Renewables

Current Opportunities in Global Renewables and Sustainable Infrastructure

Podcast

Sep 26, 2023

Nick Horton: I am joined by Joe Idaszak and Inigo Mijangos. They manage Brookfield's Global Renewables and Sustainable Infrastructure Strategy. This is a high-conviction listed equity fund that invests in around 30 stocks.

We wanted to use the session today to give you an introduction to three key areas. Firstly, how investors are allocating to the strategy. Secondly, how the asset class is evolving. And finally, touch on some of the portfolio characteristics. So Joe, a good place to start would be if you could describe where you think listed renewable infrastructure fits within a broader asset allocation.

Joseph Idaszak: We think that the equity allocation here is quite broad, and from the way that we built this strategy from the onset, we felt it could fit a number of different places within an allocation. First and foremost, I'd say is more towards the impact and sustainability-aligned themes for listed ESG-focused investors. That can be with regards to how we view and treat sustainable development goals, our pathway to net zero, the exclusions that we've put in place around carbon intensity within the portfolio, and a number of other factors along that line.

Secondly, I'd be remiss to not mention that we are focused on one of the biggest megatrends that you can find in today's market, and that would be the energy transition. Through our investments and our distinct focus on the infrastructure-like side of the equation for the energy transition, you will get a direct exposure towards companies who are making meaningful change today. They're the ones actually investing within, whether it's a new wind farm or solar farm, the transmission grid around it, or other supporting real hard assets. It's a great place to get direct exposure.

And then I think the third piece, which is very interesting, particularly for those that have and are used to a real assets allocation within a portfolio, is the public compliment factor to what you can get within a private portfolio. Maybe I'll pause there, Nick, and give it back to you.

Nick Horton: That's great. It's interesting you say that investors can use this as a private market compliment. Can you kind of go into some of the reasons why you think this is attractive?

Joseph Idaszak: Yeah, absolutely. I think first and foremost, when we think about our space within the listed universe, valuations are incredibly compelling. And when we focus on companies that have basically a three-decade forward look into investing in the energy transition, we have an opportunity to buy companies today that we're only getting for their existing assets in the ground and maybe a couple of years’ worth of pipeline. And so, if you think about it, to be able to invest in the ground floor where you're looking at anything in the range of low double-digit to maybe high single-digit equity IRRs over a long-term investment cycle, that valuation piece is really compelling.

I think also when we look at the flexibility around liquidity right now as well, there's clearly a premium for that within an allocation. So being able for us to have a portfolio of companies where we can trade in and out of on a daily basis vs. that of what you're getting on the private side is very much helpful when thinking about a tactical asset allocation. For example, if you do have a public-private portfolio approach. And then also for that recycled capital or committed capital thematic around when and where you can be tactical for putting private capital back into public and vice versa, depending on the flow of those distributions.

I think last but not least, it's the diversification that you get from our approach to this portfolio by focusing on companies that are engaging in energy transition globally. It allows us to build a best-in-class portfolio across different markets, across different geographies, and therefore can also be a little bit of a sector completion approach for private. So, we'll get into it probably a little bit later on, but we're investing in companies that most private portfolios would have difficulty getting full access to on a global scale. And I think having that as an added benefit is certainly an element of the equation here.

Nick Horton: Thanks, Joe. Let's move to you, Inigo. So, for investors that want to get exposure to the energy transition, there are obviously a lot of different options out there. Why do you think infrastructure is so important?

Inigo Mijangos: Thank you, Nick. We believe that investing in businesses that have similar characteristics to those of more classic infrastructure assets, they offer the best risk-reward proposition, in our view. They will still enjoy significant growth and reinvestment opportunities, while at the same time they will be more resilient. By infrastructure-like assets, we will refer to businesses that own very long-duration assets with generally contracted revenues and a very lean operating cost structure that provide, in our view, high visibility and, more importantly, more stability of cashflow generation. Which means that over time, the returns that the projects can generate are going to be more stable and more visible.

Interestingly, these companies do not face technology risk disruption, as they operate equipment technologies that have already been proven. And on the other side, these companies actually tend to benefit from new technologies, as more efficient equipment like wind turbines, like solar panels, like battery storage, they help to reduce its production cost, which makes them, for example, wind energy or solar energy, even more competitive vs. conventional power of sources of overtime.

Nick Horton: Thanks, Inigo. I think that point you make is an important one. We've obviously spoken to a lot of different investors across Europe, and I think there's definitely an unintended consequence when people apply a sustainability lens to some of these investment portfolios. And the main unintended consequence is one of factor concentrations.

So, if you think conceptually these sustainable portfolios tend to have a bias for these kind of low capital intense companies. They tend to have a technology bias. And as a result, the factor exposures of these portfolios tend to be high beta, have a significant growth bias, and very limited downside protection. And I think that's particularly where infrastructure comes in and certainly as a compliment to these other sustainable strategies.

Going back to the point you made on stability of cashflows, Inigo, obviously that feeds through into the portfolio characteristics in terms of being lower beta, no real significant growth bias. So, I think next let's try and move on to how the asset classes have been developing over time. And Joe, we'll start with you. Can you describe some of the areas within renewables that you're finding interesting at the moment?

Joseph Idaszak: Thanks, Nick. One thing we'd like to always comment on is that when you buy the renewable strategy that we offer, it's not just a wind farm or a solar farm story. That's certainly a big element to what we do, but by no means is the only place that we look and focus on with regards to the assets that we invest in. In conjunction with new wind farms and new solar farms, there’s a massive growing need to make our grid more flexible, more agile, and frankly a lot more emboldened than it has been ever before in the past.

So, we are looking pretty significantly at transmission and distribution companies, whether it's across state lines or within an existing country, but also at the local distribution level, as we think about not just new areas of supply, but new areas of demand as well. Now in this post-COVID world, we're much more going to be reliable on a flexible grid, one where we can maybe plug-in from different locations for work. We might not always be in an office setting Monday through Friday and therefore demand centers will change. I think that's a big differentiation for how we think about accompanying our investment approach on wind and solar alongside of other aspects of the electric grid. But also, as a key differentiator, and we focus on renewables a lot, but it'd be also important for us to mention the sustainable infrastructure side of how we invest.

It’s not just about decarbonizing the grid and creating a lower net zero footprint from an emission standpoint, but also a much more broad scale approach on positive environmental impact from infrastructure assets. And what I mean by that is, we also focus on the impact that our water distribution systems have, for example, or our waste treatment facilities. So we do have a fairly large element of water and waste-based infrastructure when thinking about how to create a full portfolio that's focused on sustainability of infrastructure more wholly.

Nick Horton: I think we've covered the opportunities for the asset class. Maybe you can touch on some of the risks that are associated with investing in the energy transition.

Inigo Mijangos: I think, Nick, it's fair to say that renewable energy is a fairly new asset class. In addition, we've seen how the push to accelerate decarbonization or the energy transition has been pretty aggressive, especially in the last few years. We can say that parts of the industry as a whole have been running faster than it could deliver. This means that we have seen challenges for the supply chain, including manufacturing disruptions on the back of COVID restrictions or freight and logistics headwinds.

This obviously has led to higher-than-expected cost inflation rates that not every company out there has been able to pass through. While in our view, technology in the wind and solar space has existed for years, it is also true to say that as equipment becomes bigger, manufacturers need to keep up with quality standards and this has created some challenges for some players in the industry. In our view, this is just a normal process in a new industry and over time will be sorted out.

Nick Horton: Let's touch on the portfolio in a bit more detail. How do you think about investing in non-infrastructure names for the portfolio?

Inigo Mijangos: As you said, the core of our investment universe and our portfolio are businesses generating visible and recurrent cash flows in the long term. We believe we can also add some value investing in what we call adjacent Center Renewal Energy businesses where supply and demand can create valuation dislocations. I'm referring this case to businesses or companies that manufacture smart meters, for example. We are seeing how they're being rolled out across the globe to promote more efficient ways of consuming power or companies involved in the energy storage or more recently in hydrogen, which we believe they will in the years to come. They will radically change the way we produce and the way we store and consume energy. We also have exposure to companies that can make our high voltage networks operate more resiliently, more efficiently, as Joe mentioned before. I wanted to highlight that these are businesses that offer a different risk proposition to the more infrastructure-like activities, as we mentioned before. So we pay even more attention to how we value them because it's a different approach.

Nick Horton: Now with an infrastructure portfolio, you're investing in utility-type companies, which tend to have historically higher emissions. So maybe it's worth just going into a bit of detail how you think about probably both exclusions and also making sure you've got the appropriate sustainability tilts in the portfolio.

Joseph Idaszak: Nick, we can start by thinking about the importance in our opinion of going and investing in the areas where emissions need to be taken out first. So, through our approach, it's important to understand that the electric grid in general is the single greatest source of all carbon emissions that we have around the globe today. So as, and when, we can start to decarbonize the electric grids, that can work in our favor as we think about the broader electrification of society and the economy as a whole.

Within that, we certainly take what we describe as a pragmatic approach around investing in this sector. We focus on three key pillars of sustainability, the first and foremost of which would be positive environmental impact. And it's not just again on decarbonization, but really how are our assets progressing towards a better overall environmental standpoint from today through the next couple of decades.

The second pillar would be it's important to have both affordable and equitable access for all of our infrastructure-based services. And the third would be the reliability, resilience, and security of those infrastructure systems. When you marry all three of those together, that's how our approach centers and focuses on investing in the companies that we do. In order to find the best actors, we have put a number of exclusions in place, both a negative and positive.

On the negative side, we're putting in place a cap, for example, on coal power with any individual company that we invest in. We do not want to see any more than 10% of their existing asset base by whether it's cash flows, revenue streams, CapEx, et cetera. There are a number of different ways to measure those from an EU taxonomy standpoint within the company itself.

As such, we take a little bit more of a pragmatic approach on natural gas with a little bit of a higher threshold only because it helps to solve for things like reliability, security, but also from an affordability standpoint. You mentioned SDGs, I brought them up earlier. We certainly focus on climate action number 13 as our key SDG for this strategy, but a number of others as well that we think infrastructure can more broadly impact on the positive side. I think about clean water, for example, affordable clean energy as well.

It really is important for us to have a capped side of the equation from an emission standpoint for doing a negative based exclusion on our power output from coal, for example, but then also our positive alignment on SDGs on that forward-based investment approach.

Nick Horton: Great. Now, last but not least is net zero, which we know is an important topic for lots of investors. How specifically do you think about net zero pathways for the companies in which you're investing?

Joseph Idaszak: I think as a lead-in from the last question, our approach towards the investing in companies that do have a cap, for example, on certain types of high carbon intensity within their individual portfolios is a critical first step for us when thinking about the companies that will then ultimately be an impact towards a really strong net zero trajectory for an overall portfolio. By putting in place a threshold, effectively, we've capped the carbon intensity for the portfolio today and ultimately, by the companies that we invest in being key investors on a CapEx basis on wind and solar, and then transmission distribution for example.

You're already going to have a very aligned portfolio on emissions reductions. When we look at our portfolio from a net zero perspective, it's one of the ways that we measure ourselves directly. And so, for example, our 2022 portfolio has a 47% reduction pathway between now and 2030 as an intermediate step. So we're hyper-focused on the net zero pathway that our companies can have, and then ultimately how that rolls up into our portfolio, so we can have a portfolio-aligned approach towards the Paris Agreement and Net Zero by 2050.

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