As uncertainty characterises today’s market backdrop, investment portfolios are navigating a new normal. Structural shifts such as rising government debt, ageing populations and sustained higher interest rates, to name but a few, are all calling out for a different approach to portfolio compositions. The question facing DC members is more than simply how to grow their pension pots – it’s where best to find a blend of return, risk management and impact that can thrive through the cycles of the coming decades.
Private markets now stand as both an overdue and exciting frontier for DC investment, with regulatory barriers and product innovation easing access. We believe that most members would benefit from a meaningful allocation to a broad range of private assets that mirrors what we see from other large institutional investors (in the region of 15 to 20 per cent).
As part of this, renewables and energy transition-aligned infrastructure is a strong example of what can be delivered – both from a returns as well as an impact perspective.
Renewables stand out for DC members because of how they deliver returns. In an era when even high-quality sovereign bonds have experienced volatility, renewables offer attractive risk-adjusted returns. A typical, operational renewable energy investment in the developed world is expected to deliver returns of 8 to 10 per cent per annum on a buy and hold basis. This is in line with, or at a premium to, listed equities – but with very different drivers.
Crucially, these returns are often contractually linked to inflation through government-backed agreements. They’re also implicitly linked to inflation exposure via power prices. Being positively exposed to inflation is a critical benefit for DC members investing into renewables, as it helps to maintain the real purchasing power of their investments.
Listed equities and corporate bonds are typically negatively impacted by power price rises. When energy prices spike – as they did in 2022 – renewables can actually benefit (through the energy it generates and distributes) while mainstream assets can falter. Indeed, energy transition infrastructure returned an impressive 22.6 per cent in 2022, providing protection when it was needed the most.
These assets expose members to risks they otherwise wouldn’t have in their portfolios – this different risk ‘premia’ delivers further diversification. This includes resource/weather risk. Predicting tomorrow’s weather is challenging. A 30-year asset’s life is much more predictable. Our data shows wind to exhibit a 2 per cent standard deviation of outcomes over a 10-year period. Solar’s standard deviation is even lower.
These renewable assets also offer diversification in terms of technology, and the risks specific to energy transition technology. For example, the operational considerations of a biomass plant vary significantly to a wind farm or hydrogen plant.
Energy security concerns are globally driving policy and regulation to accelerate the energy transition, resulting in a green subsidy race. Even where political push back is creating headwinds for new build out, such as in the US, the inherent cost competitiveness of renewables today should continue to support new development.
DC members are growing more aware of the impact of their portfolios, with the energy transition firmly in focus.
The impact of renewables is tangible – these power sources are powering homes today and contributing towards a net zero economy.
But this is not just about ‘doing good’ with member savings. The International Energy Agency (IEA) estimates that around $4.5 trillion per year needs to be invested from the early 2030s. This provides an opportunity set arguably not seen since the industrial revolution.
The structures to bring renewables into DC portfolios now exist. New vehicles such as the UK’s long-term asset fund (LTAF) have delivered a solution to the barriers to access, and we’re seeing momentum.
With its diversified, inflation-linked returns, low correlation to listed assets and measurable impact, renewables and energy transition-aligned infrastructure can power DC members portfolios – particularly amid today’s more volatile markets. As these assets fast become a key component of portfolios, the question is no longer if DC members should invest in the energy transition, but how much and how soon they can benefit.
