If you’re an LP that’s already investing in infrastructure, does it make sense to create a separate renewables allocation? The UK’s City of Westminster pension fund thinks it does.
In documents published in mid-May, the pension announced that it was planning to allocate 5 percent towards a new illiquid asset class, which it would like to be renewables. The main reasons cited were the considerable amount of investment needed to help the UK fulfil its pledge of achieving net-zero emissions by 2050; and the fact that specialist renewables managers have a “competitive advantage” over those investing in core infrastructure, even if those higher returns require LPs to “to accept the development risk that comes with this asset class”.
Whether you agree or disagree with all or some of the above, there are some themes worth unpacking here.
The first is the scale of the opportunity. In a 2018 study, McKinsey estimated that around $1.6 trillion of renewable investments would be available for institutional investors by 2030, with 70 percent of that figure comprising unlisted assets. That’s just a snapshot of a decade of investment.
Given the climate emergency and the need to electrify entire sectors, such as transport, we know renewable energy generation is not going away. We also know that renewables top the investment list in the fight against global warming. Add all of that up, and the idea of creating a dedicated allocation sounds like a perfectly reasonable move.
Equally interesting are the pension’s comments about its preference for specialist managers. In our just-published cover story on how covid-19 will change infrastructure investment, Gordon Bajnai, head of global infrastructure at Campbell Lutyens, makes it clear that LPs are now “looking under the hood at what kind of revenue model an asset has”. “They have become very sector-specific,” he adds. “They are asking how resilient those strategies and managers are proving to be.”
His conclusion? Segmentation has “significantly accelerated”.
Of course, generalist infrastructure managers are perfectly capable of investing in renewables. Almost all of them are doing it, in fact, some at significant scale. Brookfield told us in February that it had already invested about $1.6 billion of its $20 billion fourth global fund in renewables. What’s more, it could end up investing 25 percent of Fund IV in the sector. At $5 billion, that would make it one of the largest, if not the largest, renewables funds in town.
But if it’s true that segmentation is accelerating, it’s also unsurprising that LPs would want to turn to sector specialists.
There are other reasons why a dedicated renewables allocation could make sense. LPs prizing sustainability would certainly get a leg up. That’s different from saying that all renewable projects are automatically sustainable: while ticking the ‘environmental’ box, there’s nothing stopping a renewable asset from scoring poorly on the ‘social’ and ‘governance’ fronts, depending on how it is built and operated.
And the drawbacks of such an approach? We could name several, but let’s focus on a big one: there’s not really much in the way of unlisted renewables performance data.
A study published last month by Imperial College London and the International Energy Agency, while acknowledging that only a minority of renewables investments are accessible through listed markets, nevertheless used these markets as the basis of its research on the sector’s performance. Why? Because the “listed markets provide the most transparent method for assessing financial performance”, whereas “the question of how to quantify risk and return for privately-held assets is subject to fierce intellectual debate”.
In case you’re wondering, the study found renewables had performed strongly over the last decade. Importantly, the sector also seems to be holding up well during the pandemic, as we discussed in a May podcast.
Whichever way you cut it, renewables are an infrastructure play and are ideally suited to private markets. If creating a dedicated allocation helps unlock more capital to fight climate change, we’re all for it. In the end, it would serve as another milestone in the asset class’s maturation.
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