Not All Alternate Energy ETFs Were Created Equal

by: Alt Energy Stocks

A few months ago, I conducted analyses of the wind and solar power ETFs. I've recently turned my attention to the general alternative energy ETFs, or those that span several sectors.

The general alt energy ETFs fall into two categories: 1) US Only and 2) Global. The US Only ETFs are the First Trust NASDAQ Clean Edge US Liquid (NASDAQ:QCLN) and the PowerShares Clean Energy (NYSE:PBW). The Global ETFs are the iShares S&P Global Clean Energy Index ETF (NASDAQ:ICLN), the PowerShares Global Clean Energy Portfolio (NYSE:PBD) and the Van Eck Global Alternative Energy Fund (NYSEARCA:GEX).

The chart below shows 1-year's worth of weekly returns for the five ETFs. You can click on the chart for an expanded view if you are having difficulty reading it.

The table below provides a few key statistics on the ETFs.

Ticker May 22 Price ($) Expense Ratio (%) 1-yr Return (%) St Dev of Returns (%) 6-mth Return (%) Holdings (# of stocks)
PBD 14.55 0.70 (49.3) 4.2 25.6 77
QCLN 12.75 0.60 (52.5) 4.3 19.7 78
GEX 25.00 0.65 (53.9) 5.1 18.7 28
ICLN 22.96 0.48 (56.5) 5.2 17.9 37
PBW 9.19 0.70 (58.6) 4.4 8.8 80

As the data in the table demonstrates, there is more to picking the right alt energy ETF than simply looking at the expense ratio. PBD, at a hefty 0.7%, has outperformed its peer group with lower volatility over the past year.

For example, $1,000 invested into PBD six months ago would have been worth $1,256 pre-expense on May 22, 2009, and $1,249 post-expense. The same $1,000 invested in ICLN, the 'cheapest' of the group, would have been worth, respectively, $1,179 and $1,174 on May 22. Moreover, PBD would have achieved this performance with a lower standard deviation - i.e. volatility - than ICLN.

While one would need to test for statistical significance before making any hard conclusions about outperformance, these results certainly suggest that, when it comes to picking an alt energy ETF, one must dig deeper than simply the expense ratio, as strong outperformance in the long run can more than make up for a few basis points in extra cost.

Alt Energy & Cleantech Sector Allocation

The table below lists out the percentages of total fund assets invested into the alternative energy Categories. I had to make a few judgment calls on how to categorize certain firms, with the most frequent overlap being between Energy Efficiency and Electric Grid.

It must also be said that a few of the stocks held by the ETFs, especially those that I categorized as belonging to the Energy Efficiency Category, would not qualify as either alternative energy or energy efficiency for more purist alt energy investors. QCLN, in particular, holds a number of power management stocks that do not appear to be primarily, if at all, targeting environmental opportunities.

% Of Fund Value Invested In Each Category
Solar 35.3 36.8 34.9 51.2 36.1
Wind 20.0 6.4 24.8 17.9 5.7
Power Production 17.2 0 17.2 23.9 5.3
Energy Efficiency 9.1 40.2 11.6 0 13.9
Ethanol 4.0 0 1.0 0 3.5
Battery 3.2 5.4 0 0 10.4
Geothermal 2.5 4.8 1.1 2.1 9.0
Waste-to-Energy 1.4 0 3.8 4.0 0
Fuel Cell 1.2 1.1 0 0.5 1.5
Electric Grid 1.2 1.2 0 0 2.7
Biodiesel 0.7 0 0 0 0.6
Clean Transportation 0.7 0 0.3 0 4.5
Biomass 0.5 0 0 0 0
Microturbine 0.4 0 0 0 0
Environmental Markets 0.3 0 0 0 0
Electricity Storage 0.3 3.7 0 0 1.2
Hydro 0 0 0.7 0 0
Ocean Power 0 0 0 0 0.4
Hydrogen 0 0 0 0 2.0
Other 2.0 0.4 4.6 0 3.2

This table helps shed some light on the reasons behind the higher expense ratios for some ETFs. PBW and PBD, for example, hold 80 and 77 stocks, respectively, and span 15 and 18 categories. ICLN, by contrast, holds 37 stocks and spans only six categories. This wider coverage accounts, in part, for higher costs, although it also results in lower volatility.

QCLN stands out with the 3rd lowest expense ratio, a 78-stock portfolio, the second lowest standard deviation and the second highest returns over the past year. It spans nine Categories and has by far the heaviest weighting in Energy Efficiency (this may be good depending on your view of the sector).

PBW also stands out as the definite dog, which may appear counter intuitive seeing as it tracks an index by the same provider as PBD. The answer partly lies in the ETF's US focus.

PBD's top ten holdings, accounting for ~32% of total fund value, span three categories: Wind, Solar and Power Production. There is only one US-listed company, Suntech Power (NYSE:STP), with the balance accounted for by some leading European wind firms like Vestas (OTCPK:VWSYF) or renewable power developers like Iberdrola Renovables (OTC:IRVSF).

Most of alt energy's best and most profitable companies are not based in the United States, conferring the Global ETFs an advantage in constructing their portfolios. This advantage stands out when comparing the quality of top holdings in PBD vs. PBW.

Despite this, QCLN managed to perform well because of its heavy concentration in Energy Efficiency and Solar. Together, stocks in these two Categories account for 77% of fund value. By contrast, Solar and Efficiency account for only 50% of PBW's value. Both sectors have experienced strong upside over the past few weeks on the back of the Obama plan and the Chinese stimulus package.

Thus, while QCLN holds a relatively large basket of stocks, it is fairly heavily concentrated Category-wise, which has allowed it to outperform along with its main Categories. PBW follows a very similar diversification approach to PDB but the risk spreading in the latter, because of the comparative lack of high quality alt energy firms in the US, has led to mediocre performance. There is most likely also something to be said for the US stock picking abilities of PBW's makers (or the lack thereof). The result has been a lousy stock mix that has largely missed out on the latest rally.

ICLN and GEX follow broadly similar approaches and asset allocation strategies between Categories, though investors in GEX should in principle benefit through lower volatility from a somewhat more diversified portfolio. In practice, their results are effectively the same both in terms of returns and standard deviation.

Deciding Where To Invest

Which clean energy ETF to invest in depends on what an investor wants to achieve.

1. Play The Obama Administration

The Categories most likely to outperform from recent Obama alt energy policies are: Energy Efficiency, Battery, Electric Grid, Wind and Geothermal. QCLN has a 58% weighting in these five categories vs. 42% for PBW. Besides this, QCLN has outperformed PBW over the past year at a lower cost and similar volatility. The choice here is clear.

2. Play The Conventional Global Sectors Aggressively

The conventional and most mature alt energy Categories are Wind, Solar and Power Production. PBD, ICLN and GEX have weightings in these three Categories of, respectively, 70%, 93% and 77%.

Because of its high concentration in target Categories and low cost, my pick here is ICLN if an investor wants to play a strong return to growth in wind and solar. The Power Production Category is made up of developers, IPPs and utilities with strong exposures to renewables. Those entities have been at the fore of wind's growth for the past five years and will play a large role in solar going forward as ground-mounted installations expand their market share.

3. Play Global Alternative Energy 'Conservatively'

For the investor who wants broad exposure to alternative energy with relatively low risk, my recommendation is PBD. Despite its high cost, it offers good diversification in terms of both individual stocks and Categories. Moreover, its strong performance over the past six months says something about the quality of the underlying index and, indirectly, about the index makers' global stock picking capabilities.

Disclosure: None