Bond strategy: Sell Treasurys, buy … solar, like Buffett?
Warren Buffett has invested in solar power plant projects. Could a similar strategy work for an average bond investor as the search for yield alternatives heats up?
When Solyndra was still a headline term and solar manufacturers were failing, Buffett's MidAmerican Energy stepped up and acquired two large-scale solar power projects in 2012.
Buffett's first big solar buys were dubbed a "shot in the arm" for the industry, but some analysts viewed the acquisitions in a different, though still positive, light.
Buffett's researchers analyzed the long-term nature of power purchase agreements (PPAs)—requiring an "offtaker"—typically a utility—to buy the power generated from the project at a predetermined rate over a period of years, and saw an investment opportunity with an annuity-like income stream and risk profile they liked.
Traditional fixed-income investing, even with a delay in the taper timeline, remains in the doghouse in a rising interest rate environment, and that has led to the proliferation of bond replacement strategies shorter in duration and taking greater credit risk, and in some cases, risks noncorrelated to interest rates. A 10-year annuity with a steady stream of income and a competitive yield is also an option, if an investor is willing to invest like Buffett in solar power projects. You don't need billions like Buffett, though, and you don't need to own the projects.
Peer alternative energy lending firm Mosaic has attracted attention in its first year of operation for its unique alternative energy project funding model, which allows individuals to invest as little as $25 in solar power projects and become Mosaic note holders—the note is unsecured debt with the underlying loan senior secured debt backed by the solar project asset. Its notes have ranged in yield from 4.4 percent to 6.4 percent with five- to 12-year terms.
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It sounds like a bond replacement strategy, at as much as double the 10-year Treasury yield for most of its recent projects, albeit with some unique risks:
- The notes are longer term than many credit investors want
- They are illiquid, lacking any secondary market
- The owner of the solar project has to rely on income payments from the solar project's customer (though this is arguably no different than a corporation defaulting on debt)
- There's also weather risk—to mitigate against the risk of a solar project being damaged by a storm, Mosaic requires that there be sufficient property damage insurance to cover the cost of repairing the project
- There is technology risk associated with solar panel performance
Due diligence on solar investment projects is a nascent field, too, but that risk is part of Mosaic's pitch: It's one of the few nonbank companies to offer such expertise—the company says its project finance team has combined experience totaling 50 years and $1 billion of transaction volume, and a bank-like due diligence process stemming from a CIO who led Union Bank's solar project finance team..
When Mosaic recently conducted a survey of investors, the search for yield that is at a fever pitch in the fixed-income arena was not high on the list of reasons the company's notes were selling out—75 projects have been fully funded in less than a week, while three August projects raised $425,000 in 24 hours. The No. 1 reason for investment was transparency—investors know exactly which project their money is invested in. That was closely followed by environmental impact—investors can measure all the carbon saved on the Mosaic website. Investment returns were not among the primary investment triggers—in fact, some Mosaic investors have said they will take less return for greater social impact when faced with the choice.
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Michael Sidgmore, director of institutional investments at Mosaic—who recently joined the firm from Goldman Sachs' principal strategic investments team in London—said even for investors not familiar with the Mosaic approach or leading with social mission, real assets are becoming a larger part of portfolios as investors search for uncorrelated returns. In addition, investors are looking for better cash management tools and to supplement fixed-income, if not replace it.
Mosaic can structure investments to meet the yield and liquidity needs of investors—the company plans to offer shorter-duration products in the future and has just launched its first project featuring a floating rate loan. To date, the projects have been relatively small, but they are growing—Mosaic recently launched a 12.3 megawatt project to build 547 installations on the military's Joint Base McGuire-Dix-Lakehurst, N.J., eclipsing the 487 kilowatt project at the Wildwood Convention Center that had been its largest.
Institutional investors are taking note. Paul Simon, who manages the family office for Lord Stanley Fink—one of the fathers of the U.K. hedge fund industry—recently met with the Mosaic team and came away interested in the investment concept due to his focus on impact investing, but also for traditional asset allocation reasons. It offers a way to invest in the macro trend of energy security—which won't go away. Just like food or water, institutional investors think there are strong fundamentals around energy security and so are searching for ways to structure a product around that framework with the core financial features of yield, volatility management and inflation hedging.
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It's also a way for an institution to match its long-term liabilities with yield assets.
"Renewable infrastructure lends itself naturally to these requirements. ... It's a real asset, and on the assumption the PPA is of good quality, it should have low beta and uncorrelated yield," Simon said. "We are impact investors and do care about the environment but we are at the commercial end of the spectrum, so we would not compromise on returns."
He said a Mosaic note would be an interesting base allocation for a portfolio that went into the traditional fixed-income "bucket"—with a sustainability overlay. The challenge, though—and the reason that Simon has not yet invested in a Mosaic product—is the long-term lock-up periods on existing products and lack of liquidity. "It's a fixed income play and a quite creative one," he said. "Think of the aging demographic and increased need for income solutions generally by the world's population."
Sidgmore said it is understandable that investors are hesitant to allocate to a Mosaic note because of the five-year to 12-year terms and lack of liquidity, and it is something investors need to think about. But he added that the steady nature of the product and the involvement of offtakers like large utilities from which the income is derived, and the ability to lend to borrowers at higher rates as interest rates rise, should allow Mosaic to remain attractive to investors. "The projects with 5 percent or higher go quicker," said Mosaic communications manager Katie Ullmann.
"It's great that Buffett can invest billions and buy solar farms, but for retail investors, smaller institutional investors, and wealth managers, it's exciting for them to be able to get exposure to the solar asset class, which is debt backed by a real asset," Sidgmore said. "Previously, this market was financed mainly by banks."
The excitement is evident among institutions that are early adopters of the impact investing concept.
"I was in San Francisco to meet with the Mosaic team and it felt upbeat compared to Europe," Simon said. "Spending time with entrepreneurs and venture capital companies in California was inspiring."
The bigger challenge—as Mosaic's business attempts to scale to projects a Buffett might even consider, and into alternative energy sectors beyond solar—will be convincing the unexcitable, boring investors only interested in tradition asset allocation theory that a solar panel can replace a Treasury bill or corporate issue. Carbon savings aside, the asset class has to do something less monumental, but equally important, for the market to embrace it by and large: Work just like, or at least enough like, any other bond.
—By Eric Rosenbaum, CNBC.com