Premier Miton Global Renewables Trust — Refreshed mandate continues to prove its worth

Smith says Russia’s invasion of Ukraine in late February has caused a shift in the debate around renewable energy generation, from questions over the cost and availability of government subsidies and the pace of transition to net zero carbon emissions, to a greater focus on energy security and self-sufficiency. ‘Outsourcing their energy security to Russia was never a good idea for Germany,’ the manager says, referencing the suspension of the Nord Stream 2 gas pipeline project and Germany’s announcement that it is bringing forward its target of 100% renewable energy generation from 2050 to 2035. At the same time, already-high power prices have surged as a result of the conflict, with the UK electricity baseload one-month forward contract standing at £339/MWh on 9 March (source: Bloomberg), up more than £100 in the space of a week, and a huge dislocation compared with a historical level of c £50–60/MWh coming into the spring. While clearly bad for households, the surge in prices is beneficial for renewable electricity generators with exposure to merchant pricing, as they benefit from the higher price while their marginal production cost remains unaffected. The higher rate of inflation will also benefit UK producers with index-linked supply contracts; those in the United States tend to sell their power on long-term fixed price contracts, and therefore are less well positioned.

Despite these dynamics, Smith points to a sell-off in the renewables sector prior to the war in Ukraine, driven by short sellers whose view is that higher energy prices are temporary, and that higher interest rates will hurt valuations. Further, higher prices for raw materials such as steel, aluminium and copper mean new projects will be more expensive and rates of return will be lower. PMGR has very limited exposure to capital goods companies and technology stocks, and the manager prefers companies with inflation-linked revenues; furthermore, he expects a positive impact for those producers that have hedged their power price exposure in recent years, as the much higher current prices will provide a tailwind as those hedges unwind and are reset at higher levels. Following the Russian invasion, renewables stocks have largely gone up – ‘war is bad for banks but good for energy’, says Smith, pointing out that if the world is not buying energy from Russia then the price will go up regardless of what type of energy it is.

‘All the stars are aligning for higher power prices,’ the manager argues, pointing to the increasing global focus on supply and security, the fact that building more quickly costs more, and that return assumptions will be based on current higher costs. ‘Costs of depreciation and interest costs are all long term, and even maintenance costs tend to be fixed; the lease cost is fixed for the life of the asset if you don’t own the land, so it’s all fixed, and the only variable is the weather,’ he explains. The manager prefers UK suppliers in a high power price and high inflation environment, arguing that the United States does not have the same tailwinds as ‘they already have energy security and the revenues are largely not inflation-linked’. At only c 12.5%, PMGR’s US exposure is ‘pretty low for a global fund’, driven by a switch over the past year out of US and into UK yieldcos, which also boosts the portfolio’s dividend income, as the UK companies (particularly in the solar space) tend to be on higher yields.

Looking ahead, Smith argues that three big trends currently at play in renewables and the PMGR portfolio will persist: European energy security, with increased rollout of renewable capacity and higher power prices as the region weans itself off Russian gas; positive dynamics in the UK market given inflation linkage, high power prices and the structural discount of UK equities versus other developed markets; and Chinese decarbonisation, with greater wind and solar capacity an important factor in chipping away at the burden of being ‘short of everything else’. ‘Contrary to what some people believe, China cares what the world thinks,’ says the manager. ‘It is the world’s biggest and fastest-growing renewables market, and also offers decent returns,’ he concludes.

PMGR invests across a broad range of renewable energy-focused market areas (see Exhibit 3), with a particular focus on renewable energy developers and yieldcos/funds. While both these categories broadly cover businesses that own and operate renewable energy generation facilities, the principal difference is that the developers take on construction risk, while the yieldcos (which, as the name suggests, have a focus on providing income to investors) buy pre-existing assets.

At 28 February 2022, PMGR’s top 10 holdings (Exhibit 1) accounted for just over half of total assets, a slight increase from 46.1% a year earlier. The largest holding, Drax, is a UK-based former coal-fired power generator that has switched to using wood pellets (biomass) for electricity production. During 2021 it acquired one of its main suppliers of wood pellets, Pinnacle Renewable Energy, which had also been a holding in PMGR’s portfolio. Biomass was the subject of some negative press commentary during 2021, with accusations that the sector was contributing to deforestation. However, Smith stresses that Drax only uses wood that would otherwise be wasted, with c 35% of its pellet production coming from sawmill residues, and a further 40% from ‘low grade round wood’, largely the upper segments of tree trunks that are unsuitable for use as construction timber, and might otherwise be left to rot and thus release their stored carbon back into the atmosphere. The company is also developing carbon capture and storage technology, which could result in it becoming a net negative carbon emitter, thereby assisting in the broader push towards ‘net zero’.

The second and third largest holdings are both Chinese companies, which performed well in 2021: China Suntien Green Energy’s share price was up 155.5% on the back of strong gains in output and earnings, while China Everbright Environment saw a gain of 42.5% as the market showed new appreciation of its waste-to-energy strategy. Year-to-date in 2022, both companies have seen share price declines (down 21.5% and 17.4% respectively from 1 January to 8 March) as investors pull money out of China, but Smith remains convinced of their positive attributes, and together they made up 12.7% of PMGR’s portfolio at 28 February.

One of the largest portfolio shifts in the past 12 months has been a move away from US assets in favour of the UK (Exhibit 2). Smith prefers the inflation linkage of UK yieldcos, whose revenues are largely connected to government-issued renewable obligation certificates (ROCs) and contracts for difference (CFDs), both of which are index-linked, as well as having more direct exposure to power prices than their US counterparts, most of which contract their revenues over the long term at fixed prices, increasingly to corporate buyers. Greencoat UK Wind (UKW) and NextEnergy Solar Fund (NESF) are now the biggest holdings among UK yieldcos; UKW was PMGR’s fifth biggest position at 28 February 2022, having not featured in the top 20 a year previously.

Smith has very little exposure to the technology part of the renewable energy value chain, preferring to own companies that make, store or distribute electricity. This has been positive for the portfolio in recent months, as renewable energy technology stocks have sold off along with other highly valued tech names, particularly in the United States.

PMGR has seen three consecutive years of NAV total returns ahead of the MSCI AC World Index of global equities (Exhibit 4), although recent weakness in its share price means it has not quite matched this feat in share price total return terms. While the fund does not construct its portfolio with reference to any index, during 2021 it adopted a new performance benchmark, the S&P Global Clean Energy Index. The index, like PMGR’s portfolio, is made up of listed companies involved in the generation and supply of renewable energy, although in terms of constituents the two are very different, with the index having far more exposure to the United States, and to companies at the technology/components end of the renewables value chain. With stocks such as wind turbine manufacturers having struggled in the face of higher input prices for commodities like steel, and with highly valued US technology stocks having sold off more than the broad equity market in recent months, PMGR has significantly outperformed the index (by 26.4pp and 38.6pp respectively in share price and NAV total return terms) over the past 12 months (to 28 February 2022). However, over the very short term, the index has outstripped the PMGR portfolio in the past month (Exhibit 5). Note that the index returns for periods over more than one year in Exhibits 5, 6 and 7 also include the trust’s benchmark prior to FY21, which was a broad global infrastructure index.

During FY21 (to 31 December), PMGR benefited from its preference for renewable energy infrastructure plays rather than equipment makers and technology names, and stock selection within the infrastructure space was also positive. As noted in the Current portfolio positioning section, Chinese stocks performed particularly well during FY21, with top 10 holdings China Suntien Green Energy and China Longyuan Power Corporation both seeing their share prices more than double. However, Smith says that while he still expects good operational performance from the Chinese holdings – buoyed by policy support for a reduction in coal-fired power generation – he would be surprised to see such share price moves repeated in 2022. In contrast, the outlook for UK yieldcos is positive after a relatively subdued FY21, given their inflation linkage and exposure to wholesale power prices, although the manager notes that these funds’ NAVs continue to reflect substantially lower long-term power price assumptions.

In Exhibit 8 we present PMGR alongside a group of peers drawn from several AIC sectors. While it has some overlap with all the selected peers in terms of focus, PMGR is the only investment trust offering a diversified portfolio concentrating exclusively on listed renewable energy plays. Within the group are the other constituent (alongside PMGR) of the AIC’s Infrastructure Securities category, Ecofin Global Utilities & Infrastructure (currently c 26% invested in renewables); the three members of the Environmental sector (Impax Environmental Markets, Jupiter Green and Menhaden Resource Efficiency); 10 constituents of the Renewable Energy Infrastructure category (which broadly fit PMGR’s definition of ‘yieldcos’, and some of which are holdings in the portfolio); and Utilico Emerging Markets, which sits in the AIC’s Global Emerging Markets sector but has a broad focus on utilities and infrastructure.

Although the smallest fund in the peer group (as measured by market capitalisation; by total assets including ZDPs it is of a similar size to Jupiter Green), PMGR ranks first by NAV total return performance over both one and three years (out of 16 and 15 funds respectively). While it ranks a respectable sixth of 12 and second of four over five and 10 years, the shorter periods are more relevant given the fund has only been invested entirely or mostly in renewable energy for around the past three years. Impax Environmental Markets, seen widely as a ‘category killer’ in the environmental space and by far the best performer over 10 years, ranks second from bottom over one year, with only Jupiter Green having performed worse. This arguably reflects the environmental funds’ greater exposure to renewable energy technology (which has sold off particularly hard) rather than renewable generation, which (including yieldcos and utilities) dominates PMGR’s portfolio.

Despite its superior recent performance, PMGR currently stands on the second widest discount to NAV, at 16.8% versus a peer group average premium of 1.3%. Ongoing charges (1.65% for FY21) are somewhat above average, while the 4.2% dividend yield is a little below the average for the group as a whole, although it is the highest among the equity funds by some margin. PMGR’s gearing, at c 40% of net assets, is the highest in the table, although we note that it is hard to make a meaningful comparison given that, particularly among the yieldcos, companies can either carry debt at the parent company or project level, and this is not always consolidated.

While PMGR still aims to reward its shareholders with a high income in addition to long-term capital growth, its dividend was reset in FY21 to reflect the lower level of gearing resulting from the retirement of the 2020 ZDPs and the smaller 2025 ZDP issue (see Capital structure section). Dividends are paid quarterly, in broadly equal amounts. For FY21, four equal dividends of 1.75p have been announced, totalling 7.0p (FY20: three dividends at 2.5p and a fourth at 2.7p, totalling 10.2p). However, although the total dividend per share for FY21 is 3.2p below the prior year, ZDP financing costs also fell, from 7.3p to 3.9p per share. While the financing costs are charged to capital rather than income, the overall outcome for shareholders of the dividend cut and cost reduction is therefore slightly positive (+0.2p per share). The FY21 dividends were fully covered by income (7.4p per share), in contrast to FY20, where a shortfall in portfolio income (at 9.3p per share versus total dividends of 10.2p) meant the trust was required to dip into its revenue reserves. At end-FY21, PMGR’s revenue reserve stood at c £1.2m, or c 6.5p per share. Note that while this does not include the deduction of the fourth interim dividend for FY21, the movement from FY20 to FY21 did reflect the payment of the higher Q420 dividend of 2.7p per share. Based on the current share price and the FY21 total dividends, PMGR currently yields 4.2%.

At 10 March 2022, PMGR’s shares traded at a 17.5% discount to cum-income NAV. In a period marked by daily equity market gyrations as investors seek to digest the implications of Russia’s assault on Ukraine, the current discount is appreciably wider than both short- and longer-term averages (7.6% over one year at 8.2% over each of three, five and 10 years), and is the widest it has been in the past 12 months. In contrast, as recently as April 2021, PMGR’s board was issuing equity as the share price stood at a small premium to NAV (Exhibits 10 and 11). If, as Smith expects, the renewed focus on energy security (with sanctions on Russia set to be extended to ban oil imports) causes a re-assessment of the renewable energy sector (which has sold off along with may tech and growth stocks in the past six months), PMGR’s discount could narrow once more into the 0–10% range that persisted for most of 2021.

Premier Miton Global Renewables Trust has been part of the Premier (now Premier Miton) stable for almost 20 years, ever since the 2003 rollover of the Legg Mason International Utilities Trust. Initially known as Premier Utilities Trust, it changed its name to Premier Energy & Water Trust (PEWT) in 2008 and subsequently to Premier Global Infrastructure Trust (PGIT) in late 2017. PGIT’s mandate built on that of PEWT, investing in equity and equity-related securities of companies operating in the energy and water sectors generally, as well as other generic infrastructure investments. In October 2020, reflecting a gradual shift in focus towards the renewable energy segment of the infrastructure universe, PGIT’s shareholders voted in favour of proposals to change its name to Premier Miton Global Renewables Trust (PMGR) and its investment remit to a more targeted investment proposition dedicated to renewable energy and sustainable infrastructure investments. The trust has been managed since 2012 by James Smith.

PMGR sits in the AIC’s Infrastructure Securities sector, a peer group for funds that invest in infrastructure shares. There is currently no sector for funds investing in renewable energy shares, underlining the differentiation of the trust’s approach. While it is hard to find an equity benchmark to reflect PMGR’s diversified global approach, since FY21 the trust has measured its performance against the S&P Global Clean Energy Index (previously it used a broad global index of infrastructure shares).

The trust’s official investment objective is to achieve a high income and to realise long-term growth in the capital value of its portfolio. PMGR pays dividends quarterly. The trust is geared (net gearing of 40% at end-February 2002) via ZDPs (see the Gearing and Capital Structure sections).

PMGR’s investment policy is that, in normal market conditions, its portfolio should consist primarily of a diversified portfolio of equity and equity-related securities of companies operating in the renewable energy sector, as well as other sustainable infrastructure investments. In constructing the portfolio, Smith aims to find individual assets or companies offering capital appreciation, income or a combination of the two, with a range of higher- or lower-risk profiles, in order to achieve a balance of risk and return and yield and growth to fulfil the trust’s total return mandate. The manager seeks global exposure but constructs the portfolio without reference to any global indices, which tend to be heavily US-focused.

Smith describes the investment process as ‘very bottom-up’. In addition to meeting companies and visiting projects, as a chartered accountant by training, the manager makes a thorough analysis of the financial statements of potential investee companies, as well as assessing a range of valuation metrics including EV/EBITDA, price/book, P/E and dividend yield, and particularly return on equity and net debt to EBITDA. ‘As a yield-conscious investor the only way you can achieve sustainable returns is by buying companies that are sensibly valued,’ he says.

Historically the majority of the trust’s returns have come from yield, but Smith is keen to stress the importance of a mix of companies to achieve a balance of growth and income. He considers each potential investment within the context of its own sector, for example comparing US with UK renewables funds whose returns are primarily in the form of income (yieldcos), or assessing renewable technology companies against each other. The manager says it is important to compare like with like given the different risk and return profiles of each type of company. Many yieldcos use their own metrics such as cash available for distribution (CAFD), which are not applicable to other types of company. Meanwhile, renewable technology companies may offer higher capital growth potential alongside greater potential risks.

Holding periods for portfolio companies have historically typically averaged around three years. The level of turnover was markedly higher for FY20 (93.7%) because of the change in investment policy and the repayment of the 2020 ZDPs, but was back in the normal range at 37.4% for FY21. Smith says exits are usually on valuation grounds, with profits reinvested in other geographies or in smaller or earlier-stage companies that are less well understood by the market. However, positions may also be sold if a company has gone ex-growth, there is a change in management, or the investment or project has not progressed as expected.

Premier Miton has a dedicated head of ESG, who monitors and scores all the company’s portfolios from an ESG perspective. Smith points out that PMGR’s renewable energy focus is aligned with three of the United Nations’ Sustainable Development Goals (SDGs): affordable and clean energy; industry, innovation and infrastructure; and climate action. Governance has always been a strong focus for the trust, as poorly governed companies do not tend to make good investments. Furthermore, the manager notes that emerging market renewables companies in particular tend to have a good record on social factors through supporting the local economy, although this can go unnoticed by international investors as these firms may be below the radar of ESG ratings agencies.

In January 2021, PMGR was granted the London Stock Exchange Green Economy Mark, awarded to companies and investment funds that are driving the global green economy.

PMGR’s use of ZDPs as gearing (see our initiation note for a potted history) has the advantage of eliminating annual interest coupons, with the redemption value of the ZDPs instead hopefully being covered by the trust’s higher investment returns (as a result of the gearing effect) over the life of the ZDP issue, although it also carries the potential risk of being highly geared in a falling market. The 2025 ZDP issue was smaller than previous issues, with £14.2m shares issued at 100p – equivalent to c 50% gearing – on 30 November 2020. The 2025 ZDPs have a redemption price of 127.61p, equivalent to a gross redemption yield of 5.0% at issue and 4.68% at 28 February 2022. Based on the NAV of both the ZDPs and the ordinary shares (cum income) at 28 February 2022, PMGR’s gearing represents 29.3% of total assets and 41.5% of net assets. Given the ZDPs are a sterling liability, the manager may use currency hedging to offset any sterling underweight in the portfolio.

Premier Portfolio Managers (PPM), a division of Premier Miton Investors, acts as PMGR’s alternative investment fund manager (AIFM) under the AIFM Directive, and is paid an annual management fee of 0.75% of gross assets, charged 40% to income and 60% to capital. No performance fee is payable by the trust. Ongoing charges were 1.65% as at end-FY21 (31 December), a decrease from 1.76% for FY20.

PMGR is an investment trust with two classes of share: ordinary shares and ZDPs, which it has used throughout its existence to provide gearing. There are 18.2m ordinary shares and 14.2m ZDPs in issue as at 10 March 2022, with 150,000 new ordinary shares having been issued in H121 while the shares were trading at a premium to NAV (Exhibit 11). The current tranche of ZDPs was issued in November 2020 at 100p, with a maturity value of 127.61p at 28 November 2025, equating to a gross redemption yield of 5.0% on the issue price (current yield to maturity of 4.68% at end-February 2022). The ZDPs had a hurdle rate of -22.5% at 31 January 2022, meaning PMGR’s total assets would have to fall by more than 22% a year over the remaining life of the ZDPs in order for the redemption price not to be met in full.

PMGR has an indefinite life, subject to a five-yearly continuation vote, the next of which is due in 2025. At the March 2020 vote, more than 99% of votes cast were in favour of continuation.

As shown in Exhibit 13, PMGR’s ordinary shares have a high level of retail ownership on platforms such as Hargreaves Lansdown, Interactive Investor, AJ Bell and Halifax Share Dealing (which together account for around half of the share base). Average daily trading volume on the London Stock Exchange over the past 12 months (Exhibit 14) was c 31,800 ordinary shares, or c 0.2% of the share base.