising from its current 1.5% to the 2.5% level for a sustained period before there was any material impact on NAV valuations. Stronger cashflow due to higher energy prices would also increase NAVs and dividends.

Dividends can be expected to rise at least in line with inflation, so yields should be compared with index-linked rather than conventional bond yields. For most investors this – the income yield – is far more important than NAV, which is why share prices have usually traded at premiums. There is always a risk of the government clamping down on energy prices and the subsidies behind them, but this would be incompatible with decarbonisation and reducing dependence on fossil fuels. 

The rise in corporation tax from 19% to 25% as of April 2023 also negatively affects the sector, and is now reflected in NAVs. But this did not prevent funds reporting good progress in the last quarter of 2021. Scouller is positive on Foresight, which yields 6.8%, but investors might be sceptical of a fund with nearly 70% of its installed capacity in the UK, where actual electricity generation is only around 10% of capacity. 

The UK’s climate favours wind-powered generation with higher capacity usage due to it also working at night. Offshore installation and maintenance costs are higher than onshore, but its competitiveness has improved greatly in recent years and it now produces electricity more cheaply. Chris Brown of JPMorgan Cazenove favours UKW, as its “steady-state shareholder return of 6.3% is the highest of its peers” due to a relatively high discount rate (which lowers the NAV), its high exposure to short-term power prices and its straightforward capital structure.

An attractive new renewable energy investment trust

Among the newer funds, the Ecofin US Renewables Infrastructure Trust (LSE: RNEW) looks attractive. It is now fully invested. Its shares trade at a small premium to NAV and it offers a yield of 3.7%, which is due to rise above 5%. With net assets of $125m (its shares are priced in dollars), the trust is small but further share issuance will reduce the expense ratio. 

The renewables industry is much less mature in the US than in Europe, accounting for just 9% of the cash generation of the top ten utilities compared to 30% in Europe. But the pipeline of new deals exceeds $2.6bn and the manager’s target of investor returns of 7%-7.5% remains in place.

As these examples show, the funds that look the cheapest are not necessarily so, but the sector as a whole offers reliable inflation-proof returns for the yield-hungry and risk-averse.