Analysis: what’s behind the slew of new renewables funds in Germany?

New entrants tapping growth of demand from institutional investors

Last month, First Private, a Frankfurt-based fund manager, issued an unusual press release. It said its Wind Infrastructure I fund had acquired an onshore wind park, while another park the fund had previously bought was now on stream. Nothing unusual about that, you might say. And yet, since its start in 2003, First Private has only ever been known for one thing: quantitative equity investments for institutional clients. That hasn’t changed, it says.

But it hastens to add, though, that four years ago, it began “initiating” renewable funds for its clients. That means that instead of managing the products, First Private brands them and works to raise the investor capital. The management is done by a separate company, in this case a Swiss affiliate of First Private called re:cap global investors. First Private’s new sideline is going well. Wind Infrastructure I has already taken in €50m from German institutions and should hit its target volume of €200m in 2016. In addition, Solar Infrastructure I, another fund it launched, closed last year after hitting a volume of €150m. Both funds’ promise of a 6% annual return after costs has no doubt been a key draw.

First Private’s experience reflects a larger trend, which is that a slew of German asset managers are launching renewable funds to tap into a recent surge in institutional demand.

An example: According to VGF, the German Association for Providers of Closed Funds, those institutions – banks, insurers, pension funds, churches and corporates – placed €556m with green energy funds last year, or more than double the figure for 2010.

German asset managers joining the fray range from prominent ones like Allianz Global Investors (AGI), which recently closed a fund after taking in €150m from institutions, to less known ones like First Private or Munich-based CHORUS Gruppe.

The segment has, however, been dominated by two German private equity houses, namely KGAL in Munich with a 40% share, and Aquila Capital in Hamburg with 20%.

“Many in German asset management recognise that renewables are the institutional investment story for the next 10 to 15 years,” says Markus Götz, Senior Executive at CHORUS in charge of institutional sales.CHORUS recently launched a renewable fund that, like many others targeted to German institutions these days, is based in Luxembourg. This is attributed in part to a slight tax benefit for investors stemming from the treatment of dividends. Having started with €40m in seed money, Götz says he also expects the fund to close with €150m from German institutions. Like First Private, CHORUS aims to return 6.5% annually with its renewable fund.

Given such return promises, as well as the market environment, it’s easy to see why German institutions are investing more in renewable funds. Pension funds and insurers are, in particular, under pressure to find pockets of return, because their mainstays, whether German Bunds (ten-year government bonds), Pfandbriefe (covered bonds) or highly rated corporate debt, offer yields that barely make them money after inflation. Equity markets also look less attractive since they began sliding due to the crisis in Ukraine. Says Götz: “From an asset-liability perspective, renewable investments are a good fit for long-term investors like pension funds. Thanks in part to public subsidies in places like Germany, but also in France and the UK, renewable projects provide a cash flow for that long term.” Such cash flow, combined with the 50% leverage typically used, are helping the funds deliver on their return promises. Providers also claim that these funds can be more stable, as returns are not correlated to financial markets but instead factors like subsidies, leverage and the weather.

But what about deal flow? Renewable fund providers reply that while the situation is getting tighter, there are still opportunities, many of which are in Germany, where the so-called “Energiewende,” or historic switch to renewables, is unfolding. Relying in part on public subsidies, the German government aims to have green energy account for 35% of the power supply from 2020 and as much as 80% from 2050. This will depend on Germany’s ability to install tens of gigawatts of offshore wind capacity – an effort that is fraught with difficulty and the reason the German renewable funds have so far steered clear of it.

Germany’s build-up of onshore wind and solar capacity, by contrast, has gone smoothly, with around 35GW of each source already installed.
In a recent report, KGAL says that over the mid-term, Germany would continue a significant expansion of onshore wind, with between 2.4GW and 2.6GW of additional capacity to come on stream each year.

KGAL was less optimistic about German solar power due to recent cuts in subsidies for the larger projects that funds typically invest in. Still, between the projects already completed and those yet to come on stream, Germany continues to offer nice deal-flow.

Meanwhile, other European countries, including the UK, the Nordics, France, Italy and Austria are shifting more to renewables, thereby creating new investment opportunities.

In the report, KGAL report was especially bullish on the UK solar market, noting that 25% of the overall capacity (4.5GW) was installed in the country during the first quarter alone. Though much smaller than other markets, KGAL also sees Austria as a growth market, with 2GW of onshore wind capacity to be installed by the end of 2014 and 3GW well before 2020.

Looking beyond solar and wind, another attractive option is hydropower. According to Aquila Capital, a provider of hydropower funds, the energy source is not only more efficient than solar or onshore wind, it is not subsidised, thus eliminating the possible risk to cash flow. Indeed, Spain, Italy and Germany have all rolled back renewable subsidies, though in Germany the cuts only affected new installations. Aquila’s argument was in any case enough for Dutch pension investment giant APG, which, last month, invested €250m with Aquila.

According to Christian Holste, Managing Director at Aquila in charge of Real Asset Sales, the firm aims to deliver APG returns of between 6% and 8% by investing in markets like Scandinavia, Italy and Turkey. That German institutions are placing more money with renewables is welcome news for the government inBerlin, which needs the private investment to make the Energiewende work. However, Berlin should not take too much credit for that, as it has not made a renewable engagement easy for these investors. The reason is Solvency II, the EU’s new regulatory regime for insurers. Under Solvency II, now expected to take effect in 2016, investments in renewable energy are considered to be – rightly or wrongly – as volatile as equity investment. That means insurers which, for cost reasons, are obliged to use Solvency II’s standard risk model, face a capital charge equalling 49% of the value of their renewable investment.

As many of their 470 members include smaller firms that would face the capital charge if they invested in renewables, the German Insurance Industry Association (GDV), lobbied the relevant regulators BaFin (for Germany) and Eiopa (for the EU) to get some flexibility on this point. According to Holste, the GDV was unsuccessful. “Unfortunately, and for reasons that are not clear to me, the regulators wouldn’t budge on this point. As a result, many small and mid-size German insurers are having difficulties investing into infrastructure equity such as renewable energy projects,” says Holste. He adds though that as Solvency II will not apply to certain German pension funds like those for the free trades (so-called Versorgungswerke), there is still good potential for renewable investment from them.

Of course another barrier to more renewable investment from German institutions has been the lack of liquidity within the asset class. And while this may not be a concern to a long-term investor like a pension fund at the outset, it does pose a problem if the vehicle does not deliver on its return promise. Yet it seems that, currently, the desire among German institutions to find attractive returns is trumping these concerns.