Andrew Williams discusses the case for environmental investing and how this can benefit pension funds’ portfolios

In recent years, an increasing amount of pension funds have become involved in environmental investing - in several areas, including wind energy, solar power and water resources - and are beginning to discover they may not just be ‘good’ from an SRI perspective, but also for the benefits they can provide in terms of returns.

Specialist management
Pension funds can access environmental investing in many ways - with the most appropriate strategy likely to depend on a number of factors. According to UK Sustainable Investment and Finance Association (UKSIF) chief executive Simon Howard, the best route for any particular pension fund will depend on its size. In his view, large schemes should consider finding a specialist manager and investing in a portfolio of direct investments.

“Such a scheme’s size means it should have the governance resources to manage a new manager in an emerging asset class, and it should have sufficient insight into the scheme cashflows to be able to manage the relatively long building process and the even longer life and exit process,” he says.

“These assets are not readily realisable. Smaller schemes should not take the direct approach. They should try to find a suitable pooled fund and access the diversification and liquidity benefits available through that route,” he adds.

Historically, a lot of pension fund money has been invested on a private basis, with the fund acting as a ‘limited partner’ via an investment management team. As Greencoat Investing principal Connie Lee explains, such funds tend to use leverage to boost their returns into double digits, are committed for a period of 5-10 years, and could be invested in a wide range of assets under the environmental banner.

“Investment in these funds has usually come from the alternatives allocation,” says Lee.

“At Greencoat Capital, the publicly listed wind infrastructure fund that we manage is slightly different in that it doesn’t use leverage in the same way and is designed to produce a steady 6 per cent dividend that will increase in line with RPI inflation and protect capital on a real basis,” she adds.

The fund, known as Greencoat UK Wind, was the first renewable energy listed infrastructure fund of its kind, with a business model that mirrors other listed infrastructure funds, such as HICL, that Lee points out have “proven their structures over the last several years”.

In addition to wind energy, pension funds also have the opportunity to invest across other renewable energy sectors, as well as energy efficiency, water and agriculture projects, through both private and public market vehicles.

Another company with substantial experience in the area is Kleinwort Benson Investors (KBI), which has built up expertise in publicly-traded equities. As KBI head of strategy development sustainable investments Steve Falci points out, this involves investing in companies providing “scale-solutions to society’s biggest resource and environmental challenges” across water, energy and food.

“We believe specialist active management is best placed to understand the companies providing the solutions, as well as the drivers and end-markets for solutions. One example is infrastructure, [which] will be essential to meeting needs for water, food and energy,” he says.

Doing something positive
For Howard, one “obvious” advantage of environmental investing is that the scheme, sponsor and beneficiaries are doing “something positive” to mitigate global warming, something that he believes is important in terms of reflecting sponsor and member attitudes, as well as their recognition of the “stewardship responsibilities” of asset owners.

“We also think UK pension fund trustees probably have a fiduciary duty to consider systemic and long-term threats to their portfolios from factors such as climate change and this should move them to consider assets of this type,” he says.

“In more narrow terms, schemes that invest in this way will be positioned to benefit from growing demand for alternative energy, and, if the scheme funds investment by reducing assets in ‘conventional’ energy, the scheme will have reduced its exposure to falling asset values if and when societal pressures result in carbon taxes or carbon use limits that really bite,” he adds.

Meanwhile, Lee highlights the fact that renewable energy projects have “long asset lives”, with a newly-built wind farm having a typical project life of around 25 years, a “similar time span to the liabilities that pension funds are looking to cover”.

“The returns are inflation-linked, and the underlying projects are highly cash-generative, enabling fund managers to offer a stable dividend yield. There is low correlation with GDP and the broader stock market, and it is an ideal investment for portfolio managers looking to diversify their portfolios in a stable investment class. There is also potential upside as power prices are projected to rise over time,” she says.

Falci agrees that pension funds are by definition long-term investors, and he believes that investing in companies meeting the needs for water, food and low-carbon energy provides pension funds with access to “long-term growth themes that will drive returns for decades”.

“Investing in environmental equities can provide a new and diversifying source of alpha to pension funds, as there will be little overlap with existing holdings and the correlation of excess returns above the market is generally very low with other areas they have looked for growth,” he says.

However, Lee also stresses that, in order to fully realise such benefits, funds should be aware that environmental investment presents its own set of management challenges, calling for “specialised expertise, operational strength and understanding of the local market and support regimes for renewable technologies”.

Returns
From a practical, financial perspective, Lee explains that environmental investing can be ‘very beneficial’ in terms of financial returns, especially in markets like the UK, where the Renewables Obligation Certificate (ROC) regime is well established, offering inflation-linked returns with power-price upside.

“A successful example of this is UKW, which successfully completed an oversubscribed IPO earlier this year. The assets have performed in line with management expectations since listing, further acquisitions of wind projects have been made and the fund is currently in the market for a £135 million follow-on equity raising,” she adds.

Meanwhile, Falci points out that environmental investing provides the opportunity to access “strong long-term returns by investing in companies providing solutions to our biggest sustainability challenges”. As such, he says it is a very distinctive example of the ability to generate returns while also having a “positive impact on our global society”.

“The KBI Water strategy has delivered nearly 5 per cent per annum above the MSCI World since inception, while outperforming it in 10 of 12 calendar years.”

Looking ahead, Howard thinks it’s too early to predict which technology will show the best returns in the long-run, and he points out that other technologies “will probably emerge”, with energy storage linked to renewables being an “obvious case” that would attract “enormous demand”.

“A lot of money needs to be invested in transmission and distribution systems too and they should show predictable, bond-like returns as well. Schemes should probably focus on getting exposure to a wide range of end-technologies and techniques, another reason for looking for a specialist manager,” he says.

Andrew Williams is a freelance journalist

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