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Dull utilities with exposure to renewable energy have been a winning combination in the stock market this year – and the long-term outlook is looking bright.

The defensive nature of this sector has been an appealing feature during the pandemic-driven economic downturn, since most utilities continue to generate revenue – and pay dividends – regardless of high unemployment rates.

But exposure to renewable energy has delivered an added performance bonus that analysts expect will continue.

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According to Andrew Weisel, Robert Hope and Justin Strong, analysts at Scotia Capital (a division of Bank of Nova Scotia), North American utility and power companies with significant renewable energy assets outperformed their peers in the third quarter, ended Sept. 30.

Indeed, among the 29 utilities and power stocks that the analysts cover, the top seven performers during the quarter have what the analysts call a “renewables slant."

Brookfield Renewable Partners LP surged 37 per cent in the third quarter alone, followed by Innergex Renewable Energy Inc. (up 26 per cent), Boralex Inc. (up 25 per cent), Northland Power Inc. (up 19 per cent), NextEra Energy Partners LP (up 17 per cent), NextEra Energy Inc. (up 16 per cent) and TransAlta Renewables Inc. (up 15 per cent).

By comparison, the S&P 500 utilities sector gained 5.2 per cent in the third quarter and Canadian utilities in the S&P/TSX Composite Index increased 9.9 per cent, according to Globe and Mail data.

Why are renewables so popular? Mr. Weisel and his colleagues say they believe there are two factors at work here.

One, ESG investing – or socially responsible investing where stocks are selected according to environmental, social and governance attributes – has gained in popularity in 2020.

According to Morningstar, ESG funds in the United States (dominated by the iShares ESG Aware MSCI USA exchange-traded fund) attracted inflows of nearly US$21-billion in the first half of this year, virtually equal to inflows for all of 2019. Globally, ESG assets under management now total more than US$1-trillion.

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While that’s a small slice of the US$41-trillion invested globally in all funds, sustainable investing is growing faster and could be pushing even non-ESG investors to bet on where ESG assets are heading.

“It seems that many investors are positioning their portfolios in anticipation of where those ESG funds are focused,” the Scotia Capital analysts said in a note.

They expect that ESG investing will continue to support utilities that have exposure to renewables.

As well, they say the coming U.S. presidential election is driving interest in renewables: A Joe Biden presidency could be good for U.S. utilities and renewable developers, given Mr. Biden’s US$2-trillion green infrastructure plan. The Democrat is leading in the polls.

However, the analysts caution that the Democrats will need to win Congress as well as the White House to get enough support to push Mr. Biden’s green plan into action. A Biden victory also appears to be the consensus view among investors, suggesting it is already baked into stock prices.

But investors have a good reason for sticking with green-tinted utilities. Costs associated with wind and solar power have fallen to the point where renewables are economically viable, encouraging some utilities to phase out their coal assets. Even some big oil producers are joining the rush into wind and solar, potentially lifting valuations for stocks with renewable exposure.

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“We focus on continuously falling capital costs and ongoing efficiency improvements – it’s become an economic investment decision for utilities more so than a policy choice, at least in many states,” the Scotia Capital analysts said.

Renewables are outperforming. It’s a good bet that they will continue to shine.

Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.

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