Are renewables the ultimate ESG strategy?

"The renewables environment is evolving, and we have to adapt along the way."

Energy transition is creating a strong stream of investment opportunities in renewable power-related assets. But should investors necessarily view them as ESG-compliant options?

As the world increasingly moves towards renewable sources of power in a bid to halt carbon emissions, the range of renewable-related investments has widened considerably.

Wind and solar markets have clearly been around for many years now, with some investors suggesting that some segments have matured, yet there is much more to the sector than might at first be apparent.

“Renewables used to be just a sub-set of infrastructure in investors’ portfolios,” says Laurence Monnier, Head of Quantitative Research at Aviva Investors.

“But now it is a stand-alone asset class and can play a key role in investors’ portfolios, while also helping institutions meet their net zero carbon emissions targets.”

She adds: “There is also now a diversity of revenues we can generate from different parts of the renewables universe. So pension funds or insurance companies looking for stable, long-term regulatory cash flow can opt for PPA or contracts for difference-type opportunities, while absolute return investors can target other parts of the sector. We started out with wind and solar, but we have expanded and now we have exposure to waste to energy and biomass, which are more complex to manage, but offer different returns.”

Widening horizons

New technologies that improve energy efficiency, energy storage solutions, the conversion of fossil fuel-dependent businesses to clean energy sources and – perhaps further down the line – the emergence of green hydrogen are all attracting investor interest, in particular as governments and policymakers get behind the decarbonisation agenda.

Jessica Otte, Director in the Investor Relations Team at StepStone sees the sector as offering strong opportunities for clients. “Renewables are a very attractive asset class,” she says.

“Momentum is growing, especially as the past three to five years has seen it become more institutionalised in areas such as wind and solar. These are now seen as a safe and attractive area for investment. On top of that, there are new technologies emerging where risk and pricing have not yet been established and these offer the potential for strong returns.”

She also points to the sector’s green credentials as a big draw for investors. “ESG is now very much an accepted investment factor for institutional investors,” she says. “Our due diligence shows that most of these investors have some form of ESG component built into their investment process. Climate change is seeing the largest flow of capital within this and so renewables are top of mind. This is driven by top-down factors, such as policy frameworks being established around COP 21, the EU Taxonomy and the TCFD disclosures being required in the UK, but also by the bottom-up factors of a maturing asset class that I just mentioned.”

Most investors have some form of ESG component build into their investment process. Climate change is seeing the largest flow of capital within this and so renewables are top of mind.

The sustainability question

The asset class clearly has legs, with increased expertise among fund managers and institutional investors and a regulatory and market tailwind as energy sources increasingly move away from hydrocarbons. However, while renewables tick a lot of climate change-related boxes, can investors rest easy that they automatically fit within the ESG category?

It’s a question some investors have been asking. “Renewables are clearly sustainable from a climate perspective,” says Alena Antonava, Investment Manager of RPMI Railpen’s Long-Term Income Fund. “Yet we have been examining whether they automatically qualify for the ESG ‘pass’ mark and we’ve found that, while being sustainable from a climate perspective, non-climate related ESG risks need to be considered as well.”

As a result, RPMI carries out a 360 ESG review of potential and actual investments to assess and address ESG risks that are no climate-related. For example, RPMI always focuses on supply chains. “This should be at the heart of the ESG review,” says Antonava. “Services are often outsourced and therefore as asset owners, we need to maintain oversight of suppliers and service providers to ensure responsible behaviour, HR policies, health and safety practices, and so on.”

Renewables have come a long way and they clearly offer plenty of different investment strategies, in particular as the world undergoes a process of energy transition. They are an essential component in helping tackle climate change, but there may be some way to go before all renewable investments sit neatly in an ESG-compliant portfolio.

Integrating ESG is a sprint, not a marathon. You have to implement in stages. The renewables environment is evolving, and we have to adapt along the way.