Nanalyze

An ETF for Investing in Clean Energy

We’ve often said that investing in anything that falls along the ESG spectrum of investing ought to be judged purely by performance as opposed to its ability to do good. That’s because fixing the world’s big problems will only happen if we’re able to make a profit along the way which will then allow solutions to scale. No investor wants to subsidize some sector which isn’t able to beat a broader market benchmark. Let’s take clean energy for instance.

While solar installations in the US have grown by 50% annually over the past decade, our reference solar ETF called TAN has posted a dismal return of -31% over the past five years. The S&P 500 has returned +52% over the same period. As investors in the TAN ETF ourselves, we looked into the under-performance two years ago and discovered that the rapid price decrease of solar panels destroyed the margins for many solar providers. Since then, the same trend continues. According to the Solar Energies Industries Association of the U.S., module prices have fallen steadily up until 2017 when import tariffs on solar panels were implemented. The uncertainty surrounding these tariffs caused prices to rise in late 2017. After the imposition of the 30% tariff in February 2018, module prices have begun falling again due to renewed market certainty in the wake of the lower-than-expected tariff announcement and global module oversupply caused by steep reductions in Chinese demand. The TAN ETF performance visualizes this effect clearly:

The TAN ETF has underperformed the S&P 500 thanks to the rapidly decreasing prices of photovoltaic panels

5-year performance of the TAN ETF – Credit: Bloomberg

Solar is on the rise again since then (TAN performed +23.5% versus the S&P 500’s +7.6% over the past year) but it’s still sensitive to the rapid price decrease of photovoltaic panels which doesn’t seem to have an end in sight. Investing in solar power is simply not convincing enough for a sustainable energy investor to put all their eggs in one basket. Wind power, on the other hand, is having a field day. Newly installed onshore wind farms produce cheaper electricity than anything else, including carbon-based sources and solar, and offshore wind is catching up to onshore as well.

Wind is now the cheapest energy source, even beating gas and coal according to Lazard

Onshore wind leads Lazard’s levelized cost of energy comparison in 2017 – Credit: Lazard

Two companies we covered recently, NextEra Energy and Ørsted, provide great exposure to wind energy. There are also other alternatives to the two most hyped renewable resources – wind and solar. Hydropower may be off the headlines but it is still the dominant renewable resource globally, supplying 71% of all renewable electricity with very decent returns. Geothermal energy, also covered recently in our article on Ormat Technologies, represents slower growth but comes with long-term stable revenues. Biomass and marine tidal power generation are less widespread, but also offer stable growth opportunities according to the International Energy Agency.

Whether estimates about the future global climate are correct or not is beside the point. The market for sustainable power generation already exists and happens to be growing as an increasing number of countries commit to achieving zero emissions by 2050. As different renewable resources and power generation technologies face different challenges, retail investors can mitigate their industry-specific risk by diversifying across multiple renewable energy sources. iShares offers an Exchange Traded Fund (ETF) called the Global Clean Energy ETF (ICLN) that might provide a diversified investment vehicle that provides exposure to multiple types of renewable energy.

The iShares Global Clean Energy ETF

For retail investors, ETFs provide cheap and diversified exposure to certain well-defined themes that are represented by rules-based indices. For the majority of ETFs, the fund’s investment managers are not interested in making active bets but aim to follow the chosen indices closely making the fees much lower than mutual funds. The largest global ETF provider is iShares (a franchise of BlackRock) which offers more than 800 ETFs and manages more than $1.9 trillion of assets.

ICLN tracks the S&P Global Clean Energy Index that represents the 30 largest companies listed on developed market exchanges that derive all or most of their revenues from the following activities:

Eligible activities include sub-industries of clean energy production, technology, and equipment providers

Credit: S&P Dow Jones Indices

During the index construction, S&P uses a universe of stocks which meets the following criteria:

  • A total market of $300 million and above
  • A free-float market cap (e.g. the part of the market cap freely available for trading) of $100 million or above
  • Trade on a developed market exchange
  • An average traded value of at least $3 million per day over the course of the past three months

Once the universe has been established using these criteria, each company is scored according to its exposure to the eligible clean energy activities. Companies with clean energy as their primary business are considered first, and in case there are less than 30 qualifying stocks, additional companies that operate in multiple industries with significant clean energy exposure are added until the count reaches 30. Each company is weighted according to its free-float market cap multiplied by its exposure to clean energy. Individual weights are maximized at 5% at each index review.

The fund charges an expense ratio of 0.47%, somewhat lower than the average of 0.59% for thematic ETFs, and currently has $281 million in Assets Under Management (AUM).

Fund Holdings

As the index methodology leaves some space for stocks that may not provide pure-play exposure to green energy, we analyzed the fund holdings to find out how many such stocks exist in the ETF. The below table lists the main activities of each company in the Global Clean Energy ETF.

Name Industry
SOLAREDGE TECHNOLOGIES Solar
CONTACT ENERGY Geothermal, gas, retail electricity
MERIDIAN ENERGY Hydro, solar, wind
ORMAT TECH Geothermal
FIRST SOLAR Solar
VERBUND Hydro
COMPANHIA ENERGETICA MINAS GERAIS General power including hydro and gas
SIEMENS GAMESA RENEWABLE ENERGY Wind
VESTAS WIND SYSTEMS Wind
PATTERN ENERGY GROUP Solar, wind
COVANTA HOLDING Energy from waste
CHINA EVERBRIGHT INTERNATIONAL Solar, wind, waste to energy, biomass
CHINA LONGYUAN POWER GROUP Wind, coal
SUNRUN Solar
ENPHASE ENERGY Solar
XINYI SOLAR HOLDINGS Solar
ATLANTICA YIELD Solar, wind, gas, power transmission
HUANENG RENEWABLES CORPORATION Solar, wind
COMPANHIA PARANAENSE DE ENERGIA Hydro, wind, thermal, power transmission
INNERGEX RENEWABLE ENERGY Hydro, solar, wind
TERRAFORM POWER Solar, wind
BORALEX Hydro, solar, wind, thermal
CANADIAN SOLAR Solar
NORDEX Wind
XINJIANG GOLDWIND SCIENCE AND TECH Solar, wind
SCATEC SOLAR Solar
GCL-POLY ENERGY HOLDINGS Solar
RENEWABLE ENERGY Biomass
JINKOSOLAR HOLDING ADR REP Solar
TPI COMPOSITES Wind

The four stocks seen above in red text are actively involved in coal or gas power. Looking into their annual reports, we found that the revenue share of carbon-based power generation for each of these four companies is very small:

  • Contact Energy gets 3% of its revenues from natural gas
  • Companhia Energetica de Minas Gerais gets 8% of its revenues from natural gas
  • China Longyuan Power Group generates 19% of its electricity using coal
  • Atlantica Yield receives 13% of its revenues from natural gas

Geographically, the fund is heavily skewed towards the U.S. and China with these two countries being responsible for almost two thirds of the fund’s market cap. New Zealand, the 68th country by GDP in world rankings takes third place thanks to its extensive use of hydropower and geothermal power that make up 80% of the country’s electricity generation.

Top-3 countries are US, China, and New Zealand with a combined weight of almost 70%

Credit: iShares

Just because the fund is a pure play on green energy doesn’t mean it’s a worthwhile investment that will outperform a broader market benchmark.

Performance

ICLN has lost -73% performance since its inception. To make this dismal performance even worse, the S&P 500 grew by +133% over the same period.

ICLN was launched just before the start of the global financial crisis and lost most of its value by Q4 2008

ICLN performance since inception – Credit: iShares

The ETF’s launch date coincided with the beginning of the 2008 financial crisis leading the ETF to lose most of its value by dropping -71% over the course of seven months starting on 29 August 2008. Over the same period, the S&P 500 dropped by -30%. However, broad market indices like the S&P 500 have recovered since then while ICLN has been stagnating around the same price level.

Putting informed guesswork aside, we looked at the previous ten years of green energy performance over different timelines to understand where ICLN is headed. Over the past ten years ICLN’s performance has been steadily improving and has reached and exceeded double-digit growth in the past three years:

ICLN S&P 500
past 10 years’ performance -35% +204%
past 5 years’ performance +9% +50%
past 3 years’ performance +30% +38%
past year’s performance +24% +7%
past 6 months’ performance +22% +14%

We see an upward trend that has reached an annualized +44% for the last six months and overtook the S&P 500 last year. Tying this back to our earlier comments on growing global demand, decreasing costs associated with wind farms, and stable returns on hydroelectricity and geothermal energy, recent performance is supported by fundamentals behind each sub-industry of renewable energy.

Conclusion

ICLN is a diversified pure-play investment on green energy. The global trend of harnessing renewable resources and the growing demand for green energy supports a positive long-term outlook for the ETF. While the fund’s launch may have misfired due to market timing, investors who are convinced that green energy is the way forward may find this investment vehicle compelling. As we delve deeper into green energy investments, we’ll continue to explore the various companies held by ICLN in coming articles.

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