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What’s the outlook for the clean energy investment theme?

It’s been a turbulent 2021 so far for clean energy stocks, and some analysts are suggesting the bubble has burst.

Since March 1, 2021, the S&P Global Clean Energy Index has dropped around 9%, falling short of the wider S&P 500’s near 3% gain (as of March 23).

So, why has the index dropped? One reason is a cooling off after investors bet on renewables benefiting from US President Joe Biden’s climate bill – something that could cost $2 trillion and face staunch opposition from Republicans. Another is that the index is made up of a limited number of small-cap stocks. These can be illiquid and a drop in one can cause others to also fall, especially if investors start to take profits after last year’s gains.

To improve the stability of the S&P Global Clean Energy Index, S&P Dow Jones Indices is planning to increase the number of stocks included from 30 to 100. In theory, this would reduce the risks of overvaluation and sharp drops in individual holdings contaminating other stocks – especially as the new additions will include companies with larger caps, along with the reweighting of existing holdings.

The two biggest clean energy ETFs tracking the index are from Blackrock: the iShares Global Clean Energy UCITs ETF [INRG] and the iShares Global Clean Energy ETF [ICLN]. Both have seen heavy losses in the past month, with INRG dropping over 10% and ICLN falling over 11%.

The decision to add more stocks to the index could make ETFs like INRG and ICLN less volatile – no doubt a welcome move for investors nursing heavy losses. For everyone else, it could provide more reassurance that an investment in clean energy ETFs is more dependable, even if hugely outsized growth turns out to be a thing of the past.

Has the bubble burst?

Still, this isn’t a quick fix. A report from Société Générale highlighted some of the problems facing the facelift, as reported by ETF Stream.

One issue is selling off some of the small-cap stocks, which could prove tricky, as they are less liquid than larger stocks. The other is the criteria for inclusion in the index, with Société Générale saying that the definitions for clean energy exposure lacked clarity. As per ETF Stream, this is especially concerning as new holdings will be “non-pure-play energy stocks”, which raises questions about how diluted the index will become.

Chris Lau, writing in Seeking Alpha, highlights the dangers of buying momentum without checking out the fundamentals. According to Lau, clean energy companies that “existed for decades by selling stock and never making a profit” were hit hardest in the recent selloff.

For Lau, the bubble has finally burst, with the writer using the examples of Plug Power [PLUG] and FuelCell Energy [FCEL]. Plug Power had to restate earnings results going as far back as 2018 and has seen its share price drop 24% in the past month. It is also ICLN’s top holding, representing 8% of the fund.

FuelCell Energy recently posted a $46.8 million loss and had to sell shares to “improve its ‘financial foundation”. Lau adds that, even though FuelCell is expanding into other geographic markets, its “market share growth will have rising costs that outpace the rate of revenue growth”.

Is there opportunity in clean energy?

The clean energy investment theme is down 16.49% over the past month, according to our thematic ETF screener (as of the March 24 close), and is up just 2.66% for the year.

Dipping into the clean energy ETFs the screener tracks, the worst performer over the past month is the iShares Solar ETF [TAN], which is down 7.74%. The best performer from the eight ETFs covered is the Invesco WilderHill Clean Energy ETF [CNBC], which is down 1.27%, broadly on par with the S&P 500’s 1.17% decline over the same period.

So, is the future murky for clean energy stocks? Despite the recent pullback, the investment theme topped our ETF leader board recently, gaining 2.35%, while the related solar theme gained 2.27%.

Clearly clean energy is still a focus for some investors and is a theme that could see some growth in 2021. Among the tailwinds is the Biden administration setting aside sizable renewable energy spending in the upcoming $3 trillion infrastructure plan. Beyond 2021, the International Energy Association reported at the end of last year that renewable energy sources “are set to account for 95% of the net increase in global power capacity through 2025”.

The future of energy is heading in one direction and that is towards renewables. Given the recent efforts to effectively clean up the clean energy index and related ETFs, this could make for a more stable, less volatile investment opportunity. However, investors may want to be mindful of individual small caps that aren’t yet profitable to avoid getting burnt.

¬ Haymarket Media Limited. All rights reserved.

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