We catch up portfolio manager and investment director Vuyo Ntoi as he shares his thoughts on investment, COVID-19 and the IDEAS fund he manages.
The COVID-19 pandemic has upended economies everywhere. How will low oil prices and a recession-fueled reduction in global demand for all forms of energy, renewable or otherwise, affect the IDEAS Fund?
The impact on the energy sector, broadly, has been a steep reduction in demand over the period of the pandemic-induced restrictions, and demand is likely to pick up significantly as economies return to normalized patterns of consumption at the end of the lock-down. The impact of reduced energy demand on the IDEAS Fund has been relatively limited. The Fund is primarily invested in renewable energy projects with take-or-pay arrangements with Eskom. Despite minor incidents of curtailment during the lock-down period, the plants in which the Fund is an investor have continued to operate and earn revenues from the off-taker. The continued operation has been due to the plants being deemed to be providing essential services, and operations being allowed to continue as normal. We have had some challenges on plants under construction, as the construction progress has been affected by the lock-down, and will only recommence once the government eases restrictions.
Returns on infrastructure investments such as those in toll roads are also likely to be affected in the short to medium term by the COVID-19 economic fallout in terms of reduced traffic. Do you have projections on how long this could last?
There is uncertainty over the economic impact of the COVID-19 pandemic and the nature and shape of the economic recoveries that will follow the lifting of lock-down restrictions. We are therefore not certain how long the reduced traffic levels will persist, but we do believe traffic will return to within the range of normalized operations once the lock-down restrictions are removed. A v-shaped, swift recovery will mean that the GDP impact of the pandemic on traffic numbers is limited, whereas a more u-shaped or w-shaped recovery would lead to more prolonged pressure on traffic levels. The toll roads in our portfolio are quite well-capitalized, and should be able to comfortably withstand the impact of some months of reduced traffic levels. The lock-down has had less of an impact on heavy vehicles volumes, which make up a disproportionate portion of overall revenue, than on light vehicle numbers.
The Coronavirus pandemic is grabbing all of the media attention presently, but this shouldn’t detract from the continuing and bigger global threat, that of climate change. Will your focus on investing in renewable energy remain a key part of the IDEAS fund?
The IDEAS Fund’s management team remains steadfast in its belief that renewable energy is a sustainable investment class, which has positive externalities for the environment and society at large. We believe that renewable energy investment will remain a key part of our strategic focus over the near to medium term, should its positive investment attributes be maintained.
Will the unprecedentedly low crude oil price impact your ability to attract institutional investment in renewable projects?
Our clients choose to invest in the Fund based on their view of the risk adjusted returns and diversification it can offer to their overall portfolios, and based on the positive externalities arising from its investments in renewable energy and other developmental assets. We do not believe the low oil price will have an impact on these perceived benefits.
Will “Availability fee” guarantees and your other cash flow safeguards be enough in a big global recession? Is this where your due diligence proves its mettle?
The attractiveness of availability payment guarantees from governments is really a function of the credit quality of the governments providing them, as this determines what their ability to stand behind the guarantees will be. When we enter projects with availability payments we review the sustainability and reasonability of the level of payment, and we are confident in government’s ability to fulfil these obligations. While governments are under fiscal pressure due to the pandemic and the likely recession that will follow, the guarantees are in local currency and we believe the South African government will access global liquidity sources to ensure its ability to fulfil its obligations.
Are you expecting smaller sub-contractors or suppliers to projects you’re invested in to face possible stress due to a recession? How does this impact your view on earnings for the year?
The pause in construction during the lock-down period is likely to put financial stress on sub-contractors who have not been able to do work and earn revenue over the period. Smaller contractors, who typically have lower cash resources to weather incidents like the slowdown will likely be under more stress than their larger counterparts. This comes in a backdrop where even the largest contractors in South Africa have faced different levels of financial distress. The thinning contractor market might result in higher construction prices on new projects going forward, and on maintenance contracting on existing projects. We, however, do not believe that this will be a material feature affecting the performance of existing projects in the portfolio.
SADC and pan-Africa will need investment in socially impactful projects like never before after this pandemic crisis, could you explain to our readers the ripple-effect social benefits of investing in your fund?
SADC, and the rest of the continent, has always had a shortage of social and economic infrastructure. The COVID-19 pandemic has only served to highlight the shortcomings in the supply of these amenities to the population, as health facilities, access to clean water and sanitation and economic infrastructure come to the fore. The IDEAS Fund is well positioned to be a conduit through which investments can have a spillover effect that boosts the quality of life of the citizenry. The Fund’s toll road portfolio has helped to create economic infrastructure that has boosted trade logistics and the associated manufacturing, mining and agriculture industries. The Fund’s renewable power portfolio has provided power to a stressed South African grid averting even deeper power cuts and mitigating the impact of power shortages on the economy. In addition, the renewable portfolio has been key in reducing the country’s carbon footprint, with projects in the AIIM portfolio generating 3,151 GWh of clean power in 2019, equivalent to the annual power requirement of over 1 million households. Furthermore, the portfolio helped to offset approximately 3 million tons of CO2-equivalent in 2019, which equates to taking around 650,000 cars (5% of South Africa’s traffic) off the road.