A creative approach to alternative income assets
With bond yields and equity returns falling, investors are increasingly looking to new, secure sources of income. Unusual assets such as solar panels and energy facilities could be worth considering, writes John Dewey
Energy efficiency is increasingly important to the UK’s National Health Service (NHS), which is estimated to pay an annual energy bill of as much as £750 million. Powering lifesaving equipment and large hospital buildings on a 24/7 basis is a growing strain on public finances, so it should come as little surprise that energy efficiency facilities have been gaining favour. What may be less well known is that such facilities have also been a lifeline to investors looking for a stable source of returns.
In Dundee, for example, a £15.4 million project is underway that will include the construction of a new energy centre for Ninewells Hospital and Medical School, cutting NHS Tayside’s energy costs by 10 per cent. The project is scheduled for completion by year-end, with funding managed by Aviva Investors on behalf of institutional investors and the UK Green Investment Bank.
The Dundee project is one of a number of more esoteric examples of what is widely known as alternative income investing. In an uncertain macro-economic environment, with falling bond yields and equity returns, pension funds and insurance companies have turned to new types of assets to match their liabilities. Infrastructure projects and real estate are examples of such assets that provide long-term, inflation-linked cashflows, with the backing of high-quality counterparties.
With interest rates close to zero and returns in traditional asset classes exposed to heightened volatility, there are clear benefits for investors in having returns underpinned by a contractual obligation and knowing that those returns should increase in line with inflation. As a consequence, alternative income investment funds have become increasingly popular in recent years.
While alternative income assets may offer attractive returns relative to more traditional listed assets, they are not entirely immune to yield compression and supply-demand imbalances. There is, therefore, a need to take a dynamic approach to portfolio construction; identifying assets from a range of sectors that will collectively meet investors’ long-term requirements. That could mean tapping multiple markets simultaneously, including infrastructure debt, private credit, and real-estate finance.
It is in this context that the Dundee hospital power facility and projects like it should be assessed. By investing in a relatively small-scale hospital energy centre, pension funds and insurance companies can be much more confident of the returns likely to be generated than they would by investing in equities or bonds in the current climate. Other UK hospitals have received similarly motivated funding for energy centres, but the range of assets that suit this style of investment extends much more widely, including to solar panels, wind turbines, biomass plants and other energy efficiency projects.
Such assets are a little more unusual than typical infrastructure projects and may be less familiar for many investors. However, by taking a more imaginative approach, they can buy assets that are designed to deliver cashflows that are not only predictable, stable and linked to inflation, but are also subject to less competitive pressure and better priced. Rather than buying into an entire solar farm, for example, which is an increasingly competitive space; investors might get a better deal by building a diversified portfolio of domestic solar panel installations.
There are some challenges associated with this kind of investing, not least the fact that assets such as solar panels and energy facilities are less liquid and harder to access than a typical equity or bond. Rather than simply using a Bloomberg terminal to place an order in seconds, investors need a certain level of expertise and the right relationships to buy these types of assets. They also need a much more long-term commitment to the market to access the best opportunities.
Private assets need to be closely scrutinised to understand the exact cashflows, counterparties and credit characteristics involved. While some assets within the infrastructure and real estate sectors may be more standardised than others, alternative income investing is generally much more diverse than investing in traditional assets.
Timing is also an important consideration for anyone accessing this market for the first time. Given the many weeks and even months it is likely to take to select a manager, evaluate new assets and make an investment, there is a risk that a particular asset will become less attractive during that time. There is a need to clearly define desired outcomes at the outset and retain a dynamic approach that exploits relative value across multiple sectors and can be adjusted as market conditions change.
None of this should give investors reason to shy away from alternative assets, but it simply underlines the need to take sensible, measured investment decisions. In reality, only the most experienced firms will have the resources in-house to assess the diverse range of opportunities and perform detailed due diligence. Investors will need to identify managers with the right relationships and expertise to build and manage a portfolio on their behalf over time.
Following the UK vote to leave the European Union on June 23, the outlook for global markets remains highly uncertain. In this environment, the benefits of a dynamic investment strategy that exploits the opportunities available in private assets should be clearer than ever.
With all sorts of idiosyncratic risks likely to emerge as the Brexit negotiations continue in the coming months, now is a good time to consider a more creative approach to investing, tapping assets that may not be widely held but will yield reliable returns well into the future.
Unless stated otherwise, any sources and opinions expressed are those of Aviva Investors Global Services Limited (Aviva Investors) as at 07 July 2016. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Past performance is not a guide to future returns. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested.
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