Futuregrowth’s renewables focus to provide long-term stable returns

This article was originally published in Hedge News Africa. 

Underpinned by South Africa’s independent power producer initiative the fund facilitates infrastructural, social, environmental and economic development. 

Futuregrowth Asset Management has built an impressive track record in South Africa’s power sector, driven off the back of investing in renewable energy deals that form part of the Department of Energy’s Renewable Energy Independent Power Producer Procurement Programme (REIPPPP).

The Futuregrowth Power Debt Fund specialises in energy-related industries and sectors, and forms part of Futuregrowth’s suite of developmental investments.

The fund is largely invested, or committed to invest, in renewable energy deals under the REIPPPP, including investments in solar photovoltaic (PV), concentrated solar power (CSP), wind farms, and, recently, hydro projects.

“We started looking at the sector back in 2011 when renewable energy was new in South Africa. It was just starting to appear around the world with regularity and in scale,” says portfolio manager Paul Semple. “Our hands-on involvement from early on means we know the sector well. We work closely with people in the field and with the banks that also fund these types of deals.” 

Projects approved so far are located across five of South Africa’s provinces, with 90% of the fund invested in rural areas. All projects under the REIPPPP enter into an off-take purchase agreement with Eskom for power they will produce during the next 20 years and these revenue streams will be used by the projects to repay their debt finance.

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Semple heads a team of five dedicated investment professionals who source and originate energy assets and manage their exposures. They form part of Futuregrowth’s broader credit and equity team, with total assets under management of R190 billion.

The Power Debt Fund is an open-ended fund and, with almost R10 billion market value, Futuregrowth’s intention is to grow the fund and investor returns. It continues to look for new energy opportunities to invest in, working closely with people in the field. 

The fund invests in a wide range of energy-related debt instruments across the credit spectrum including project finance arrangements, government and parastatal bonds, as well as private-sector energy producers and supporting services, subject to Futuregrowth’s Credit Committee approval. Its benchmark is the South African STeFI Composite Index.

“We are very hands-on. In one case, our team flew to India to meet suppliers and the engineering contractors directly to negotiate remedial terms and ensure that the wind farm was completed according to our agreed milestones and standards.”

The fund’s mandate allows for 100% of its market value to be invested in the unlisted space such as in project finance type deals, and up to 5% can be invested in equity transactions.

“Banks have been a good source of assets and in the beginning we relied on them quite heavily to source and syndicate deals,” says Semple. “In the last couple of years, we have sourced more directly from the primary market, undertaking bilateral deals with energy developers. This is where we see opportunities going forward as the market is growing quickly with broader private-sector investment in alternative energy.” The fund is currently invested in 33 independent power producers, operating under contracts signed with the Government across rounds one to four of the REIPPPP. It is also invested in underlying developers of renewable energy projects.

“The fund invests across the credit spectrum and in smaller ticket sizes for more subordinated debt, although the bulk of the portfolio is currently invested in senior debt with scheduled loan repayments," says Semple. 

The REIPPPP, launched by the government's Department of Energy in 2012, allocates contracts to independent power producers to build renewable energy projects, generate and supply electricity into Eskom’s national power grid over a 20 year period at agreed tariffs adjusted for inflation.

The fund’s investments are predominantly drawn down through the construction phase of the renewable energy projects (typically the first 18-24 months), with producers then holding 20-year contracts to supply Eskom, and the debt is repaid to the fund over 15-18 years.

Semple notes that the project finance arrangements are large and complex with many different contracting parties required to build a renewable energy project, and the team deals with multiple credit risks ranging from financial, legal and technical concerns to weather patterns.

“Most projects rely on natural resources, like the wind and the sun. Some have experienced lower-than-expected wind strength. Our consistent winners that have operated and delivered as expected have developers that understand the South African environment and how to construct."

Building strong relationships early on has been a meaningful advantage for the Futuregrowth team, especially with developers in early rounds of the programme who have carried on to be successful preferred bidders in subsequent rounds of the REIPPPP.

Not all deals have gone smoothly, however, and there have been cases where the team has had to take steps to mitigate risks, particularly in the 2010-2015 period where overseas suppliers of equipment used to construct projects had liquidity issues following the global financial crisis, leading to irregular supply of project construction materials.

“We are very hands-on. In one case, our team flew to India to meet suppliers and the engineering contractors directly to negotiate remedial terms and ensure that the wind farm was completed according to our agreed milestones and standards,” says Semple.

Semple notes that the renewable energy sector has bucked the declining trend of fixed investment into the South African economy, with a very successful track record since 2012 funded mostly by the local capital market but also some international investors.

Underpinned by the REIPPPP, more than R200 billion has been invested into 93 projects over the past decade, with important spin-offs into other areas such as local infrastructure and manufacturing. Independent power producers currently produce more than 4000MW, accounting for up to 10-15% of the national power supply.

Preferred bidders under the REIPPPP’s fifth bid window are expected by December 2021 and financial close of the projects by mid-2022, offering exciting new investment opportunities for the fund.

“The renewable energy industry started off in South Africa with a bang, and then from 2015-2018 there was a hiatus with Eskom not signing new contracts and a lot of changes at government level,” notes Semple.

“Things are opening up again, with contracts being signed and a lot of new energy development on the go. The government’s integrated resource plan (IRP) was updated in October 2019, which has reinvigorated the energy sector. We expect growth of the sector to continue as reliance on Eskom’s coal-fired power generation declines over the ensuing years.”

The fund provides long-term stable yield enhancement and is suited to retirement funds looking for a long-term consistent yield, underpinned with inflation-linked income security over the cash flows of the renewable energy projects. Returns have been quite stable and consistently strong, exceeding inflation by 4-6% over the last 10 years.

“Long-term returns are expected to remain stable given that there are 15-18 year debt repayment deals in place with independent power producers,” says Semple.

The fund aims to provide investors with a vehicle that facilitates infrastructural, social, environmental and economic development in southern Africa, including electricity generation from renewable, alternative and traditional sources, power distribution and reticulation, and supporting industries and sectors. It delivers on a variety of social impact requirements such as: job creation through employing local labour to build and maintain the plants; SMME development through employing contractors; mentorship and skills transfer from international developers; meeting BEE equity requirements; investment by the projects into local socio-economic infrastructure and development; and compliance with the international Equator Principles.

Taking a broader view, Semple believes the renewable energy sector is at a “tipping point” in terms of activity and scale after a very successful initial execution of the REIPPPP. Many new projects are being developed to meet the growing demand for private-sector energy production and deregulation is required to ensure that new energy sources come on-stream over the next 10 years.

“In particular, the government’s IRP needs to be updated to help guide private-sector development. We need government to get fully behind new energy production initiatives, and to ensure alignment for investment in South Africa. There are developers, both local and international, that are waiting to invest and many potential beneficiaries in the local supply chain,” he says.

Semple adds that South Africa has some meaningful advantages in terms of capitalising on the global trend towards renewable energy, including a resource-rich climate for generating renewable energy, an extensive national transmission and distribution network able to connect large numbers and diversified sources of alternative energy, and an established track record of independent power procurement under the REIPPPP, which boasts an extremely robust legal framework and is trusted by investors globally.

“There will be twists in the road, but we are optimistic that government will do the right thing as we move away from dependence on coal-fired power. We rely on our skills and experience to mitigate the risks.”