One persistent misconception about “green” investing is that investors must be willing to sacrifice financial returns for some social or environmental benefit. Not only is this notion outdated, but in today’s environment, it could deprive investors of valuable opportunities to include a vital non-correlated asset class to their portfolios.
With recent volatility in the markets compounding investors’ health concerns regarding the coronavirus pandemic, strategies that focus on renewable energy have become increasingly important as risk management tools for clients, thanks to their lack of correlation to equities.
Add in the potential for sustainable, long-term income generation, and the green energy sector is an area that could be newly compelling for many investors.
With that said, the renewable energy space is unfamiliar territory for many investors who are accustomed to a traditional 60 / 40 equity and debt portfolio.
What should these clients — and the advisors who serve them — look for as they explore this asset class? Here are some thoughts to consider:
What to Invest In
Many investors associate green investing with early-stage green technology or other solutions that are still in development.
In fact, the infrastructure side of the renewable energy world — specifically, wind and solar farms — has been producing steady and robust cash flows for years, based on long-term contracts to supply power to utilities, municipalities, corporations and other entities.
Green technology, by contrast, often involves speculative investments in unproven approaches that, even in the best-case scenario, face a long road ahead before they might achieve significant adoption.
Though such innovations may generate a lot of buzz, the barriers to entry in the energy industry are steep, and even promising green tech companies can find that the market for their offerings never materializes. Suffice it to say, significant risk and volatility are involved.
Solar and wind farms, on the other hand, are durable assets that have some of the same characteristics that make real estate or fixed-income investments attractive in asset-protection strategies. Namely, long-term income and resistance to equity market volatility.
When to Invest
Even though green energy infrastructure tends to be less risky and volatile, it’s not without uncertainty.
The first two-to-four years of a typical renewable infrastructure project’s life cycle is the development phase, which includes site selection, permitting, engineering and design, power contracts and financing.
Many of these elements are within a developer’s control, but many are not, such as town council votes on permits.
A less risky approach is to invest in green energy infrastructure after development is completed, and the project has moved into construction.
Some risks remain after this point, but they primarily center on the possibility that construction won’t finish, which is mostly within the builder’s control and can be mitigated.
What Happens After Investing
The availability of any power-producing asset is the ratio of time within a given period that it’s able to generate power. This is a measure of the asset’s ability to fulfill its power supply contract and a key driver of its ability to produce ongoing income and value for investors.
The question for investors is whether the maintenance of the project they’re considering is in good hands.
Does the investment firm that owns the asset, for example, have in-house engineering expertise that can optimize operations to maximize availability? If not, how will it limit downtime? Every idle minute is income left on the table.
Managing Correlation & Making a Positive Impact
The bottom line: Green power infrastructure investments can fulfill a similar role in an investor’s portfolio to that of real estate, reducing correlation to the equity markets and mitigating risk.
By knowing what to look for, investors can protect their portfolios and potentially bring some peace of mind to their financial outlook.
Robert Sher is co-founder of Greenbacker Capital, an investment firm focused on the sustainable infrastructure sector.