Recently the world, and the US particularly, have suffered multiple extreme weather events. These, plus the devastating IPCC report, make it increasingly difficult to deny the climate is changing. Even some Republicans who have been long-time stalwart deniers of climate change are begrudgingly acknowledging it as an emerging (if still-low priority) reality.
Against this background, we recently recommended investors start accumulating positions in ETFs that invest in various aspects of clean energy. This note reiterates and updates that recommendation.
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Summary
- We reiterate our recommendation to accumulate clean energy-related ETFs.
- The growing concern about climate change and the need to address carbon emissions all but guarantee this will be a growth sector in the coming decade.
- We add two new ETFs to our recommended list: PBW and GRID. Both cover the clean power and grid infrastructure – an essential building block to enable renewable electricity development.
Market Implication
- The clean energy industry is still an emerging sector and will be subject to volatility due to uncertainty about government policy/investment and rapidly evolving technology.
- We suggest investors start with small positions and add to them on market weakness or as the outlook clarifies.
Recently the world, and the US particularly, have suffered multiple extreme weather events. These, plus the devastating IPCC report, make it increasingly difficult to deny the climate is changing. Even some Republicans who have been long-time stalwart deniers of climate change are begrudgingly acknowledging it as an emerging (if still-low priority) reality.
Against this background, we recently recommended investors start accumulating positions in ETFs that invest in various aspects of clean energy. This note reiterates and updates that recommendation.
Clean Energy Has Outperformed at a Sector Level
Since the March 2020 selloff, clean energy ETFs have been a clear winner (Chart 1). After the election, clean power, electric vehicles (EVs) and battery ETFs rallied strongly on hopes of early infrastructure legislation that pours money into these sectors. As it became apparent traditional infrastructure would be the early priority, clean power and EVs traded in narrow ranges, but batteries have rallied strongly after an initial selloff. (Table A-1 at the end of this note summarizes the ETFs in each group).
As the outlook for further investment clarifies, we expect clean energy and battery ETFs will continue to outperform the S&P 500.
Our Clean Energy Recommendations
Table 1 summarizes our current recommendations. We have added two ETFs in the clean power sector – GRID and PBW, highlighted in bold. We discuss these below. We note the following points:
- The clean energy sector includes ETFs focusing on wind power, solar energy, hydrogen and smart grids.
- All these ETFs sport very high (or negative) P/E ratios and low dividends, implying most companies in this space make little or no money. This is very much an emerging sector.
- Many of these ETFs are still small with assets under management in the tens or hundreds of millions of dollars. Only three (GRID, PBW, LIT) are larger than $1 billion. Money is only starting to flow into this space.
We Are Not Fans of Electric Vehicle ETFs
For all the publicity about electric cars and the glitz and hype surrounding Tesla, we do not currently recommend EV ETFs.
EV ETFs are largely investing in companies that are developing some aspect of smart or autonomous driver technology. We think this technology has little chance of becoming mainstream until society can build out smart-road technology that help autonomous cars communicate with each other. Given most municipalities and state governments lack the wherewithal to fix potholes, it is safe to say smart road technology is distant.
Meanwhile, the next decade’s public policy thrust will be getting people to switch from internal combustion engine cars to straightforward electric cars, not cars with new-age driver technology. The major car makers will dominate this space. Another Tesla emerging against that competition is highly unlikely.
Two New Clean Power Recommendations
We add two new buy and hold recommendations – PBW and GRID. PBW is a diversified clean power ETF. Its holdings include solar energy, wind power, biofuels, clean energy utilities, energy management companies, and various energy technologies. GRID focuses on smart electric grid technology and development.
Unlike most clean power ETFs, they are over a decade old, so provide some perspective on society’s and the market’s views about the prospect for clean energy over time (Charts 2a and b). For about a decade after the Global Financial Crisis, PBW and GRID underperformed the S&P 500. They started improving in 2019, but they really took off after the March 2020 market crash and growing climate change concern.
We favour PBW and GRID because they focus on infrastructure needed for much of the rest of the clean energy infrastructure to make a difference. For example, much of wind power comes from offshore or unpopulated places; the electric grid needs establishing for investment in wind power to make sense.
PBW may also be attractive for some investors because it invests exclusively in US companies. At least short term, US companies may benefit more from new investment than non-US companies if President Joe Biden’s proposed $3.5tn infrastructure plan passes in something close to its present form.
Hydrogen Is Speculative, but Not Disappearing
We concede hydrogen will not be a viable source of mass-produced clean energy for the foreseeable future. Most methods of producing hydrogen are expensive and require fossil fuels. They will be clean only with effective carbon capture and storage technology in place. Then you must store and transport hydrogen – this infrastructure is essentially inexistent now. A recent paper by engineering professors at Cornell and Stanford highlighted these problems.
Hydrogen can be produced from electricity, but it will be green only if the source of electricity is renewables. To produce clean energy hydrogen, a plant will require its own source of renewable electricity, or renewable electricity must become far more widespread.
Still, writing off hydrogen is difficult. The clean power technology is evolving rapidly. Will a clear winner evolve, or must we settle on a more diverse mix of clean power sources? Second, some carmakers, including Toyota and Honda, support hydrogen and are investing in the technology. And third, hydrogen may prove to be more viable in some parts of the world than others.
Both hydrogen ETFs on our buy list invest in hydrogen-related companies globally.
Clean Energy Is a Patient Trade!
As mentioned, clean energy is an emerging sector, so most companies in the space are small. Almost certainly, this space will grow enormously over time. But it is also highly uncertain when and how much new money flows into the sector. Clean energy technology is also rapidly evolving. The bottom line is many of the companies in the space will probably fail. Others will have to or want to sell out to larger competitors.
All this suggests the clean energy sector will suffer volatility in coming years, both to the upside and downside. Investors willing to do lots of single company research may be able identify the likely winners that emerge.
For most investors, we recommend investing in clean energy via ETFs. We do not recommend large overweights currently; rather, we suggest starting with small positions capitalizing on market weakness or growing confidence about the sector to add to positions.
Above all, clean energy for now is a patient trade. It is time to start gaining exposure to what will be a major growth sector over the coming decade.
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.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)