As investing in renewable energy infrastructure has grown in popularity in recent years, so too the number and types of strategy on offer have proliferated, according to a report published yesterday (March 17) by consultancy Bfinance.

At least 65 managers are raising capital for funds dedicated to the sector now, compared to 50 in 2019, by Bfinance data. And 55% of respondents to the Infrastructure Investor 2021 LP Perspectives Survey in February said they planned to invest more into renewables following the Covid-driven disruption. The swift rise in interest in environmental, social and governance (ESG) strategies is also a factor.

As a result, asset owners need to get up to speed quickly with an area of investment that is brand-new to many of them, and where managers, or general partners (GPs), often lack a substantial track record.

For one thing, few global renewables managers have portfolios that are as internationally diversified as they claim, Bfinance said (see first graph below). That should not be hugely surprising, however, “given the importance of local expertise and partnerships with regional developers in this asset class, especially in today’s more competitive environment”.

Geographic diversification of 'global' renewables
managers assessed for an Asian pension fund
(Click for full view)

Another key point to be borne in mind, the report said, is that this sector should no longer be approached as a fixed income proxy. “The line-up of investment strategies continues to evolve with a shift towards less well-established technologies and approaches as managers seek new ways of delivering outsized returns.“

STYLE DRIFT?

For example, more renewables fund managers are now prepared to enter projects during the development phase rather than after completion, said Bfinance. “Indeed, entering early and divesting upon commencement of operations now represents the most well-recognised route to double-digit returns in developed markets.”

Moreover, some GPs are expanding the geographical remit, such as adding central and eastern Europe or developed Asia, added the report. And many are incorporating newer technologies, such as offshore wind, rather than focusing purely on the more conventional sectors of onshore wind, solar and hydro (see graph below).

Style drift in renewable energy funds
(Source: Bfinance; Click for full view)

These trends can represent a challenge for investors looking to select a fund in that they manifest as style drift for the relevant managers, the report said. While there is a case to be made that infrastructure investors should remain nimble as societal needs and new technologies evolve, Bfinance added, a changing profile can make it harder to judge the team’s capabilities, with track records becoming less representative and relevant.

GETTING TECHNICAL

Such factors make it all the more important that asset owners understand some of the technical aspects of the asset class and how GPs run these portfolios, especially as the market environment has also changed.

For instance, one trend associated with the growing readiness of managers to take on development activities is what Bfinance describes as the internalisation of certain activities. While many managers have long had operations and maintenance teams, bringing development and construction management in-house is a newer trend, added the report.

“Fee structures for construction and development often entail significant milestone payments: if these payments are being made to an in-house entity rather than an external entity, investors must ensure robust benchmarking; conflicts of interest must be managed effectively.”

Furthermore, with construction costs falling and subsidies being scaled back or eliminated, the profitability of conventional renewable technologies is becoming more dependent on merchant power prices. It is increasingly important to understand economics and asset underwriting.