How investors are turning to non-traditional sectors for income streams – By Craig Reeves, Founder, Prestige Asset Management/Prestige Capital Management…
Since the financial crisis of 2008, many of the economic factors that have been taken for granted in global investment simply no longer apply. We are living in a new world of risk and opportunity. Austerity and a change in the regulation of the banking sector are having unanticipated consequences on the way businesses are financed and the role banks play in the economy.
The printing of money by central banks is also changing the complexion of global financial markets, with higher premiums now being placed on real assets like property. Traditional sources of yield have dried up and investors are now turning to alternative investments and equities.
We can see this new world order exhibited in the fact that equity market volumes have tended to stay below 2007 levels, real wages have failed to rise and while unemployment has dropped, government debt piles have remained steadfastly high. We can see signs of deflation and markets that have acted as traditional sources of diversification, like commodities for example, failing to provide the returns they historically delivered.
Taken together, these factors are creating a new and unfamiliar environment for the investor to navigate. Allocators are starting to investigate strategies that can take advantage of this new reality, capitalising on opportunities that did not exist to the same extent five years ago. Prized among these are real-asset strategies, or those which take a more traditional approach to generating returns, for example by replacing banks as sources of credit finance.
The new economic landscape is creating investment opportunities at the same time as investors go looking for non-traditional sources of returns. Take the energy sector in the UK: it is changing drastically, both in terms of how energy is generated, and how it is consumed. The UK urgently needs to develop new sources of electricity, including from renewables, as other projects are decommissioned. A potential gap in generating capacity is starting to emerge.
The last government identified eight technologies capable of delivering 90 per cent of the UK’s energy needs by 2020, and in 2011 adopted a program to provide +15 per cent of the country’s energy from renewable sources by 2020. Investors domestic and foreign are being asked to help with the costs of this huge transformation of the UK power infrastructure.
Large power projects like that at Hinkley Point in Somerset, which is being jointly financed by France’s EDF and China’s General Nuclear Power Corp, bring with them guaranteed price tags for the electricity they will provide over three decades or more. For investors, projects like this can provide government-guaranteed income streams outside the bond market, as the government will need to underwrite price levels in order to attract capital.
Beyond the energy sector, the UK’s farming and food processing industries have also seen tremendous change. Energy costs have been rising for farmers and food groups, along with the price of specialist equipment, machinery and farmland itself. Energy consumed by UK agriculture exceeded GBP1.4 billion in value in 2012, and while farmers hope to see costs drop as a consequence of more renewable energy coming online, the capital investment cost of alternative sources of energy remains a significant barrier to the UK agriculture and food related industries. The cost of electricity in the UK has not fallen materially in the past year, despite the decline in the oil price, and the cost of electricity for UK consumers is approximately 87 per cent higher than it was a decade ago.
Farmers and Food groups are also finding that waste disposal via landfill is becoming economically challenging: on top of normal landfill rates – UK taxes on landfill have risen from GBP56 per tonne at the standard rate in 2011, to GBP80 per tonne in 2014. UK agricultural waste tends to be active and priced at the higher end of the market (compared with inactive waste like concrete), hence cost effective alternatives are starting to look far more attractive.
As banks have exited the credit finance market, farm groups and food processing groups have experienced difficulty in obtaining the loans they need, including to improve infrastructure on farms and on site (e.g. investment in specialist equipment, machinery and renewable energy generation). Although lending to UK SMEs increased slightly last year (9 per cent more than in 2013, according to the British Bankers Association), approved borrowing overall was lower in Q4. Borrowing from the agriculture sector from banks was also lower in Q4 2014 versus the previous year.
For the Bank of England, the problem has been how to encourage much-needed new lending to the UK agriculture and food processing related sectors. Business investment has fallen 34 per cent in five years and new firm creation in the UK is oddly low. The overall impact is a negative one for UK farming and food processing – recent figures from the likes of the OECD and the US Department of Agriculture demonstrate that the British agriculture sector’s level of comparative efficiency has been falling steadily when compared with other developed economies.
Lack of investment in new equipment, machinery and vehicles also has a large part to play in this tale. While the UK government has devoted some money towards R&D, it has not compensated for the high cost of power nor the ageing farming and food processing infrastructure.
A gap has been created here for private investment strategies that can step into the vacuum created by the retreating banks. Credit strategies typically offer consistent positive returns with lower volatility than market-based funds with the added benefit of low correlation to public markets.
In the alternative investment sector we have seen an increase in the number of credit funds on the market. Like real estate funds, they require portfolio management teams that understand the SME sectors they are dealing with, and who can draw on backgrounds in commercial lending and auditing, for example. Credit strategies are scalable, as the demand is there for loans, and a well managed fund can oversee a considerable loan portfolio with relatively few capacity issues.
Both farming, food processing and renewable sectors present an attractive income stream for allocators who are casting around for consistent and non-correlated return profiles at a time when government bonds like the German 10 year bund are threatening to enter negative yield territory. Together, they can also provide a combined investment opportunity, namely the provision of ‘on farm’ renewable energy. This can include wind turbines, solar panels, and increasingly even bio mass and bio gas using waste from the same farm which would otherwise be costly or increasingly impossible to dispose of in landfill.
On farm energy generation brings with it the combined attractions of loans secured against UK farmland (which may now be the most valuable in world) and additional 20-30 year guarantees from the UK government, which is acutely aware of the problems of a lack of commercial bank financing in this sector.
The availability of dedicated credit finance pools for the development of local renewable energy sources is already helping farmers make their businesses more cost effective, and the sector is becoming increasingly aware of the implications of potential power shortages in the future, as more of the UK’s nuclear power generating capacity is decommissioned. Emphasis now lies on the proper delivery of investment finance to the sector through managed assets strategies that can be effectively deployed, with the right terms and guarantees to support them over the medium to long term.
Originally published in the Alternative Investment Management Association “AIMA Journal” Q2/2015
