Ask Money: Is a lack of diversity in investing always a danger?

Ben Yearsley of Shore Financial Planning helps a reader with a question about diversification.

We often read that it makes good sense to maintain a diverse portfolio. Indeed, it does, but I am guilty of not falling in line on this.

Now that I am in my 80s, my main interest is to create income rather than growth. Hence, I hold 10 of the 12 renewable energy investment trusts listed in Money Observer, which form about 65% of my total portfolio.

They are all paying dividends in excess of 5%, and only one of them, US Solar Fund (LSE:USF), is showing a capital loss at the moment. My initial investment in Bluefield Solar (LSE:BSIF) is now up by 37%.

I am well aware that several of them trade at a high premium to NAV, but I would have thought that NAV in these instances is not as easy to establish as NAV in, say, an equity trust. I also understand that government renewable energy subsidies have been greatly reduced or eliminated, so that producers are left to stand on their ‘own two feet’.

We are told that renewable energy is the future – so could one of your experts please tell me what the downside is, if there is one, and whether my portfolio is vulnerable because of its lack of diversification?

Neville Lloyd, by email.

Ben Yearsley at Shore Financial Planning replies: There are various points raised in this letter, and it’s an opportune time to talk about them, as JP Morgan has recently released a report on the renewable energy sector.

There are a few things to bear in mind about renewable energy. Subsidies have largely been ended for new projects, but existing projects still receive subsidies. However, one key reason why subsidies have been abolished is that the cost of new renewable energy projects has fallen so far that such ventures no longer need subsidies to make them financially viable. As a result, new projects will continue to come on stream.

The reader mentions that the pricing of the underlying investments is not as transparent as it is with a straightforward equity fund. That’s true, and on that basis, it is as easy to overstate the NAV as understate it. With unquoted holdings, you only know what an asset is really worth once you have sold it.

The key driver of these renewable trusts is the future price of energy. The recent report from JP Morgan says power prices will gradually decline over time, but most renewable trust managers predict gradually rising prices. If prices do fall over time, the current NAV will look too high. I’m not saying I agree or disagree with JP Morgan’s report, just that, as with every investment, this isn’t a one-way bet.

I like the sector and have been a long-term investor, but given the sector’s performance over the past few years, I would be looking to diversify away into other income-producing areas.

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