COP26 And How To Gain Exposure To Renewables

Summary

• COP26 addressed climate change, but results were mixed and, to many scientists, disappointing.
• Green ETFs work well for those who wish to invest in renewable energy but know little about it.
• A quick look at SMOG, ICLN, and TAN.
• Net Zero by 2050? Maybe, but if we don't make it soon, events will force our hand. Either way, it's bullish for green equities.

Christopher Furlong/Getty Images News

Since the industrial revolution 200 years ago, humans burning fossil fuels for energy have (and continue to) dump huge amounts of greenhouse gases into the atmosphere. In 1880, CO2 in the air was 280 ppm; today, it's close to 420 ppm - the highest in at least 3 million years.

At last November's COP26 climate summit in Glasgow, Scotland, the global community made an effort to reduce the burning of fossil fuels in order to limit global warming. Many scientists were disappointed with the decisions, however.

We are now beginning to see the results of high greenhouse gas levels in the atmosphere. Extreme weather events (heatwaves, droughts, wildfires, deluges, storms, etc.) are increasingly common. The Arctic (Greenland) ice cap, Siberian permafrost, and now, the Antarctic is melting at record rates. Just a few weeks ago, the news was that sea levels may rise two or more feet in 5-10 years. Even if the probability is low, that would be economically and otherwise disastrous.

Unfortunately, the response from a distracted and science-doubting public is mostly: Meh! Watch the current disaster film "Don't Look Up" to see why.

Yet, technology now provides the means for change and the world is slowly moving away from destructive fossil fuels and into a renewable energy future. This bodes very well for green equities.

Clean energy ETFs are ideal instruments for investors who know little about the subject but wish to invest in it. I have done well with these ETFs over the last few years just by buying and (mostly) forgetting about them; I believe this trend will continue, even accelerate, going into the future.

Clean energy ETFs' recent performance is stellar

Look at these 9 best-performing clean energy ETFs as of last September. All showed a strong one-year appreciation of 19-63%. Since September, they appear to be consolidating and have mostly drifted down somewhat.

In this article, I will profile 3 of the larger and more well-known clean ETFs referenced above. We will look at The VanEck Vectors Low Carbon Energy ETF (SMOG); the iShares Global Clean Energy ETF (ICLN), and the Invesco Solar ETF (TAN). Although there is some overlap in holdings, each has its own unique flavor.

Below is a chart showing the 3 profiled ETF performances compared to SPDR S&P 500 ETF (SPY) over the last 3 years.

Data by YCharts

As you can see above, all 3 of the clean energy ETFs easily beat SPY over the last 3 years; the S&P index has caught up some, though, in recent months.

SMOG for clean air equities

SMOG tracks the price and yield performance of the MVIS Global Low Carbon Energy Index. To be included in the fund, 50% of a company's revenue must come from renewable energy sources. The majority of SMOG's 71 holdings are involved, one way or another, in the effort to curtail carbon emissions. The ETF is rebalanced quarterly. A detailed look at SMOG can be found here.

As of January 3, SMOG's top holding was global BEV leader Tesla (TSLA) with an 8.56% weighting. NextEra Energy (NEE) is second, at 8.46%. NEE is a U.S. electric utility with natural gas, nuclear, and a growing renewable power-generation base. In third place is Iberdrola, S.A. (OTCPK:IBDRY), at 7.34%, a leader in Europe's renewable transition.

Not surprisingly, SMOG's top 10 holdings include 4 BEV manufacturers: Tesla, NIO (NIO), XPeng (XPEV), and Lucid (LCID). Large metro areas across the globe, especially in Asia, are often plagued with smog, a major health problem. Smog (the pollution, not the ETF) may also increase COVID-19 mortality rates.

SMOG has $293 million in assets under management, a weighted average market cap of $183 billion, a P/E ratio of 109, and a distribution yield of 0.45%. The expense ratio is 0.62%.

My gut feeling is that since the BEV manufacturer equities have been hot lately, SMOG's valuations may be a bit stretched. On the other hand, I believe BEVs (I have a Tesla) to be demonstrably superior to ICEs in almost all ways, and, as others find this out, the EV transition may happen sooner than most think. BEVs' equities are highly volatile. For example, Tesla, a trillion-dollar company, rose nearly 14% on January 3. Buy SMOG on pullbacks and get a small position in Tesla while (mostly) avoiding TSLA's scary roller coaster ride. If someday, another BEV manufacturer takes the lead away from Tesla, you'll be there with SMOG.

ICLN for broadly-based renewable equities

ICLN is a broadly diversified ETF. Its 77 holdings cover nearly every facet of the renewable universe - wind, solar, hydro, equipment manufacturers, utilities, and more. The ETF invests at least 90% of its assets in securities that comprise the WilderHill New Energy Global Innovation Index and is rebalanced semi-annually. A detailed look at ICLN can be found here.

The top holding for ICLN, at 8.6%, is Enphase Energy (ENPH), a leading solar microinverter supplier. For more on Enphase see my recent Seeking Alpha article here. Next up is Consolidated Edison (ED) at 6.6%. ED is a New York-based (3.6% dividend) utility transitioning into renewables with a strong and growing solar presence. Danish wind turbine supplier Vestas Wind Systems (OTCPK:VWDRY) is ICLN's third top holding at 6.57%

ICLN has $5.67 billion assets under management, a weighted average market cap of $22.7 billion, a P/E ratio of 52.7, and a distribution yield of 1.2%. The expense ratio is 0.42%.

ICLN is, I feel, the most conservative of the 3 green ETFs profiled here. It is broadly diversified, has the most assets under management, and holds dividend-paying utilities - it pays a respectable 1.2% dividend. It's not overweight hot sectors such as BEVs and solar, so price movements are less volatile than SMOG or TAN. Since the fund is down 24% over the last year, I feel investors are relatively safe in starting or adding modest amounts at this time.

TAN for solar equities

TAN is all solar. Its 44 holdings are all involved, one way or another, in the global solar energy industry. This includes companies of all caps and technologies: suppliers, installers, raw material suppliers, equipment makers, and financiers. Holdings are both pure-play (more than 2/3 of their revenue from solar-related business) and medium-play (at least 1/3 of their revenue from solar). The weighting scheme favors the pure-play companies. Holdings are rebalanced quarterly. A detailed look at TAN can be found here.

The fund's 3 top holdings are SolarEdge (SEDG) at 10.95%, an Israeli-based maker of solar optimizers and software. In second place is Enphase at 9.45%. First Solar (FSLR) is third at 7.37%. FSLR is a supplier of cadmium telluride solar modules for residential, commercial, and utility-scale solar.

TAN has $2.78 billion in assets under management, a weighted average market cap of $11.15 billion, a P/E ratio of 119, and a distribution yield of 0.12%. The expense ratio is 0.69%

My take on TAN, down over 26% over the last year, is that while valuations still look stretched, now may be the time to start cautiously accumulating shares. The sun shines everywhere on the earth (even in the Arctic) and while few can place wind turbines on their property almost everyone (even apartment dwellers) can make some room for panels.

Renewable ETFs have been outperforming fossil fuel ETFs by a large margin over the last 5 years

No matter what your thoughts on renewable equities, you may wish to hold them simply because they have returned so much more than fossil fuel equities. Look at the 5-year chart below.

Data by YCharts

Renewable Energy will continue to flourish, regardless of pacts, politics, or scientific research acceptance

Why do I say green energy will flourish, regardless? Simply this: Pacts such as COP26, subsidies, mandates, and extreme climate change events may all accelerate the transition to renewables but renewable costs have dropped so quickly in recent years plus they are so much cleaner than fossil fuels, the transition will happen anyway. Everyone benefits.

However, if we see a climate change calamity such as a quick sea-level rise or an especially traumatic storm, the transition may turn into a stampede and green equities will rocket up.

Invest in clean ETFs or not, renewable energy is here to stay and it's now entering into a rapid growth stage.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of ICLN, TSLA, ENPH, ED, FSLR either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.