Beleaguered clean energy funds eye rebound amid interest rate cuts, rising demand

Sign up for the Globe Advisor weekly newsletter for professional financial advisors. For more from Globe Advisor, visit our homepage.
Microsoft Corp. MSFT-Q chief executive Satya Nadella announced in May that renewable energy sources will power 100 per cent of the company’s artificial intelligence-related data centre by next year. The comment, among a string of other developments in recent months, is helping revive the prospects for clean energy funds, which have lagged the broader market significantly for the past couple of years.
After topping out at more than US$20-billion in global inflows amid a flurry of fund launches in 2021, clean energy went ice cold as surging interest rates saw valuations tumble and capital flee from solar, wind, hydro utilities and other related stocks.
Globally, assets in the clean energy and technology funds category slid by 23 per cent in 2023 to US$58 billion, according to Morningstar Inc., “mainly due to high interest rates, inflation and falling valuations in renewable energy stocks.”
Net sales in the category dropped alongside valuations. After inflows of US$25.9-billion in 2020 and US$28.1-billion in 2021, global sales in the category slowed to US$3.6-billion in 2022 before seeing outflows of US$1.5-billion in 2023.
Alexander Smahtin, senior analyst, investment management, at Global X Investments Canada Inc., says clean energy firms, which often have capital-intensive projects, saw their margins pressured as interest rates rose. But the outlook is improving.
“Now that we’re entering a regime in which interest rates have at least plateaued – and are beginning, in some cases, to get cut – margin pressure is easing,” he says. “Combine that with this secular increase in demand, you can see where some tailwinds are emerging.”
Clean energy funds in Canada and elsewhere have started to reverse some of their declines. Among the eight operated by Canadian asset managers, all but two – Desjardins Sustainable Cleantech Fund and NEI Clean Infrastructure Fund – had negative returns in the double digits last year, according to Morningstar Canada, and the Desjardins and NEI funds are the only two with positive returns for this year as of June 30.
John Bai, chief investment officer of NEI Investments, says an investor rotation back into utilities is underway, including into renewable power businesses. It’s a change the widely expected shift in U.S. monetary policy and a growing consensus that the U.S. economic engine is decelerating has spurred on.
“We’ve seen markets driven by a stronger-than-expected U.S. economy, consumer and job market. But we think cracks are beginning to form,” he says.
The NEI fund has holdings in renewables as well as hydroelectricity generation and transmission companies, such as Clearway Energy Group LLC CWEN-N.
Mr. Bai says the fund’s rebound “highlights some defensive characteristics, combined with low valuations within the sector.”
More than 50 per cent of the fund is allocated to international equities, with several holdings in markets forecasted to close the gap with U.S. stocks this year and next, such as Europe and India.
“Those exposures have been headwinds in the past couple of years, but they’re becoming tailwinds,” Mr. Bai says. “There’s a case to be made that there will be a rotation out of the U.S. into those other areas.”
Among Canadian investors, attracting institutional interest into clean energy funds remains a challenge given their relatively tiny scale, says Ian Tam, director of investment research at Morningstar Canada.
“For example, some solar companies are so small that a pension fund would be almost better suited buying the entire company in a private setting … as opposed to buying a fund or a basket of securities,” he says.
The clean energy sector may also have suffered as momentum for sustainable investments slowed in recent years. Morningstar Canada survey data suggest Canadian retail investors still want to invest sustainably, but interest has lagged amid the volatility in financial markets. “They’re just not doing it,” Mr. Tam says.
But AI expansion could provide a boost to U.S. renewable energy stocks.
A recent research report from analysts at Citibank notes that independent system operators in the U.S. that manage power transmission regionally are forecasting large increases in solar power generation.
The U.S. solar pipeline has increased by one terawatt to 2.3 terawatts and “will play a key role in the data centre buildout in the U.S.,” the Citi analysts said. “Investors are looking to gain exposure to the theme.”
In Canada, following regulators in Europe and the U.S., a push by the Canadian Sustainability Standards Board should also result in more transparent reporting requirements for issuers in the next few years, giving investors better tools to evaluate sustainable funds, Mr. Tam says. “This shift should help asset flows into these types of products.”
Yet, the financial prospects of the funds and their underlying holdings will ultimately attract investor capital, he adds.
“We have to remember that sustainable investing is investing first and foremost – investors should be after good risk-adjusted returns.”
For more from Globe Advisor, visit our homepage.