Overweight Clean Energy ETFs

Summary

• We upgrade several clean energy ETFs from marketweight to overweight, including BATT, LIT, TAN, FAN and GRID.
• The sharp and likely sustained rise in energy prices has renewed attention on alternative energy sources – if more for energy security than slowing global warming.

Market Implications

• We anticipate clean energy ETFs focused on batteries, wind, solar and infrastructure will outperform the broader S&P 500 over the medium term.

Introduction

We upgrade several clean energy ETFs from marketweight to overweight. These include LIT and BATT (batteries), FAN (wind power), TAN (solar power) and GRID (electric distribution).

This reverses our 11 March move when we downgraded the sector to marketweight. At the time, clean energy ETFs had performed well after the Russian invasion of Ukraine started amid concerns about oil and gas supply. But further gains depended on US President Joe Biden’s Build Back Better legislation, with its significant clean energy and decarbonisation funding, and it was becoming apparent it was going nowhere.

Oil and natural gas prices are soaring. And the prospect that prices will remain elevated has renewed attention on the need to develop alternative energy sources for security purposes – if not to slow the relentless accumulation of atmospheric carbon and global warming. Biden’s recent executive order calling for a shift to zero emissions vehicles and a national network of charging stations provides additional impetus for the clean energy sector.

Another factor is the prospect that Ford and General Motors will start rolling out lines of electric cars during 2023. If they are cheaper than Teslas, demand could be robust.

Battery ETFs Should Recover

LIT and BATT are ETFs that focus on the electric vehicle battery supply chain, from mining minerals to manufacturing batteries and electric vehicles (Chart 2). As more electric vehicles come to market, demand for batteries should soar. Miners and manufacturers are already struggling to meet demand for batteries, and this will worsen over the next few years. This tight supply situation should benefit many companies in this sector.

Bring on Wind and Solar

The primary sources of alternative (and clean) energy are wind and solar. At this point, many new wind and solar installations can generate electricity cheaper than any fossil fuel source.

Key ETFs in this sector are TAN, which focuses on solar power, and FAN, which focuses on wind power (Chart 3). Both are global in scope. If Biden can roll back tariffs on solar panel imports, that could hurt some US panel producers. But foreign companies and installation companies would benefit.

A Robust Grid Is Essential

We also upgrade GRID, an ETF focusing on companies involved in developing smart electric grid networks. It is no secret that the electric grid infrastructure in the US is barely adequate for today’s requirements. It is unprepared for the energy and electric demands likely to emerge in the coming decade.

Admittedly, there has been little discussion of a need to upgrade the electric grid even as many focus on clean energy, but that will be essential if today’s clean energy investments are to make a difference.

We expect to see more interest in this sector in coming months.

Other ETFs Remain Marketweight

We leave two hydrogen ETFs (HDRO and HJEN) at marketweight. Hydrogen is still an aspiration technology. Wind and solar are much more likely to attract investment at this point, while hydrogen could lose ground in the near term.

We leave two more general clean energy ETFs at marketweight for now, PBW and ICLN. They invest in a broad range of companies involved in various aspects of clean energy or have units involved in this business. We expect these ETFs to perform in line with the broader market.

Over a 30-year career as a sell side analyst, John covered the structured finance and credit markets before serving as a corporate market strategist. In recent years, he has moved into a global strategist role.