"But this time it's different"
In my conversations with fellow professional investors in sustainability, I increasingly hear concern that valuations in the public markets are getting too high. The SPAC wave is particularly targeting sustainability and climate solutions, and companies that don’t even have revenues yet are ending up with market caps above $1 Billion. That’s making some veteran investors break out in hives.
To be clear, I’m not trying to ring any alarm bells about an imminent collapse. I do personally believe, as I wrote about a couple of weeks ago, that we are in the beginning stages of a second cleantech bubble. But I’m not smart enough to time the market or give any kind of investment advice. My personal guess is that we really are only at the beginning phases of a longer term wave of capital surging into the sustainability market.
That said, many of the institutional investors I speak with are clearly facing a bit of a dilemma — they believe in the sustainability megatrend as a long term investment opportunity, but with such high valuations the attractiveness of doing that through public equities seems low. And the volatility of venture capital as an asset category means they don’t want to put all their eggs in that basket either; venture capital is always a relatively small portion of these major investors’ portfolios. They’re also under a lot of pressure to find yield opportunities in general, when government debt returns are currently so low.
So, many of these investors are turning to sustainable infrastructure — particularly renewables. The theory is simple: Even after bubbles burst, infrastructure build-outs tend to continue onward, and well-designed projects should continue to throw off cash flow even during market downturns.
The first part of this theory seems to be mostly true. Investment bubbles into areas of innovation can mean cheap capital flowing into those innovations and thus helping to drive down their costs. This can spur additional deployment and adoption even as the investment returns for the backers of those innovators goes south. To give just two examples:
- In the five years after the collapse of the dot-com bubble, over 500 million internet users were added worldwide, as compared to around 300 million users added in the five years leading up to the collapse.
- When the mid-2000s cleantech bubble collapsed, global solar installations continued to accelerate, rather than slow down.
One caveat is that when the valuation inflation is actually in the deployment end of a market (versus upstream innovation), naturally when such bubbles collapse that can lead to a pause in further deployment. In the Panic of 1873, for instance, speculative investors lost big in their bets on railroad deployment. And indeed, in the subsequent five years in the U.S., the deployment of new railroad miles stagnated (see Table 1 here), before then picking up again starting in the next decade. Nevertheless, as noted above, if there is a second cleantech bubble underway right now, it’s clearly at the upstream innovation end of the market given that so much of the SPAC activity has been targeted there.
The second half of the theory, that returns to infrastructure would be stable even during sectoral or economic downturns, is unfortunately not so simple. It seems to come down to how investors are getting their exposure to the underlying projects.
In this 2019 paper comparing historical infrastructure returns (tl;dr: see Figure 1 in particular), the researcher concluded that publicly-traded infrastructure indices had in fact been strongly correlated with other public equities performance, rather than being anticyclical. This wasn’t because the underlying assets underperformed when the stock market went down. The researcher’s basket of privately-held infrastructure didn’t see nearly the same correlation. As he wrote (on page 32):
“Private infrastructure... delivers consistently higher returns compared to listed infrastructure and global equities. A cumulative return analysis shows that private infrastructure was the only index that reported positive returns during the 2007-2008 period, while the [private infrastructure] index’s performance further improved in the aftermath of the [Great Financial Crisis] period.”
There seem to be two main reasons why attempting to access the anticyclical advantages of infrastructure via public equities is difficult. First, many of the publicly-traded entities that are considered “infrastructure” are in fact blended corporate and project structures — developers, construction services, and equipment vendors, for example. These aren’t yieldcos or REITs that consist purely of operational assets. Second, the euphoria in the sectoral or broader stock markets tends to bleed over into higher prices even for the more asset-heavy platforms, so that investors attempting to buy in have to do so expensively. When the rug gets pulled out of the stock price support, even if the underlying projects are performing the same as before, the shareholders still see significant losses when they sell.
Look at Hannon Armstrong’s stock price over the past year, for example. This is a publicly-traded company that is explicitly designed to provide dividends to shareholders from various types of clean energy projects. However, as investors have bought into the sustainability space, they’ve driven up this company’s stock price such that the dividend yield is now fairly low (under 3%). To be clear, I’m a fan of what I see the company doing. My only point is that when the sectoral stock prices are going up so much, it makes it challenging to buy into attractive yield through the public markets route.
Fortunately for institutional investors, they can access sustainable infrastructure through the private markets. And many are doing so. In fact, there’s such a rush into private market renewables that the returns have reportedly dropped 200 to 300 basis points over the past year. But they’re evidently still attractive to these investors in an otherwise low yield market environment.
I expect a lot more capital to flow into renewables and sustainability private infrastructure during 2021 for these and other reasons. And especially into areas like distributed (versus utility-scale) project finance where the return profiles can be significantly more attractive still.
But what about the average individual investor who is not “accredited” and thus can’t easily access the private markets? For an average investor just looking for yield from investing into solar projects and the like, the available options are much harder to identify.
Groups like Mosaic and Wunder originally started out providing crowdfunding opportunities for individual investors to back solar projects. But as a result of their own success, these groups were able to then access very large amounts of institutional capital, and shifted away from the crowdfunding approach. Others like Greenbacker also offer project-based yield, but only to institutional and accredited investors.
SolarCity is offering what they describe as “Solar Bonds” that are ostensibly a way for individual investors to access solar projects. But a look at one of their SEC filings around the product reveals that it’s really just corporate debt, not direct exposure to the underlying projects.
New efforts do arise. One new one is Raise Green, which is taking the crowdfunding approach to provide investments in specific, local projects. And this article mentions a couple of available opportunities based in Europe. But these options are still rare and hard for small investors to find.
Some “green bond” ETFs are available as well. But green bonds are very often not related specifically to renewables or sustainability projects, and are in fact issued under voluntary standards. So it’s not quite the direct exposure to sustainability projects that investors might want.
Institutional investors are able to go directly after project investments as part of a sustainability thesis, and thus also protecting themselves somewhat against any sectoral downturn. And it looks like many are going to ramp up their efforts in this area in 2021.
But meanwhile, small investors will have more challenges in doing so. As far as I can tell, it’s a gap in the current capital markets.
Disclaimer: While my firm Spring Lane Capital is an active investor into sustainable, private market project capital, I have no current affiliation to any of the companies mentioned above, nor do I directly own stock in any of the publicly-listed companies mentioned. This is a thought piece and should not be construed as or relied upon as investment advice.
