4th Quarter Thoughts...on London and the Three Curves that Matter

Leaving behind a busier September than any I can remember, for me, it feels like a Rubicon has been crossed in some hugely important areas. And so I thought I’d share a few personal reflections on related social and investment developments and things that have caught my eye. In doing so I refer to some great people and teams whose efforts in pushing at the envelope’s boundaries continue to improve the world. That said, a quick but necessary disclaimer: only those mentioned below that I work with closely can I ordinarily endorse without equivocation. Even on those, but especially on the rest, you’ll still need to make up your own mind. All other thoughts are my own.

London is vibrant again, at least for now. My latest visit in the quarter’s final week was an emotional roller-coaster full of impact and inspiration. Returning swells of commuters are bookends to the quiet periods in between lunchtime and rush hours (the town remains largely absent tourists). Together with the petrol pump queues, these herald fast-brewing demand and supply mismatches across the economy. They mimic, and to some extent reflect, the rising forward humps appearing in what are for me the 3 most important curves in investing and life:

1. forward energy prices
2. inflation (and bond yields)
3. mortality.

The key questions today for pension funds and insurers is: “Do the short-medium term (drivers behind) increases in energy prices and inflation (supply and demand imbalances) and mortality (Covid-19) warrant a permanent re-rating?” Whilst all three curves may be more or less volatile in themselves, it’s always important to understand the volatility of their components to get a handle on whether any short term rise or fall is likely to persist. I always ask and try to examine, “What is going on ‘in the underneath’?” and will return to these critical curves (in a post later this week) as they really do matter...for investors, advisers and of course for everyone in society!

Meanwhile in our own corner of the investing world, in renewable energy investing, higher anticipated energy price rises over the next 2-3 years are already impacting current asset valuations (perhaps expect some potentially material uplifts in September/December quarter-ends NAV valuations for listed renewable Investment Trusts for example, or at least for those with some variable forward revenues in their mix). But in thinking about any longer term persistence I’d venture that it’s the general supply cycle for renewable energy projects versus that for the capital seeking those assets that has a bigger impact on longer term pricing and forward yields.

More precisely, it’s the timing (the mean duration) mismatch between project supply, driven by land acquisition, planning and development timelines (a 2-5 years process perhaps) and capital deployment decision-making (say 0-2 years) that’s more responsible for persistent forward yield compression. Put more simply, it takes much more time to bring on-stream generation, transmission, distribution, storage and grid-efficiency assets from start to the operational stage than it takes for even “slow-moving” institutions to decide on what and where they want to deploy and the means of implementation. Hence in many developed OECD markets where renewable investing is now institutionally established, including the UK and main European markets, there is patently more capital (demand) than operational stage renewable energy (supply) for example, driving downward pressure on yields for these assets.

Of course, avoiding yield compression traps is critical for larger institutions seeking scale and/or speed deployment. In our view at @Renewity, this risk is diversifiable. Investors that limit their options for such challenging execution to the origination network of a single manager risk falling into such a trap. I confess I omitted this point from my recent article in September’s The Actuary, “Covering all bases: a multi-manager approach to investing”, though was nevertheless proud (as was my mum!) to have my first article in this esteemed publication, so thanks to all who helped us with this: @Sophie Mayall, @Helena Jones and @The Actuary team.

Another aspect demanding more attention in renewables allocations is the changing ie increasing exposure to energy market pricing in the forward cash flows of assets. Long term government subsidies are being withdrawn, capped, rolled-off or eliminated (a trend that might accelerate post #Covid as debt burdens and lower medium-term growth put public sector balance sheets under pressure). Replacing them to a good extent are invariably corporate “off-take” power purchasing agreements (PPAs), though these are typically with shorter durations than the government price regimes that preceded them. The resulting triple whammy, with implications for return volatility / risk, asset pricing and forward yield expectations for developing assets, combines the following for investors:

1. More long-term exposure to energy market pricing (typically at 7-10 years duration or further out) in investors’ portfolios
2. Energy market pricing is more volatile and greatly unknown in advance, with outcomes generally differing markedly from the best consultants' anticipated forward curves (notwithstanding that tools like contracts-for-differences and other OTC hedges can help take out some of this price volatility)
3. Investors' remaining PPA exposure is to corporate rather than government credit; this is usually (but not always) a weakening of the credit-worthiness of the counterparty underpinning investors’ returns.

This increasing return volatility / risk exposure is again diversifiable, most effectively through a maximum diversification strategy implemented via a multi-manager approach. Investors now need to understand and optimise this factor, amongst many, to achieve the best risk/return outcomes, to raise exposures and so aid society’s chances of reaching a #net-zero world.

In renewables, technology (as well as regulation) is always changing, along with investor attitudes. And my latest week in London reinforced that both are in permanent flux. This article, Does Orca machine hold key to ambitious net-zero targets? from the excellent @Gary Smith of @Haven Green takes some of the noise out of the perhaps understandable initial excitement around the Orca launch. Gary has also written well about the strategic importance of renewables for many #SWFs and the related geopolitical dynamics for major oil-producing sovereigns in “Oil-producing nations need to act.” So I was delighted and inspired last week to get some thoughtful input on the subject from @Hamita Taib at @BIA. Thanks to both and indeed thanks to all at @Haven Green for the continuing creative and thoughtful investor and market input. @Richard Hurley, @Damien Varley, @ Robbie Ekblom, @Liam Price, @Celia Larkin, @Peter Lindqvist

Also grabbing my attention last week was the announcement of Quinbrook’s Fortress deal. Expected to be the largest single site #solar PV installation in the UK, the solar-with-storage combo is fast-becoming a useful return-enhancing staple in a bunch of markets. Whilst this project shows what can be achieved at scale, I’m at least as interested to see in time more distributed, smaller applications of this combination coming on-stream, en masse. Both approaches, scale and distributed, have significant implications for the future shape and nature of grid networks of course.

We all deserve to expect more progress in renewables from technology, land planning regimes, grid restructuring….and from politicians. In the UK, whilst the government’s previously announced?Advanced Nuclear Fund of up to ￡385m (including up to ￡215m for the next generation of smaller/domestic nuclear technology design) was a welcome boost, larger more “traditional” nuclear plants are also clearly still under consideration. How the balance between the two approaches develops over time will likely have major implications for whether, how and most importantly when we’ll reach #net-zero. Security and grid fragmentation (again) will in both instances be critical issues.

Finally to note that along with everyone else, we also see an increasing volume of hydrogen deals in our directs book and note the launch of several new hydrogen strategies and teams recently.

What else is shifting in the ground beneath our feet? Well with all that’s going on in the sector it’s no surprise to see renewable asset managers themselves changing, adapting fast, as they seek to explore further beyond their home or core markets to avoid yield compression, acquire more scale and deliver more product to meet investors’ demands. Perhaps most notable this week was Al Gore’s Generation Investment Management’s investment in Octopus Energy. We see a growing landscape of interesting M&A opportunities amongst management teams and asset managers seeking stable long-term platform/ownership and investment. A bevy of near-term deal opportunities heralds what we expect will be an active sector in the next few years.

On the busy conference circuit, the Reuters Impact / Finance conference (#RFI2021) was stimulating. A quick congrats to @Renewity's own @Wendy Mayall, as well as @Rafael Mateo (ACCIONA Energia), @Christoph Brand (Axpo Group) @Megan Lorenzen (Salesforce) and with excellent moderation from @Tove Feld (TRIG) in delivering the Keynote Panel: The Future of Sustainable Power Financing.

Thanks also to the @UCEA team and especially @Joao Teixeira and @Ed Catchpole for a lovely lunch at Brown's where, as a long-term blepharitis sufferer, I was intrigued to hear from @Nicox on the nitric oxide (NO) potential for relieving blood pressure in the optical nerve. My thoughts extended also to possibilities for NO treatments in the context of the current pandemic; there’s a key need for more effective NO delivery in helping relieve excessive oxidisation in the blood (part of the body’s inflammatory reaction to #Covid-19). I’m also keen to see what the Nicox team can achieve with their (currently Phase 3 trialling) treatment for glaucoma and the potential for helping millions of sufferers, particularly in the developing world. @Michele Garufi

I also enjoyed meeting the lively @IANUA team for the first time; building a creative and high-quality approach to deal origination and distribution.

However, even with lots going on as above, the real highlight of my week was undoubtedly the face-to-face meeting for the first time in 18 months of the bulk of the @Renewity team.

Having grown to now 19 talented people, wholly “under cover of Covid”, this was our first group physical meet. It really was a true inspiration to get everyone together; Zoom is good, but like most, we agree that in-person is so much better. I hope we can do that again soon-ish. Growing rapidly, remotely, is something of which we can be quite proud; my respect goes out to all those businesses, entrepreneurs and teams that have struggled through and/or been newly formed under these difficult circumstances.

On our side we are delighted to welcome @Mark Barry, @Lucy Nicholls, @Paul Waters and @Kalyani Impanudi to the Renewity fold; we all look forward to working hard for our clients and partners. The 4th quarter will also see us roll out our 2nd annual RFP for managers, so the research team and interns @Brefo Gyasi, @Arinze Onyenezi and @Ten Esan will all be busy. Great also to see @Kevin Selleslags from our strategic partner @Energex Partners at our small event.

The same thanks and delight goes out to all those friends, colleagues and investors who took time out to chat face-to-face last week. I’m reminded once again that it’s the intangibles of these personal relationships that matter more than most things that can be counted!

So we move on to October, which is Black History Month in the UK. (BTW if you’re a CEO or business leader you MUST read this – "It’s important to show up" - from the ever excellent @Dawid Konotey-Ahulu). From my own personal perspective, and as the single white minority in my immediate family, this is when I learn even more than usual about my extended family, with enthusiasm, curiosity and respect.

Yes, in society, as in investment, some things deep and fundamental (ie not just work-life balance/arrangements) definitely feel like they've changed, are still changing. We are clearly entering dangerous territory and volatile times, possibly like never before, in this “new normal”. The forces seeking to shape society seem partly to be well-intentioned (and we know where that path can lead), with some patently designed to subvert society’s stabilising aspects and institutions for "honest" gain, whilst a bunch appear to be just plain malicious with fully disruptive objectives at best. All are highly threatening to hard-won individual rights and freedoms we have grown to treasure. We therefore all need to stay vigilant, maintain awareness, continue to act thoughtfully and tread very carefully in matters of personal physical and financial health, as well as in broader institutional investment and societal decision-making.