Several years of swimming against the tide of cheap oil have left alternative energy ETFs unloved, but the savvy investor may see this as the ideal time to buy. Passive options in the space remain limited. As we speak, there are currently only two alternative energy ETFs for sale in Europe.
The historically low-oil price over recent years has contributed to uninspiring returns for alternative energy funds. However, for investors considering an investment now, the future appears much brighter. Many believe that the reliance on carbon-based energy sources is unsustainable and that we are approaching a political tipping point, when we have no choice but to fully embrace alternative energy sources.
The speed at which this takes place is heavily dependent upon political will, and by extension regulation. When the pendulum does swing towards green energy, both available funds should be well positioned to benefit.
As with other forms of socially responsible investment, the thesis grounding an investment in a ‘green portfolio’ is jointly financial and social.
Before we discuss the only passive options we should define what we mean when we talk about alternative energy. Although there is no standard definition, the term generally encompasses renewable energy such as wind, solar, biofuels, hydro, wave and tidal, geothermal and associated businesses.
For example, both funds below hold the Danish Vestas Wind Systems and Spanish Gamesa Corporación Tecnológica stocks, which are two of the largest wind turbine manufacturers in the world. They also include First Solar, the US-based producer of solar panels.
While both funds profess to provide access to global alternative energy equities, there are significant differences between them. Over time, these differences will result in different risk/return profiles.
The oldest and largest alternative energy ETF in Europe, as measured by assets, is the iShares Global Clean Energy ETF (INRG). This fund provides exposure to 30 of the largest global stocks involved in clean energy production and clean energy equipment and technology.
Trailing in size is the Lyxor New Energy ETF (NRJ). The fund tracks an even narrower benchmark, comprising only 20 of the largest global alternative energy stocks. Interestingly, the requirements for entry are broader, not just renewable energy such as solar, wind and biomass, but also firms involved in improving energy efficiency, which includes those producing energy meters, superconductors, micro turbines and fuel cells.
Despite fishing in the same pond, and seemingly targeting similar investment territory, each fund’s holdings are remarkably different. At the time of writing, the funds share only three holdings.
Both funds are extremely narrow and therefore particularly susceptible to single-stock risk. The Lyxor fund has the fewest holdings and has no cap on single stock weights and is therefore particularly prone. Currently, its largest holdings are Vestas Wind Systems and American renewable energy utility NextEra Energy at 10% of weight each. The iShares fund combats this risk by limiting single stock exposure to 5%, which in practicality achieves a similar effect to an equally weighted fund.
Due to their concentration, sector ETFs often have significant biases in geography. At the time of writing, the Lyxor fund has 45% exposure to the US, whereas the iShares fund’s largest country exposure is to China at 30%.
The Lyxor fund does include constraints with companies from one of the Distributed Energy, Energy Efficiency, and Renewable Energy sub-sectors not permitted to take up more than half fund weight. The iShares fund has no such constraints.
Due to their concentrated holdings, these funds would be best used as satellites to a core portfolio.
A third alternative energy ETF run by PowerShares has already been condemned and is due to shutter next month due to lack of interest. While both the iShares and Lyxor funds have been open for almost 10 years they have also struggled to attract assets.
Their age is also apparent in their construction and fees. Should alternative energy investing swing back into fashion, we can expect the launch of more sophisticated passive products which address some of the shortcomings highlighted above, offer even more targeted exposure and charge lower fees.