Understanding the opportunities and risks of investing in clean energy in 2023

Clean energy has become one of the foremost themes of recent years, becoming an attractive option within an investment portfolio. It provides not only a good and diversified income stream, but also diversification from traditional asset classes and, in many countries, the sector benefits from government support mechanisms. 

But as the macroeconomic environment has changed, it has become more expensive for companies within this space to borrow and therefore develop their technologies. So, is clean energy still a viable investment in the year 2023?

Having read this article, you will have improved your understanding of how clean energy funds are managed and their core qualities. You will also have greater knowledge of the space’s interaction with geopolitics and its position relative to competitors in the marketplace. 

30 minutes of CPD include:

Article: 10 mins

Related learning podcast: 24 mins

Related learning article: 3 mins 

Quiz: 5 mins

How is the current macroeconomic climate impacting the clean energy sector?

Having become fertile territory for stock pickers and growth investors alike, the clean energy sector seemingly had its momentum paused in the wake of higher inflation or more pertinently, higher interest rates and yield expectations. With Prime Minister Rishi Sunak also delaying some plans and the cost of borrowing now much higher than it was pre-pandemic, does the sector still have the same allure amidst this modified economic backdrop?

David Harrison, manager of the Rathbone Greenbank Global Sustainability fund, believes there is reason to be optimistic: “We would argue its (the environment) broadly supportive of investment in the clean energy space. There has been a clear commitment globally to increase the penetration of clean energy sources. A good example is the Inflation Reduction Act in the US and similar policy approaches in Europe and China. This has spurred investment across multiple clean energy technologies and global penetration remains below 50%, so the growth runway remains strong. It’s important to note that clean energy technologies such as wind are often more attractive than carbon-based solutions on an economic basis too.”

Darius McDermott, managing director of FundCalibre, recognises the short-term challenges facing the sector but was similarly upbeat on its longer-term prospects: “Following Russia’s invasion of Ukraine in 2022, energy was the highest performing sector. Now that’s traditional energy, oil and gas, but also alternative energy sources, whether that be clean energy or energy transition.” He continued, “As we often see, funds that do well one year tend to do less well the next because valuations just get a bit heady, but if you were to ask me to write down a theme that I believe will have long-term structural support, for possibly the next 20-30 years, this is one of them.”

“During times of economic uncertainty, the clean energy infrastructure sector remains relatively resilient, with critical assets supporting the functioning of society,” added Will Argent, fund manager of the VT Gravis Clean Energy Income fund. Therefore, he points out, even with the possibility of recession in many key regions, the case for investing in the sector strengthens to mitigate against more demand-led sectors.

What are the main challenges in investing in this sector?

While the longer-term investment case for clean energy as a theme may be less opaque than other technology-focused sectors, there are certainly still challenges to consider, as Darius explains: “The transition to clean energy is expensive – we can’t just magic millions of turbines or solar panels or lithium batteries out of thin air. I think there will be bumps in the road and I think Russia/Ukraine has been quite a substantial bump because it did lead to a short-term energy crisis. And actually, in that short-term period, making sure your country wasn’t cold last winter was probably more important than focusing on being carbon neutral by 2050 or any other Paris Accord-related issues”.

This is, of course, the stark reality of energy transition. Necessary though it is, while oil and gas remain available, the shift toward clean energy will always be susceptible to shorter-term needs and requirements. Though strides are being made, this is very much a technology of tomorrow making an incremental impact on today.

David Harrison and the team are cognisant of this and approach the sector with the fundamentals in mind, “It is important to focus on clean energy solutions that make a fundamental economic profit and to be wary of those that are more speculative,” he said.  “Judging barriers to entry is critical too – we want to understand if a certain business will be part of the ecosystem in 10 or 20 years.  Lastly, it’s a fast-moving sector, so you have to stay informed of new solutions and challenges to more established technologies.“

Related learning: Why saving money is a greater driver than cutting back on CO2 emissions 

With so much of the sector being tilted toward technology, is there an unavoidable growth bias within clean energy or can the sector appeal to a value investor as well?

Although clean energy has been around for decades (with solar panels, for example, dating back to the 1880s), this remains an emergent technology, particularly in how clean energy sources interact with our current infrastructure – i.e. moving energy extracted from solar panels and wind farms to a centralised grid.

As a result, the sector may arguably be viewed as a defacto-technology play, albeit one that is underpinned by government incentives and subsidies. For investors conscious of the growth/value dynamics of any prospective allocations, clean energy would, on the surface, be viewed as a strictly growth-driven investment, a point to which David Harrison concurs albeit with a caveat: “By its very nature, the clean energy sector is a long duration set of assets.  This will inevitably point you to more growth assets.  We are still at a relatively early stage of the investment cycle in many cases.  As the sector matures there are likely to be more companies that appeal to value investors.  One exception is the utility space.  Utilities have invested significant capital in clean energy assets already, so they can offer attractive exposure for more value-minded investors.”

The Sustainable Investment team at Liontrust also recognises the sector’s inherent attributes as being growth-centric, but also sees hidden value within it, beyond that of the more traditional growth offering: “The sustainability focus of the Liontrust Sustainable Future Managed funds leads us to invest in quality businesses tackling the world’s most challenging problems with innovative solutions. These businesses, which have strong long-term growth prospects, tend to trade on near-term valuations greater than the average company without such bright futures – and are therefore designated as ‘growth’ stocks. We believe these companies have better growth and greater resilience than the market understands so we can aim to use this underappreciated advantage to deliver outperformance.”

What are the main opportunities within the space?

As with other technology-oriented sectors, there is often merit in scouring the production chain for investment opportunities. While the end product itself –  in this case perhaps a wind turbine or a solar field – may appeal, the components required to deliver these products may also offer unique and sustainable exposure to a longer-term theme.

David Harrison discusses, “We think there are significant opportunities in the ‘picks and shovels’ of clean energy technology.  These are the companies that provide the semiconductor chips and power management infrastructure to wind turbines for example.  Many have niche positioning and are hard to replicate.”

He continues, “As renewables play an increasing role in the global energy mix, there will be a substantial need for investment in power grids and energy storage capability.  This is another area that could provide an attractive investment opportunity.  Lastly, companies that are playing a role in de-carbonising existing assets are potentially very well placed in the long term”

What role does a clean energy allocation play within a diversified portfolio?

Clean energy clearly shares some of the technology sector’s qualities but its sensitivity, and uneasy bond with traditional commodities, and by extension, geopolitics, makes it a different proposition for investors. 

So, how should investors view an allocation toward clean energy?

“It’s a theme with an obvious tailwind”, said Darius, “We know that governments, not just in the UK but across the globe, are moving toward carbon neutrality. I’ll say it won’t be a straight line and it will probably be quite rocky, but if you can find a thing where everybody goes, ‘We’ve got to do this’ whether it’s the Inflation Reduction Act in America or subsidies in Europe, for these type of themes you’ve at least got a bit of help, so it’s a thematic investment, but one that you can see long term support from over multiple decades. But it won’t be in a straight line!”

David Harrison agreed but again stressed the need for caution from a bottom-up stock selection perspective, “It can offer a structural growth opportunity that has become more mature and investable in the past 10 years. The investment choice within clean energy has expanded significantly and many of the businesses are cash generative and well-established.  Short-term volatility issues are more than offset by long-term growth opportunities. It is critical, however, to make sure the businesses you own have durable business models that cannot be competed away over an economic cycle.”

Related learning: Balancing the views and needs of ethical investors 

A reminder of the Learning Objectives

• Identify the opportunities within clean energy
• Understand how the recent inflationary environment has impacted the sector
• Explain the investment qualities that clean energy offers