SMALL CAP IDEA: Falling interest rates boost renewable infrastructure

Last month, the Bank of England provided much-needed relief to borrowers by cutting the base rate for the first time since March 2020, reducing it to 5 percent from a 16-year high of 5.25 percent.

With the latest inflation figures coming in lower than expected, the chances of a second cut in September are becoming smaller.

For private investors, this could mean a further boost for the stock market, as lower interest rates make bonds and savings accounts a little less attractive. But while a rising tide lifts all boats, some stocks are destined to sail more smoothly than others.

One sector that could particularly benefit from the changing interest rate environment is renewable infrastructure investment trusts.

Historically, these trusts have increased in value as interest rates have fallen.

According to research commissioned by Foresight Group, which manages the Solar Pension Fund (FSFL), this trend has remained in force for at least the last decade.

“This inverse relationship appears to hold true for all publicly traded renewables, but there is a particularly strong correlation with investment trusts,” says Ross Driver of Foresight Solar.

For those who follow the green revolution closely, this is promising news. In fact, it is one of the many positive aspects that could revive interest in the sector.

The Labour government, backed by a strong majority in Parliament, appears willing to support the renewable industry and investors are breathing a sigh of relief at the prospect of political stability.

The government’s revised budget for this year’s Contracts for Difference (CfD) auction and proposed changes to the planning regime indicate that the winds are finally blowing in the right direction.

Adding to the optimism, energy price forecasts have been trending upward, offering the potential for higher revenues and improved cash flows for renewable energy projects.

After a tumultuous period following Russia’s invasion of Ukraine, European countries have stepped up their efforts to achieve energy independence, creating a more favourable outlook for long-term planning in the renewable sector.

This renewed optimism is a welcome change after a challenging period of macroeconomic headwinds.

The high inflation environment that followed the pandemic pushed central banks around the world, including the Bank of England, to raise interest rates.

The Bank of England, in particular, has raised its base rate 14 times since December 2021. This aggressive fiscal tightening, the most intense in four decades, has affected investor interest in renewable energy investment trusts, effectively closing the securities markets to new issues and paralysing the growth of these vehicles.

“The transition to a lower-carbon economy is one of the greatest investment opportunities of our generation. The window of opportunity is opening again,” says Foresight’s Driver.

“I don’t think everything will be rosy from now on; there will certainly be some bumps along the road, but the general direction of travel now is more positive.”

Against this backdrop, renewable infrastructure investment trusts look attractive based on the current discounts at which their shares are trading relative to the companies’ net asset value (NAV).

This discount could be as high as 40 percent. As capital returns to equity markets, this gap would be expected to narrow and share prices would benefit from a rebound, although as Driver points out, this is unlikely to be a straight line of progress.

For those seeking income and growth, the Foresight Solar Fund is worth a closer look. At current prices, it offers a projected dividend yield of 8.5 percent.

NextEnergy Solar Fund is another standout fund, with a projected return of 10 per cent, making it one of the biggest payers in the FTSE 350.

In addition, NextEnergy recently received the green light to launch a £20m share buyback programme, further increasing its appeal.

But the list doesn’t end there. Also worth considering are Bluefield Solar, UK Wind, The Renewables Infrastructure Group (TRIG) and John Laing Environmental Assets (JLEN).

When assessing my ISA, all six trusts performed well across key criteria: they are asset-backed, offer income and have growth potential.

Of course, it is important to remember that none of these investments come with a guarantee of success.

While the downside risk at current levels does not seem particularly daunting, renewable energy investment trusts are not without risk.

However, with the combination of political support, improving market conditions and attractive valuations, they may offer an interesting opportunity for those looking to invest in the transition to green energy.