The VT Gravis Clean Energy Income Fund marked its sixth anniversary in December. In this Q&A, taken from a recent webinar presentation, Will Argent, investment adviser to the Fund, provides a brief review of 2023 and gives his views on outlook for 2024.

A video with highlights from the discussion can also be viewed here:

The average life on existing assets across our portfolio companies are actually very long. On a portfolio basis, we do not see a need for or expectation of huge refitting in the near term. We do not really have exposure to companies that deal with repair work. Whilst we do have some exposure to vertically integrated businesses in Europe, they have their own internal capabilities for repairs, which is quite negligible in the context of the Fund. The answer would be no when it comes to asset degradation for our owners of operational assets. The gradual expectation of repairs and refitting should be modelled and built into expectations. It should not come as an unexpected surprise through the life of the asset. The other thing I would highlight is that in terms of repowering, you can repower assets. A solar or wind asset could be repowered with upgrades, for example.

NextEra Energy Partners is the mid green line that shoots up to a very high trading dividend yield.

They had a challenging year, certainly in terms of performance. Ultimately, it’s probably a good example of the situation of some companies that, given the higher cost of financing, some assets that NextEra were planning to acquire are no longer going to happen. The viability or desire to do that was reduced given the prevailing environment. Assets that are now not coming into the portfolio that were expected to drive very strong dividend growth, led the company to reduce its dividend growth expectations. We went from a low-teens growth rate for the next three to four years, to a high single digit growth rate. That saw a very sharp impact on the share price, I would dare say a very unjustified and over the top reaction. That started to come in, as you can see, with the yield coming back in, and that reflects the dividend hasn’t been reduced, it is just a slowdown in that growth rate, which is still running at a pretty attractive rate in my opinion. Our sector is very sensitive of near-term noise. In the UK, you have seen this inflation print that’s a bit offside versus expectations – nothing massive, but it’s sending a ripple through the sector. There’s this tendency for quite heightened volatility at the moment, and we saw that in NextEra Energy Partners. We like the company – it has got some very strong long-term assets, high-quality off takers. These are the counterparties to which it’s exposed, for its electricity sales and right now I think it offers attractive value. Even if you had expectations that the current rate hike cycle wasn’t over, for example, when you’re sitting on a well-covered, resilient 10-11% trading yield, I think that’s attractive and looking to grow in the high single digits over the next few years. We understand why the company made the changes it did. We have engaged with the company over the recent months and we have confidence that the recalibration is appropriate and can be supported going forward.

My view would be that the necessary upward shift in discount rates that’s occurred over last year, for example, very warranted, but that shift in reference yields lower probably. I don’t see that putting any pressure, or it’s going to remove any pressure to increase discount rates further at the end of December valuations, which are the point we’re next waiting for – the NAV update. In that regard, it’s positive. I would suggest, and as I showed just a small selection of examples in terms of where share ratings are relative to net asset values, if those net asset values stabilise, I won’t even talk about any improvement, but if those are shown to continue to be stable, as I think they have been, even while discount rates have been moving higher, obviously being offset by tailwinds provided by stronger inflation outturn on renewable obligation certificates. Given today’s inflation print, we now know the average of the monthly year-on-year RPI prints for the last year, which comes in just below 10%, that’s the rate at which renewable obligation certificates will inflate in a few months’ time. Coming back to the reference yields impact on NAV, I think I’m looking for stabilisation in NAVs, and like I say, the disconnect between share prices and those NAVs which now incorporate pretty high discount rates, I think there’s certainly scope for that discount to reduce in the coming year.

On one hand, I think given our focus on operational contracted infrastructure assets, a recession or the economic cycle, I think doesn’t really have too much of any impact on those cash flows and that focus of the companies to which we’re exposed and by extension the income we expect to accrue. It doesn’t hold fear for us in terms of the economic environment. On the other hand, were the UK to tip into recession, and presumably that would come hand in hand with further negative pressure on inflation, it’s probably going to leave the prospect of more imminent rate cuts, I suppose, which would be conducive for us. A lower rate environment, a lower reference yield environment, is a tailwind for our longer duration income focused strategy.

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