by Corporate Bonder

Market Overview

Data compiled by the Bank for International Settlements indicate that the total size of the global debt securities market (domestic and international) was $98.7 trillion as at September 2011, of which $89.9 trillion were notes and bonds. Governments accounted for $44.6 trillion of outstanding debt securities, financial organizations $41.9 trillion, corporations $11.2 trillion and international organizations $1.0 trillion.

The focus of this report is on corporate borrowers. US corporations are the largest debt issuers, accounting for 46% of corporate debt globally, followed by the Eurozone with 20%, Japan 9%, China 6%, and the UK and Canada with 3% each.  The Merrill Lynch Global Broad Market Corporate Index (MLGBMCI), excluding financials, can be used as a proxy for the global corporate bond market in order to estimate splits by credit ratings, currency and sectors.

Two thirds of the MLGBMC Index (ex-financials) has been issued in USD and 77% has an investment grade credit rating. Capital intensive industries account the majority of issuance with Utility, Energy, Telecommunications, and Basic Industry sectors accounting for 14%, 15%, 11% and 10% respectively.

Factors affecting issuance during the March 2012 quarter

There were 849 new developed market corporate bonds issued during the quarter, raising over $414 billion. BBB rated corporations were the largest issuer group by credit rating accounting for  29%. Sub-investment grade and European issuers increased their proportion of issuance versus Q4 2011 as market sentiment improved.

The following two charts illustrate how issuance was split by credit rating and currency during the three months to 31 March 2012.

Factors affecting investor demand during the quarter

U.S. long-term mutual funds experienced $105.8 billion net inflows over the quarter. Despite appetite for risk has made a come back, investors in aggregate continued to move out of equities and into bond funds, with $10.0 billion coming out of equity funds and $93.7 billion of net inflows to bond funds over the period.

The ECB’s introduction of the Long Term Refinancing Operation and improving US economic data led to an increase in risk appetite from investors. Credit spreads tightened, particularly for bonds issued by financials and corporations based in so-called periphery nations. Some of the spread tightening has unwound at the end of the quarter and into the start of the second quarter as familiar themes of Spanish sovereign risk and bank balance sheet uncertainty re-emerged.

Developments in the low-carbon corporate bond market

The misfortunes of equity investors in publicly listed wind turbine manufacturers are well documented.  The following brief analysis is a glance at the bond market for wind turbine manufacturers and explores how bond investors have fared and how they perceive the risks surrounding the companies.

The author could only find two bonds from dedicated wind turbine manufacturer companies, listed in the table below.  (In addition, Suzlon (SUZLON.BO) has convertible bonds on issue, but has not issued conventional bullet bonds)

Table 1. – Wind turbine manufacturer public bonds – What currency?
Issuer	Coupon	Maturity	Price*	Yield (YTM)	Credit Spread (OAS)
Nordex (NRDXF.PK)	6.375%	2016	95	7.9%	680
Vestas (VWDRY.PK)	4.625%	2015	88	9.5%	864

* At 12/4/12

Each company had one senior unsecured bond, with the rest of their debt financed through banks in the form of term loans and revolving credit facilities.

In the author’s opinion the bond documentation carries weak covenants, more in line with investment grade bonds, rather than the high yield bonds. Further, the companies do not provide information regarding financial covenants provided to the bank lenders (and not the bond investors), which cedes control to the banks and creates uncertainty for bond investors (and even more so for equity investors).

As demonstrated in table 1, the bonds of Nordex and Vestas have lost capital value since they were issued, however Charts 1 & 2 illustrate that bond investors who bought the bonds at the issue date have broken even (so far) with coupons received making up for the capital loss. The charts also illustrate the size of the capital loss that equity investors have incurred over the same period.

While wind turbine manufacturer bonds have outperformed their equity counterparts, they have underperformed the broader bond markets. Charts 3 & 4 illustrate how the Nordex and Vestas bonds have risen in yield and credit spread versus the Merrill Lynch Eur High Yield B-BB Bond Index (an index of higher risk European corporate bonds) and the Merrill Lynch EMU Non-Financial BBB Bond Index (an index of lower risk European corporate bonds).

Neither bond has an official public credit rating. However,  4 gives us an indication of how the market perceives the credit worthiness of the bonds. The higher the credit spread, the higher the credit risk is perceived.

When the Vestas bond was originally issued, it was priced with a credit spread close to a low BBB bond, while the Nordex bond was closer to a BB rated bond. The market’s opinion of their credit worthiness has clearly deteriorated since then, with Vestas trading more in line with low single B bonds and Nordex with high single B issuers. The Vestas bond has underperformed Nordex since the latter originally issued its bond in April 2011.

Corporate Bonder is a corporate bond fund manager in the London. This article first appeared on the Climate Bonds Initiative blog.

Posted by Guest Contributor at 02:23 PM | Permalink | Comments (0)

by Sean Kidney

Warren Buffet is a famous proponent of value investing and he surely received a sign of the value in solar investments over fossil fuels last week. The MidAmerican Energy $850m Topaz solar project bond we mentioned a couple of weeks ago was so successful that a second tranche is expected to cover the remaining debt of the project. The offer was oversubscribed by $400m which would have mopped up the total $1.2bn of debt in the project; Buffet's Berkshire Hathaway (BRK-A) controls MidAmerican.

In contrast, Buffet’s investment in $2bn of bonds from gas company Energy Future Holdings is taking a hit due to low gas prices in US. The market value of the investment is already at $878m with further write downs expected.

It’s interesting to note that the expansion of drilling in the US rewrites the script on the increased policy risk of renewable investments over fossil fuels. It seems investors are beginning to recognise the steady fixed returns on renewables over the volatility of fossil fuel prices. Topaz is the latest in several large solar bonds offered including Desert Sunlight ($595m) and NextEra Genesis ($562m) both at AAA tranches due to loan guarantees. Topaz and the secondary tranches of the other two projects were both rated at BBB-/A-.

Sean Kidney is Chair of the Climate Bonds Initiative, an "investor-focused" not-for-profit promoting long-term debt models to fund a rapid, global transition to a low-carbon economy. 

Posted by Guest Contributor at 09:12 AM | Permalink | Comments (0)

by Corporate Bonder

The global bond market is huge. Data from the Bank for International Settlements shows that the total size of the global debt securities market (domestic and international securities) was $99.5 trillion as at June 2011, of which $89.9 trillion were notes and bonds. Governments accounted for $43.7 trillion of outstanding debt securities, financial organizations $43.8 trillion, corporations $11.0 trillion and international organizations $1.0 trillion.

Against that, Bloomberg has estimated that there are $230bn outstanding of fixed-interest securities that meet their “green bonds” definition. And of course the IEA talks of $1 trillion of investment a year needed for the global shift to a low-carbon economy.

The Solar Corporate Bond Market

There’s been a lot commentary on the collapse in the solar market and the accompanying share prices of solar companies. In this first of what we plan will be a quarterly market update we’ll have a look at the bond market for the solar industry and how it has been affected by market developments.

To illustrate the state of the market we found three solar companies that have issued corporate bonds and another five with convertible bonds outstanding. The bonds are listed below; they show that the market is clearly distressed, with yields on a number of bonds greater than 20%, despite a significant rally in solar convertible bonds during January. Credit spreads of greater than 1000 are typically thought of as being at distressed levels. The pricing data is as at February 7th 2012 (Bloomberg).

Table: List of bonds (convertible and conventional) issued by solar companies. Market prices trading at distressed levels.
Bond	Price	Yield	Credit Spread
WFR (MEMC) 7.75 19 USD	84.3	11.0	950
SOLARW 6.375 16 EUR	61.5	22.4	1884
SOLARW 6.125 17 EUR	58.5	20.6	1855
REC 11% 14 NOK	97.9	12.9	912
REC 0% 16 (FRN) NOK	77	14.3	1162
REC 9.75% 18 NOK	71.8	18.2	1428
REC 6.5% 14 EUR CONVERT	60.9	38.2	2949
SPWR 4.75 14 USD CONVERT	91.8	9.0	842
SPWR 4.5 15 USD CONVERT	87	9.4	876
TSL 4 13 USD CONVERT	87.7	13.7	1289
STP 3 13 USD CONVERT	73	34.6	3356
JASO 4.5 13 USD CONVERT	84.8	18.6	1761
SOL 4.125 18 USD CONVERT	67.8	12.0	1405

REC Case Study

REC (RNWEF.PK) is a useful case study as it has publicly listed senior debt, subordinated convertible debt and listed equity which we can use to compare the performance of different parts of the capital structure. The chart illustrates the total return (rebased to 100 at 15 April 2011 when the longer bonds were issued) for all listed instruments in the capital structure.

The senior bonds have exhibited less volatility and a smaller fall in market price due to their lower risk profile than the convertible bond and the equity. Nevertheless, having lost less will be of little comfort to investors that bought the longer dated senior bonds at or around the issue price of 100, as they are now priced in the 70s. The fall in the price of the bonds reflects a substantial increase in the market’s perception of the risk in the sector and uncertainty regarding the value of solar assets. This does not bode well for solar companies looking to raise finance in the debt markets at present as the required yields are simply too high to make the businesses viable. The lowest risk solar companies in the market may be able to access markets but most companies will have to wait until yields come down and investor appetite improves before they can issue bonds.

Implications for Other Renewable Energy Companies

Corporations with solar activities amongst a much larger set of businesses (eg. integrated utilities or industrial conglomerates) are better placed to raise corporate finance for solar activities as the interest rates the market requires on these more diversified businesses are currently significantly lower.

While the solar market’s woes are unhelpful to the broader renewable energy market, many of the issues are specific to the industry and therefore should not inhibit the borrowing ability of corporations operating in other renewable energy activities. The current sovereign and financial sector malaise is a much more serious issue for broader renewable energy financing at the present time.

REC bond spreads

Bryn Jones, manager of the Rathbone Ethical Bond Fund commented: “the solar market continues to suffer from a number of headwinds, however senior bonds with higher coupons or structured debt can outperform equity in more stressed conditions. As a result this could support the view for more Structured Bonds issuance within the renewable energy space.”

Corporate Bonder is a corporate bond fund manager in the London. This article first appeared on the Climate Bonds Initiative blog.

Posted by Guest Contributor at 03:19 PM | Permalink | Comments (0)

Sean Kidney

Where did all the CREBs and QCEBs go? Mystery solved.

The US has for a long time used tax credits to promote the development of oil and gas and other industries. With tax credits the bond issuer still pays a coupon, but their payment is subsidized, effectively lowering the rate of interest paid.

The Obama administration brought in a big program of credits for renewable energy bonds. The plan was that States, large local governments, tribal governments and public power bodies would issue bonds to finance energy efficiency or renewable energy. The US Treasury states that some $5.6bn of allocations to over 1800 applicants have been made for these tax credits. This would seem to suggest that there were $5.6bn of bonds out there, but when we went looking we found we could only find out information about a few of them.

A report late last year by the US National Association of State Energy Officials has helped explain what’s happening. It seems that only a small part of the approved tax credits have actually led to a bond being issued.

The Government allocated $2.4bn for Clean Renewable Energy Bonds (CREBs) and $3.2bn for qualified energy conservation bonds (QECBs). After some investigation, Bloomberg New Energy Finance calculates public issuance at $646m, although they believe there is also a private placement market of up to $400m. That would bring total issuance up to around $1bn. I.e. bonds have been issued for less than 20% of allocated tax credits – that’s a severely under-utilized public finance mechanism!

Renewable energy financing consultant and former Ernst & Young senior partner, Jonathan Johns, has previously written for Climate Bonds Initiative on the benefits of tax-exempt bonds. I asked him what was going on.

First, he said that he’s “not that disappointed”. He says that “these are nudge rather than demand pull measures and require participants to pull schemes together and go through various procedural hurdles involved.  In a way they illustrate the future challenges of the industry as it seeks new sources of capital from the bond markets.”

Jonathan says that nudge mechanisms are often undersubscribed. “It’s interesting to note that those states with a strong record in renewables, e.g. California have used very high percentages of their allocations (which are based on population) whereas some more equivocal states have not. For other states there will be a natural cap on appetite if there are state or local borrowing limits.”

“There are lessons to be learned for the US and other jurisdictions – future schemes need to be more streamlined and remove some of the barriers – and also be accompanied by focus on demand stimulation and distribution channels for the bonds themselves.”

“Tax exempt bonds are a cost effective form of support, as relief is limited to the interest on the capital and not based on the capital itself. There’s also a relatively high payback per job created, with that payback localised when there’s a strong energy efficiency component – that’s been the case in over 50% of QECBs issued.”

A relatively large number of bonds issued are for small schemes in the $1m to $5m range. In other jurisdictions this has been difficult to achieve, with bond issues confined to recycling of large scale project finance portfolios.

Johns thinks it’s important to build on the CREB/QECB story and take the bond market to its next stage of development through the Climate Bonds Initiative and other mechanisms. Positive thinking.

Sean Kidney is Chair of the Climate Bonds Initiative, an "investor-focused" not-for-profit promoting long-term debt models to fund a rapid, global transition to a low-carbon economy. 

Posted by Guest Contributor at 09:17 AM | Permalink | Comments (0)

Tom Konrad CFA

The silver lining of all market declines is the chance to buy stock in quality companies at attractive prices.  That opportunity has been notably absent over the last two years, which is why my focus has shifted to smaller and smaller companies in search of reasonable valuations over that time.  Although I still don't believe the market is cheap by any measure other than comparing it to a couple months ago, the volatility is starting to bring some individual bargains, especially on heavy selling days. 

For instance, I've started to acquire some of the waste management stocks that I looked at last week, although I'm still waiting on another round of selling to purchase others.  In particular, I am looking for companies with high dividend yields that are well covered by free cash flow and earnings.  I also want companies with low levels of debt to ensure that income would be relatively stable, even when revenues drop.

Clean Conglomerates

I like the waste sector because I think it will benefit as higher commodity and energy prices lead to more profitable recycling and waste to energy operations. 

In contrast, the companies I'll look at today are not in any one sector, but rather they are broader industrial companies with a range of businesses in the clean energy arena that have drawn my attention over the years. 

Because these companies are large and well covered by mainstream analysts, I don't feel that I have the resources to gain an informational advantage over other market participants.  Instead, my strategy with companies like these is to wait until a general market downturn produces good valuations, and buy those companies which have decent dividends supported by healthy capital structures, earnings, and cash flow, with the intent on holding them for the long term.

In particular, I'm looking for a dividend yield around 3% or more, with earnings and Free Cash Flow (FCF) yields considerably higher than the dividend, so that there is room for earnings and cash flow to fall without imperiling the dividend.  I'm also looking for moderate levels of debt, preferring companies that are mostly equity rather than debt financed. 

I looked at the following seven companies:

1. ABB Ltd. (ABB), which attracts me because of their expertise in electricity transmission and distribution, especially high voltage DC transmission.  They've recently been expanding their cleantech offerings with acquisitions in smart grid, electric vehicle, and efficient motors sectors.
2. AECOM Technology (ACM) provides planning and technical support services in the sectors as diverse as transportation, facilities, environmental, and energy markets.  Since efficient infrastructure requires careful planning, a shift towards greater efficiency should mean more business for AECOM. Many renewable energy projects (such as hydropower) also require a level of planning expertise not necessary in traditional fossil fuel projects.
3. Roper Industries (ROP) makes medical and scientific imaging equipment, energy systems and controls, and radio frequency products and services.  Many of their activities are focused on saving money for utilities, such as better ways to deliver water, better logistics, and leak detection systems.  Such efforts do a lot to improve energy and resource efficiency as they help their customers' bottom lines.
4. John Deere (DE) provides services and products to the agriculture and forestry industries, so I see it as a potential beneficiary of increased demand for biomass for biofuels and electricity generation.  
5. Siemens (SI) is an electronics and electrical engineering company with significant wind turbine, electric transmission, and building efficiency offerings.
6. General Electric (GE) has been pushing their commitment to energy efficiency and renewable energy for most of the last decade, with green technologies accounting for a growing share of revenues.
7. Johnson Controls (JCI) is both a leading battery manufacturer, and is a leader in building automation, a key technology in increasing building efficiency. 
   

I compare the companies' dividend, earnings, and cash flow yields, and Debt/Equity ratios in the chart below.



Conclusion

Of the companies listed, only ABB, Deere, Siemens, GE, and Johnson Controls have even moderately attractive dividends.  Of these, only ABB and Siemens have a level of debt I consider low enough to give it flexibility to cope with a sluggish world economy.  Yet both these companies have uncomfortably low FCF to support their dividends.  Free cash flow can be quite volatile, so I would want to take a closer look to decide on the cause of the current low cash flows at the companies before making an investment.  Furthermore, neither stock is particularly attractive on the basis of earnings, since analyst's predicted growth may not materialize, and both trade near 17 times 2010 earnings.

Of all the companies I consider here, Roper Industries looks the healthiest, with strong alignment between earnings and cash flow and low debt, but as with ABB and Siemens, the current valuation is unattractive. 

Especially when you consider that company analysts tend to be overly optimistic as a whole, we should probably discount the 2011 and especially 2012 earnings estimates.  None of these stocks looks like a great value at current prices, despite having fallen between 12% (ABB) and 35% (AECOM) year to date.

I take the lack of great values as a sign that this market decline likely has farther to go.

DISCLOSURE: None.
DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

Posted by Tom Konrad at 12:53 PM | Permalink | Comments (2)

Tom Konrad CFA

Dumpster diving for high yielding gems.

An earlier version of this article was written at the end of July and published on my Forbes blog, before the August market implosion. I've updated it here to reflect the new stock prices and some recent company news.

Renewable energy has many advantages over fossil energy.  One of the most important is that it's renewable.  As supplies of Oil and other fossil fuels are used up, they become harder and more expensive to extract, while renewable energy is generally getting cheaper over time, due to improving technology.

Unfortunately, while there is no real limit to how expensive fossil fuels might become, as we start using more and more renewable energy, we will start running into resource constraints which will eventually end the decline in renewable energy prices.  Where fossil energy uses a small capital investment up front, followed by a long tail of fuel cost, renewable energy requires a large capital investment up front, followed by little or no fuel cost.  Unfortunately, that up-front capital investment is not just money: it's an investment in capital equipment such as solar panels or wind turbines using much more raw material than an equivalent fossil fuel plant.

Commodity prices are already high and rising higher because of buoyant demand in developing countries.  The transition to clean energy will only accelerate this trend, as old fossil fuel based generation is replaced with new renewable energy that require a far larger investment of industrial metals.  This is what Jeff Vail calls the Renewables Gap, and John Petersen calls the Alternative Energy Fallacy.  We cannot transition to clean energy without making other significant changes to our economic system: the resources in energy and raw materials are not there.  In reality, we must make those changes, because we simply do not have the resources to transition to clean energy while continuing business as usual.

Commodities and Trash

Rising commodity prices have recently been hurting waste haulers even as volumes fall during the recession.  On July 28, Waste Management (WM) missed Q2 Earnings expectations by $0.12, earning $0.50 per diluted share.  Waste Management's CEO, David Steiner, attributed a $0.04 earnings shortfall to increased operations and maintenance due to rising commodity prices in the earnings call, yet "[h]igher commodity prices, improved recycling volumes, acquisitions and year-over-year yield increases contributed to the [year over year] revenue growth."  Overall volumes dropped due to a slower economy, and management attributed a decline in revenues to this, in addition to increased competition. 

The other side of rising commodity prices is not a cost, but a revenue source.  This comes in two forms: Recycling and Waste-to-Energy.  Waste Management is expanding in both these areas, with significant waste to energy operations, which benefit from rising energy prices, and recycling operations, which benefit with rising prices for recycled paper, plastics, and metals. 

Stocks Trashed

While Waste Management has fallen from around $36 to below $30 (17%) because of the earnings miss and market decline, another waste and water purification stock I follow, Veolia Environnement SA (VE) has been much worse hit, falling from $26 to $15 (42%) because of lower guidance related to restructuring because of declining volumes, plans to downsize, and an accounting fraud in its US division.  Veolia has been hit by declining volumes and increased competition in the US, as well as European economic woes. 

Yet both Waste Management and Veolia are high yielding companies, and are beginning to look tempting to income investors as dividend yields are pushed up by declining stock prices. Unfortunately, Veolia's restructuring could easily lead to a dividend cut since the company already distributes most of its earnings to shareholders in the form of dividends, and this could lead to a further fall in the stock price, if it is not already priced in. 

Progressive Waste Solutions (BIN) also missed second quarter earnings, a shortfall the company blamed on bad weather.  The stock fell further than many others in the recent sell-off because much of it's revenue comes from Western Canada, where the economy is heavily dependent on the oil fields.  But I seriously doubt that oil price declines will come anywhere near the levels needed to seriously dent the oil sands boom, so investors' fears over oil seem to be providing a buying opportunity in this stock, as outlined in a recent Barron's article.

The downtrend in waste stocks has been industry-wide, with the Global X Waste Management ETF (WSTE) having declined 18% over the last three months, while the S&P 500 index has declined less than 15%.  This under-performance is surprising in an industry which is often considered a defensive play.



Safe Income From Trash?

While I'm tempted by the high current yields, I want to be sure that the companies can easily cover their rather high dividends with earnings going forward.  I'd like a stock with a high dividend yield, but with that dividend well covered by earnings and Free Cash Flow (FCF).  I'm also looking for a low leverage ratio (debt to equity,) so that the effects of any future decline in revenues will have only a moderate effect on earnings.  Below, I show dividend yield compared to three years of earnings yeilds and estimates as well as trailing FCF yield and debt to equity ratios for several waste management stocks.

As long as earnings and FCF yields are comfortably higher than the dividend yield, the company in question should be able to continue to pay (or even increase) the dividend.

	Per Share
Stock	Price	Dividend	2010 EPS	2011 Est	2012 Est	FCF	Debt/Equity
Waste Management (WM)	$29.40	$1.36	$2.10	$2.14	$2.44	$2.04	1.38
Veolia (VE)	$15.18	$1.47	$1.60	$1.85	$1.95	$0.85	1.94
Casella Waste (CWST)	$4.81	$0.00	$0.24	-$0.50	$0.09	-$0.13	4.95
Republic Services (RSG)	$27.50	$0.80	$1.71	$1.88	$2.13	$2.25	0.87
Progressive Waste (BIN)	$20.91	$0.51	$0.94	$1.12	$1.30	$1.54	0.79
Waste Connections (WCN)	$30.99	$0.30	$1.24	$1.48	$1.71	$1.74	0.83

Data Source: Yahoo! Finance

As I noted earlier, while Veolia has an attractive yield of almost 10%, but with earnings and Free Cash Flow yields only slightly higher, and FCF far below, Veolia will probably have trouble maintaining its dividend if the fierce competitive environment and low waste volumes persist or worsen, with 84 cents of every dollar earned being paid out as dividends.  With a Debt to Equity ratio of almost 200%, the company is quite vulnerable to further drops in revenue, although they may be able to pay off some of this debt by selling divisions as part of the downsizing. 

Waste Management's dividend payout is also higher than I would like at 64% of earnings and 67% of free cash flow, but the lower debt to equity ratio makes this more manageable, so I expect they will be able to maintain the current dividend.

Of the other companies listed, both Republic Services and Progressive Waste are beginning to look attractive because their lower dividends (at 3% and 2.5%) are very well covered by earnings and cash flow, and their low debt means that earnings will be more resilient in the face of a potential continued revenue decline.  On the other hand, if earnings continue to grow as projected, these two companies have plenty of room to increase dividends further.

Conclusion

The falling volumes and increased competition in the waste management industry, along with the last few week's market decline have made these stocks into attractive income investments.  Since the sector has a reputation for earnings stability, the recent earnings misses and revisions have hit investors particularly hard, leading to potential buying opportunities.  Nevertheless I feel there is still room on the downside, so it's probably better to dip a toe into the trash bin rather than engaging in full scale dumpster diving. 

The most attractive names right now are Waste Management and Republic Services, while Veolia's gigantic dividend will tempt braver investors, and Progressive Waste is probably worth including in a portfolio for additional diversification.  I have a bias toward Waste Management and Veolia because they have stronger focuses on recycling and waste-to-energy, which I believe will serve them well if commodity and energy prices continue to rise due to growth in emerging economies. 

DISCLOSURE: Long WM,BIN.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

Posted by Tom Konrad at 10:49 AM | Permalink | Comments (9)

Tom Konrad CFA

Conserving the planet for conservative investors.

Investing in clean energy stocks has an (often well-deserved) reputation for risk.  Although energy efficiency and more inclusive progressive energy indexes have held up fairly well over the last few years, the performance of narrower clean energy sectors has been dismal, and some industry observers feel that the declines in wind and solar are structural (and hence permanent) as opposed to cyclical (and therefor temporary.)

This presents a conundrum for investors with long time horizons who not only need their investments to earn a steady return and meet long term financial obligations, but also care about the long term health of the planet.  Individuals saving for retirement, as well as many pension funds and insurers match this profile. 

Why should such long term investors care about the environment?  Because runaway climate change has the potential to undermine the goals which they are saving to achieve.  If a property insurer doubles its money by investing in businesses that increase the frequency of floods, droughts, and hurricanes, the financial gains will be undermined by an increase in claims.  A retired couple will be happier and healthier on any given amount of money if the Florida condo where they planned to retire is not inundated by sea level rise, ocean acidification has not destroyed the coral reefs where they want to take their grand kids snorkeling, and they can feel optimistic about those same grand kids' future health and economic well-being not being undermined by environmental toxins and energy insecurity.

Funding Clean Energy

There is a temptation to compare investing in clean energy to investing in information technology (IT), since both are rapidly advancing technologies that are disrupting old, inefficient ways of doing things.  But clean energy is fundamentally different from IT in that it is very capital intensive.  Lists of the most successful college drop-outs in history are dominated by IT moguls who started companies in their garages or with minimal capital: Bill Gates, Larry Ellison, Larry Page, Micheal Dell, Paul Allen, and Steve Jobs, are six of the top ten on one list I found.

It's unlikely that the same list will be filled with clean energy entrepreneurs thirty years from now, because clean energy start-ups are capital-hungry, and college drop-outs have a harder time convincing investors to part with a few million dollars than businessmen with degrees and successful careers behind them.  Clean energy projects are typically even more capital-intensive than traditional energy projects (with the exception of nuclear,) because the low fuel and operating expenses come at the cost of higher up-front costs. 

According to an IEA 2010 report, between $600 billion and $1 trillion will be required every year until 2030 above existing infrastructure requirements in order to transition to a clean energy economy.  The Stern report places the economic costs of avoiding dangerous climate change at approximately 2% of global GDP.  Only the global bond market has the necessary amount of capital to deploy, but nearly all fixed income investments in low carbon technologies have very short maturities, and do not match the investment needs of the conservative institutions that would prefer green investments over brown ones, if they only had the option.

Climate Bond Initiative

The Climate Bond Initiative was founded in late 2009 to bridge the gap between the needs of fixed income investors and the needs of clean energy developers.  The initiative's goal is to catalyze the issuance of Climate Bonds to finance the global transition at speed and scale.  To do this, the Initiative is developing the financial infrastructure necessary for the new class of Climate Bonds to emerge with the speed and scale necessary for the task at hand.  Large pension funds such as the California State Teachers’ Retirement System, investor groups such as the Ceres Investor Network on Climate Risk,  governments like the California State Treasurers’ Office, and nonprofits such as the Natural Resources Defense Council worked together to create a Climate Bond Standard which will be suitable for the broadest possible range of investors and projects, while still giving investors an assurance that the underlying projects are indeed helping to mitigate climate change.

The Climate Bond Standard was initially scheduled to be released at the end of July, but it was expanded to include a broader range of bond types, and so the release is now scheduled for this week.

For the Small Investor

The limited number of Climate Bonds issued to date have mostly been sold in the commercial market, but we can hope that the new Standard will catalyze the issuance of Climate bonds available to the retail investor as well.  While retail investors are unlikely to provide a large fraction of the funding needed for the clean energy transition, retail investors can play important roles in helping to engage the public in the effort to tackle global warming, and help draw attention to the efforts of participating institutions. 

In my opinion, retail Climate Bond offerings cannot come soon enough.  When small investors see that green energy investing can not only be the right thing to do for the planet and our grandchildren, they are more likely to give political support to government initiatives that remove the barriers and confront the vested interests that are holding back the transition to a clean energy future.

Not to mention I'd like to buy a few Climate Bonds for my own IRA.

DISCLOSURE: None.

Posted by Tom Konrad at 08:09 AM | Permalink | Comments (0)