Fund Finance Insights

Future focus: Infrastructure and renewables, Part 1

5 minute read time

Committing funds for infrastructure renewal has been a popular policy on both sides of the Atlantic – which means opportunities for investors. So how concrete is the case for infrastructure assets?

  • In Europe, funds with an ESG focus are forecast to outnumber ‘conventional’ funds as soon as 2025.
  • Price-to-earnings ratios are racing ahead, with some commentators fearing a bubble in clean energy stocks and funds.
  • The UK leads the world in offshore wind power, and the government’s aim to quadruple capacity by 2030 is expected to boost investment opportunities.

1. Renewables are mainstream

This won’t be news to most investors. Indeed, shareholders in companies traditionally associated with fossil fuels have been increasing the pressure on management teams to buy or build renewable infrastructure assets for some time.

In the investment space, that’s clearly led to a flowering of specialist funds. In the general ESG (environmental, social and governance) space, PwC is predicting that funds with this focus in Europe will outnumber ‘conventional’ funds in assets under management as soon as 2025. Even their base case puts ESG aggregate fund values at €5.5tn by then, and their growth even during the pandemic gives weight to this forecast.

Renewables infrastructure is slightly different. ‘ESG’ funds often seem to contain a lot of assets that have happily passed a greenwash test; but funds dedicated to significant physical assets designed to have a real impact on efforts to reach net zero are, by definition, deep green.

And they’ve done brilliantly, particularly over the past couple of years, as governments around the world have recommitted to Paris Agreement targets and the effects of climate change have become more visible to businesses and consumers alike. Indeed, some fear a bubble in clean energy stocks and funds, with price-to-earnings ratios racing ahead (though most assets are in something of bubble at the time of writing). A glance at the relative performance of the S&P 500 and S&P’s Global Clean Energy Index over the past four years hammers home the point.

Research firm Hardman & Co issued an analysis of renewable energy infrastructure funds (REIFs) two years ago, and concluded: “REIFs’ earnings are high quality and their dividend payment profiles are both attractive and, in most cases, secure.”

2. Pent-up activity post Covid

“In terms of investment, Covid-19 did slow things down, but there was a pretty big rebound in the second half of 2020,” says Angela Marchant, Senior Director in Institutional banking at RBS International.

“True, the challenge for first-time managers looking to raise investor capital is considerable. Investors are still a little risk-averse, so there’s a preference for established funds, and proven technologies and business models. We would expect to see that risk appetite grow as the market normalises.

“We’re starting to see more funds with even more stringent approaches to ESG criteria and sustainability. And the number of banks looking to lend to renewables infrastructure projects has grown”

Angela Marchant, Senior Director, RBS International

Jonathan Dames is a Partner at law firm CMS specialising in infrastructure deals. Although he says his perspective is by definition more backward-looking, his experience confirms that analysis. “The lag between deal announcements and getting into the weeds of the paperwork has lengthened,” he says. “That looks like it might be changing as we emerge from the pandemic.”

A big driver of fresh investment is likely to be that unstoppable appetite for ESG. “We’re starting to see more funds raising with even more stringent approaches to ESG criteria and sustainability,” says Marchant. “And the number of banks looking to lend to renewables infrastructure projects has grown. We started supporting this sector in 2013, and it was only a handful of banks then. We’ve been a constant, but now we’ve been joined by many more banks in this fund finance space.”

3. Follow the wind

Offshore wind power is a UK success story – the country leads the world in current capacity, and the prime minister has called for a four-fold increase in wind generating capacity by 2030 to provide all domestic electricity needs.

Onshore wind projects face fewer technical challenges, but bigger regulatory hurdles, meaning investments might be slower off the mark than the pre-set plots available for offshore project bidders. New subsidies announced for onshore last year should help. And with the scale of the hardware coming off the production line, there are plenty of meaty investment opportunities in big wind.

Three companies dominate the turbine market: Vestas, Siemens Gamesa and GE – whose 14MW Haliade-X structure is the most powerful currently on sale. Denmark’s Vestas has a 15MW prototype aiming for mass production in 2024. The V236 has blades 115.5 metres long – sweeping an area of 43,000 square metres – and a turbine capable of 80 gigawatt hours (GWh) per year, enough to power 20,000 homes.

In short, these are massive and expensive machines demanding heavy upfront capital commitments. Good news for those looking to deploy cash.

4. Public funding will only go so far

“Build back better” may be the clarion call from US and UK politicians. But, while there’s talk of big support for infrastructure, there are caveats. In the UK, for example, the Levelling Up Fund (£4.8bn), the Towns Fund (£3.6bn) and the UK Shared Prosperity Fund (which replaces EU infrastructure grants of about £1.5bn) are all focused on smaller, local projects.

The UK Infrastructure Bank could be more interesting to watch. It’s offering financing for local authority and private infrastructure projects aimed at tackling climate change and boosting regional economic growth. With an initial £12bn of capital and £10bn of government guarantees, it is expected to “unlock more than £40bn of financing for key projects across the UK”.

Dames points out that the government appetite for putting private money into big public infrastructure remains muted (especially around old-school PFI-type projects such as hospitals and roads). But at the same time, the exchequer is heavily in the red post pandemic, and structural shifts such as blanket 5G coverage, rural fibre broadband and EV charging (especially in cities) are going to require investment from somewhere.

Combine that growing interest in ESG with new technologies and a need to balance government aspirations to meet net-zero targets with stretched public treasuries, and there is a clear opportunity for fund deployment.

In part 2, we’ll look at how funds have been approaching this opportunity – and how they might prioritise infrastructure investments post Covid.

By Richard Young