In 2011, green power projects had expected returns of 8% and brown power projects 9%. Their 10-year annualised total returns in 2021 were 16% and 17% respectively. These two figures may seem related but correspond in fact to very different economic fundamentals.

In modern asset pricing theory, the long-term equilibrium of asset prices is such that expected returns i.e., discount rates must reflect the risks to which investors are exposed. However, over shorter periods of time, persistent shifts in investor preferences or ’taste’ for certain investments can also have an impact on asset prices as the demand for these assets changes and supply responds. Investment in green power infrastructure is a case in point. A decade ago, few large institutional investors had exposure to wind and solar power projects. Today, such  investments represent between a quarter and a third of a growing allocation to infrastructure investment (see Blanc-Brude et al., 2022).

In this paper, we examine the impact on realised performance of this permanent shift in investor preferences for low carbon energy investments, and how it relates to the expected returns of green power investments. We show that while green infrastructure has outperformed the ‘Core’ infrastructure market over the past decade, this is largely the result of excess demand or such assets that has pushed asset prices up and discount rates down. We find that controlling for a number of risk factors that are present in the returns of unlisted infrastructure equity investment, there is no persistent ‘green’ risk factor, but instead a ‘green price premium’ that investors have been willing to pay to increase their holdings of such assets. We construct a  ‘green minus brown’ or GMB power infrastructure portfolio that would, in theory, replicate a green risk factor, using a portfolio of pure green power investments (wind and solar) and one of pure brown power investments (coal and gas). Controlling for the effect of well-documented risk factors like size, leverage and profits, the GMB portfolio produces a statistically significant negative alpha. Prima facie, this result could be interpreted as the presence of a ‘green’ risk factor in the returns of green and brown power infrastructure investments. However, we show that the evolution of cost of capital spread between the two ‘legs’ of the GMB portfolio explains away its negative alpha. In other words, taking yield compression into account, standard pricing factors suffice to explain the realised performance of the GMB portfolio.

We show this impact of excess demand for green power investments on yield compression by building a measure of the liquidity of the market for green power investment. When too few green infastructure investments are available in the market, asset prices increase and yields compress. Controlling for this effect, any outperformance of the green power sector over the considered period disappears.

We find that this phenomenon peaks in 2019 and that the expected returns of green power investments are now much lower than they used to be i.e., their pice is higher. It follows that  realised returns should not be used directly as a proxy of the future performance of green power investments.