Listening to Bill Gross
A Case for Real Assets & Renewable Power in Today’s Investing Environment
As bond guru Bill Gross outlined in his recently published August 2016 Investment Outlook, he believes “real assets such as land, gold, and tangible plant and equipment at a discount are favored asset categories” while investors should be wary of traditional financial assets like bonds, stocks and private equity. Regardless of your views on the market (or Bill Gross himself), investing in real assets will continue to play an important role against a backdrop of ultra-low interest rates, sluggish growth and ongoing uncertainty. While Gross offers more familiar examples of real assets like real estate and commodities, renewable energy assets like wind and solar demand mainstream attention within the broader real asset discussion. Renewable assets provide investors with long-term yield, capital appreciation, inflation protection, and the diversification benefit that comes from adding wind or sunshine risk to a portfolio — all from a rapidly growing renewable power sector that accounted for 99% of new electric generating capacity in the U.S. in Q1 2016.
Long-Term Yield in Today’s Environment
Today, central banks have created an environment in which both economic growth and the high-yielding returns that should accompany it are difficult to find. Investors are fleeing negative yields on government debt and driving yields on investment grade corporate debt to record lows. The search for income-producing assets is widening and leading many to believe that today’s yield grab could be setting up tomorrow’s problems for investors in traditional financial assets like stocks and bonds. In the words of Bill Gross, “in this high risk/low return world, the obvious answer is to reduce risk and accept lower than historical returns. But don’t you have to put your money somewhere? Yes, of course, except markets offer little in the way of double digit returns.” While this challenging macroeconomic environment may create problems for traditional financial assets, it simultaneously can serve as a tailwind for investment in income-producing real assets like wind and solar infrastructure projects where correlation to equity markets and sensitivity to interest rate movements is minimized.
Corporate Debt vs. Real Assets
As an example to build on Gross’ advice, let’s consider a simple comparison between a traditional financial asset (in this case long-term investment grade corporate debt) and a real asset (in this case an equity ownership interest in a long-term renewable power infrastructure asset).
Earlier this month investment grade rated Walt Disney Co. (DIS) locked in the lowest long-term borrowing costs of any U.S. company in history when it issued a 30-year bond at 3%. Recently, we’ve seen similar activity out of tech companies like Apple, Google and Microsoft. These record low yields demonstrate that investors today have an insatiable thirst for high-quality investment grade paper because it is issued by corporations regarded as safe while offering higher income than other assets like U.S. Treasuries. This type of corporate debt is just one example of what Gross would likely describe as “investable assets [that] pose too much risk for too little return.”
Given the record low yields on these corporate debt assets, you can see why Gross is able to make a case for investing in real assets — and I believe an even more compelling case can be made specifically for renewable power infrastructure assets within the real asset category. Let’s consider an investment in an operating (no development or construction risk) solar infrastructure asset. With a time horizon (20–25 year power purchase agreement) and credit exposure (guaranteed cash flows from an investment grade rated entity buying the electricity such as a corporation, municipality, or utility) similar to the corporate bonds in the previous paragraph, an investor can expect predictable 8–12% returns without the risk of the “increasingly possible” negative returns and principal losses that Gross warns of.
While the above example is overly simplistic, it does demonstrate a comparison of the returns an investor looking for secure long-term yield can expect from each asset class. A more robust discussion (for another blog post) is needed around additional benefits, risks, and how to gain access to each asset class as well as a comparison with other real asset investments like commodities and real estate.
Many investors still view renewable power infrastructure assets as unfamiliar or risky despite their ability to deliver investors long-term guaranteed revenue streams — an especially rare quality in today’s challenging macroeconomic environment. Meanwhile some of the largest institutional investors have been taking advantage of this asset class for years. As Blackrock states in its Infrastructure Rising Report, “the best way to navigate the expanding infrastructure landscape is to find the fast rivers. By fast rivers, we mean sectors or geographies experiencing fundamental change or growth, resulting in increased opportunity and deal-flow for investors.” The renewable power sector undoubtedly fits the “fast river” definition. Long-horizon investors who have done their homework on the sector will be the ones most appropriately compensated by these compelling risk-adjusted returns. I believe Bill Gross would approve.