A recurring feature of megatrend investing is overpaying for assets at the start of a hot trend and giving up on them just as valuations get interesting. Seduced by hype, investors buy into megatrends when too many companies are in the speculative phase. All too often, the sector or theme struggles.
That could be true of the clean-energy sector, which has been belted in the past few years as solar, wind and other renewables providers disappointed the market. The S&P Global Clean Energy Index (AUD), a key barometer of 100 of the world’s largest clean-energy-related companies, has been smashed.
After soaring in 2020 and early 2021, the index has halved, as Chart 1 below shows. Over three years to end-February 2024, the index’s annualised return is almost -12%. Investors in clean-energy stocks who bought in late 2020 learned a painful lesson in chasing megatrends higher.
Chart 1: S&P Global Clean Energy Index (AUD)
Australian clean-energy stocks have fared relatively better but are slightly down over three years to end-December 2023 (-1.6%), according to the Deloitte Australian CleanTech Index. Like in other markets, Australian clean-energy stocks have underperformed the broader market.
To put things into perspective, the US and other key equity markets worldwide are at or near record highs. Also, the decarbonisation of economies is accelerating with more investment in renewable projects. Yet clean-energy stocks have collectively produced large negative returns over the past three years, albeit off a large peak in early 2021.
What gives? Higher inflation and interest rates have hurt global renewables companies working on large projects. Sharp increases in commodity, labour, and energy costs to build clean-energy projects have hurt performance.
Higher interest rates have lifted debt-servicing costs for renewable energy projects, which often have a lot of debt, and reduced their net present value. Falling power prices overseas have compounded the problems for renewables companies, particularly utilities, on the revenue front.
Perhaps the biggest problem has been project delays and regulatory challenges. Community opposition to large renewable projects, such as solar farms on agricultural land, or offshore wind farms, is growing. Moreover, some governments have reduced financial incentives for clean-energy projects.
Cost blowouts, project delays, community activism and regulatory uncertainty are a toxic combination for some renewable-energy projects. It’s no surprise that several clean-energy companies overseas have downgraded their profit guidance – an outcome of commissioning projects when conditions were far more favourable than today.
That’s the bad news. The good news is that renewable-energy capacity continues to grow and will only get larger as the world decarbonises. The US Inflation Reduction Act and green-transition policies in Europe will continue to boost the sector this decade. Better still, aggregate valuations have fallen sharply, providing an entry point for long-term investors.
Every stock has its price. Nobody doubts that the global clean-energy sector is going through a period of immense short-term headwinds as industry, communities and governments adapt to renewables. But is a halving of the sector globally in the past few years justified given clean-energy’s prospects?
Readers of this column know I like to hunt for out-of-favour stocks and sectors that are irrationally oversold due to short-term sentiment. That is, assets trading at bottom-quartile valuations that will reward investors who ultimately receive a return premium for a) buying into volatility, and b) taking a long-term view.
Clean energy fits the bill. Further short-term weakness in clean-energy indices cannot be ruled out, but much of the bad news is already priced in. As megatrends go, clean energy has solid long-term foundations, and it wouldn’t surprise to see more fund managers start to rotate capital back to clean-energy stocks by reducing their exposure to tech and other high-flying sectors.
Exchange Traded Funds (ETFs) are a useful tool for megatrend investing. The clean-energy sector is underrepresented on the ASX, meaning investors need to look overseas for opportunities. With limited local choice in specialist active funds in clean energy, index investing via ETFs makes sense.
Here are two beaten-up clean-energy ETFs on the ASX to consider:
- Van Eck Global Clean Energy ETF (ASX: CLNE)
CLNE, the first ETF of its kind in Australia, provides exposure to 30 of the largest global companies involved in clean-energy production, technology, and equipment. Launched in March 2021, CLNE’s top-10 holdings include some of the world’s best-known solar and wind-power companies, and other renewables providers. They include NEXTracker Inc, Enphase Energy Inc, Meridian Energy and First Solar.
Just over a third of the ETF is invested in power producers and energy traders, and almost another third in electrical-equipment manufacturers. Almost half of CLNE’s portfolio is invested in US clean-energy companies. CLNE returned -23.5% over one year to end-February 2024. Over three years, the annualised return is about -15%.
The average Price Earnings (PE) ratio in CLNE was 15.42 times and the price-to-book ratio was 1.29 times, at end-February 2024. That’s attractive for leading global companies in a long-term growth industry. The main risk is that CLNE is highly concentrated by ETF standards, with only 30 stocks in its portfolio. Conservative investors might prefer an ETF that owns a larger number of stocks and is more diversified. The annual fee is 0.65%.
Chart 2: Van Eck Global Clean Energy ETF
- BetaShares Climate Change Innovation ETF (ERTH)
ERTH provides exposure to up to 100 global companies that make at least half of their revenue from products or services that help address climate change or other environmental problems through the reduction of CO2 emissions. ERTH’s underlying index includes well-known global companies in clean energy, green transport, waste management, sustainable product development, and energy efficiency and storage. Almost half of ERTH is invested in US stocks.
ERTH returned almost -30% in calendar year 2023. The three-year annualised return is -10.2% to end-February 2024, making ERTH among this market’s worst-performing ETFs in the past few years. Prospective investors might view that as an opportunity to buy ERTH at a sharply lower price, after heavy falls since late 2021.
ERTH’s forward PE is 29.1 times, and its price-to-book ratio is 2.23 times. ERTH tends to own renewables companies more focused on climate-technology innovation, compared to CLNE, which looks the cheaper of the two ETFs at current prices. ERTH, however, has less concentration risk than CLNE, holding 100 securities. Its combined management fee and annual expenses is similar to CLNE’s fee.
Chart 3: BetaShares Climate Change Innovation ETF (ERTH)
Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation, or needs. Before acting on information in this article consider its appropriateness and accuracy, regarding your objectives, financial situation, and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at 27 March 2024.