clean energy investments / dedraw studio

This article appears in the May 2023 issue of Investment Executive. Subscribe to the print edition, read the digital edition or read the articles online.

Investing in a clean-energy ETF might be good for an environmentally conscious investor’s soul, but there should come a time when it’s also good for their net worth.

Unfortunately, that time is not quite yet.

Of six Canadian-listed clean-energy ETFs, the performance of all five launched in 2021 is bathed in red ink rather than green, with negative returns since their inception dates.

There isn’t much recent good news either. Early in the second quarter, year-to-date performance was mostly flat to slightly negative. Investors can blame high interest rates, which have tended to punish growth companies, particularly up-and-comers that have yet to post earnings.

However, the inauspicious start and uninspiring recent past aren’t indicative of the more promising future for green-energy ETF investors. The steep stock valuations that prompted a sell-off a couple of years ago have become much more reasonable.

Secondly, generous government subsidies and tax credits — particularly in the U.S. — will reduce costs and improve profitability. Thirdly, the secular growth story for renewable energy remains intact.

“It’s certainly the largest growth area in energy investments as we look over the long term,” said Jennifer Stevenson, lead manager of the Dynamic Active Energy Evolution ETF and a vice-president with 1832 Asset Management LP in Calgary.

Most future energy spending, according to the International Energy Agency, will go to renewables. The Paris-based IEA forecasts that renewables will surpass coal as the world’s largest electricity source by 2025, and will account for 38% of the global total by 2027.

A veteran manager of traditional energy stocks, Stevenson applies the same selection process to her portfolio of about 33 companies engaged in renewable power, emerging solutions and innovation.

She favours profitable companies with sound business plans and financial strength. “Innovation is really exciting,” Stevenson said, “but as an investor we want to invest in companies that are making money, and that have defined projects, legitimate customers and verifiable growth programs.”

Two of the Dynamic ETF’s holdings are Sunrun Inc. and Sunnova Energy International Inc., U.S.-based companies that provide solar-power systems to residential customers. Policy changes in California are expected to boost usage of the energy-storage batteries these companies provide.

Led by the Inflation Reduction Act (IRA) in the U.S., generous government support will fuel the growth of renewable energy providers and related products and services.

The IRA could be a “game changer,” said Karl Cheong, head of distribution with Toronto-based FT Portfolios Canada Co., which offers the First Trust NASDAQ Clean Edge Green Energy ETF. “This is by far the most aggressive and thorough attempt at decarbonization on the planet.”

The First Trust ETF holds about 60 stocks and invests primarily in renewable energy technologies. Its largest recent weightings are in equipment, semiconductors and automobiles, including electric vehicle maker Tesla Inc.

First Trust’s direct index-fund competitors are the BMO Clean Energy Index ETF, the CIBC Clean Energy Index ETF and the newest entrant, the year-old iShares Global Clean Energy Index ETF.

Cheong said renewables have already become competitive with traditional sources, with the cost of solar and wind energy falling dramatically year over year relative to coal and natural gas. And government support will make the economics of renewables more favourable than ever.

“When you take in all these tax credits for the cost side of the equation, you’re going to really improve their profit margins and corporate profits over time,” Cheong said.

A favourable attribute of the IRA is its 10-year time frame, Stevenson said: “It transcends any future change in [U.S.] administration, which means that companies can plan for long-term, large-scale projects. That’s really important from an investor standpoint.” As the U.S. Treasury Department releases eligibility information for federal assistance, Stevenson expects business investment will ramp up: “We’re looking forward to that as well with a number of the companies that we have invested in that are well-poised for that kind of activity.”

Also helping defray the upfront costs of renewables projects, Stevenson said, are government incentives elsewhere, such as provisions in the recent Canadian budget and programs in Europe, Japan, South Korea and Brazil.

Harvest Portfolios Group Inc., whose Harvest Clean Energy ETF invests globally, said the European Union looks set to help its clean-energy companies compete with their U.S. rivals by cutting red tape.

In a commentary, Oakville, Ont.-based Harvest pointed to the EU’s Green Deal Industrial Plan for the Net Zero Age, known as the GDIP, and to programs such as the €210-billion funding available through the RePower EU plan.

“The GDIP’s core pillar is the construction of a predictable and simplified regulatory environment,” Harvest said. “That should, on paper, make the EU funds available in programs like RePower EU easier for businesses to access.”

The Harvest ETF holds an equally weighted portfolio of what the company describes as the 40 largest clean-energy companies.

Even as governments around the world provide more incentives to clean-energy companies, their stocks have tended to become relatively less expensive.

“Two years ago, anything that had ‘renewable’ in the name of the business plan was given a premium valuation by the market,” Stevenson said. “Now the market is more discerning about what companies get what valuations.”

This closer relationship of stock prices to fundamental values is reflected in the First Trust portfolio. About 18 months ago, based on the ETF’s holdings that reported positive earnings, stocks were trading on average at a pricey 50 times forward earnings. Now, the average forward price/earnings ratio is 22. That’s still a premium to the overall market, Cheong said, “but not at the dramatic levels we’ve seen over the last few years.”