Under the hood of Australia’s climate tech funds: CLNE ERTH
Two takes on the climate change and clean energy thematic.
Mentioned: HelloFresh SE (HFG), DocuSign Inc (DOCU), Verbund AG (VER), VanEck Global Clean Energy ETF (CLNE), BetaShares Climate Change Innovation ETF (ERTH), East Japan Railway Co (9020), Alstom SA (ALO), Brookfield Renewable Partners LP (BEP), Orsted A/S (ORSTED), Meridian Energy Ltd (MEZ), Plug Power Inc (PLUG), Tesla Inc (TSLA), Vestas Wind Systems A/S (VWS)
Investing in clean energy or climate change companies hasn't been easy for Australian investors. The ASX 200 hosts more miners than solar panel makers, and major players are often listed on hard-to-access exchanges in Europe or Asia. The space is also new, forcing investors to sift between hundreds of companies they may never have heard of.
Two ETFs launched this year are working to fill the gap. VanEck’s Global Clean Energy ETF (ASX: CLNE) and BetaShares’ Climate Change Innovation ETF (ASX: ERTH) hit the ASX a day apart in March 2021. On offer are two takes on the broad climate change and clean energy thematic, with investments ranging from a Danish wind farm manufacturer to a German meal-kit provider.
Both funds are riding a wave of enthusiasm for thematic investing. The ASX hosts almost 15 thematic ETFs investing in everything from robotics to video games. More are on the way.
Those considering investing face several questions: What does investing in climate change or clean energy look like in practice? How do the two funds differ? What are the risks?
In today’s Under the hood, we look at ERTH and CLNE to answer these questions for investors.
Two approaches to combatting climate change
Both CLNE and ERTH operate in the spirit of the climate change thematic while offering investors slightly different takes on the theme.
The VanEck Global Clean Energy ETF is a pure-play clean energy fund. It tracks the S&P Global Clean Energy Index, a list of 30 businesses generating clean energy and/or building the equipment and technology that make it possible. It’s a broad church, taking in solar, wind, geothermal as well as the plant-based ethanol often added to gasoline.
A broader take is on offer at the BetaShares Climate Change Innovation ETF. The ETF tracks the Solactive Climate Change and Environmental Opportunities Index, which includes up to 100 companies working across five sectors designed to combat climate change: renewable energy, green transport, waste management, sustainable product development and energy efficiency and storage.
Both funds are global, taking in companies listed on developed and emerging market exchanges from Brazil to Denmark.
A two-step screen picks out companies for investment from the global pool. The first steps cuts firms only marginally involved in the relevant activities. ERTH requires holdings earn at least 50% of revenue from one of its five sectors. CLNE prioritises companies where clean energy is a “primary business”.
A second set of filters then cuts heavy emitters or controversial sectors. ERTH removes firms involved in fossil fuels, nuclear, armaments and sin industries. CLNE requires companies have low carbon intensity scores, which measures how much carbon is emitted from energy use.
Neither index discloses the use environmental, social or governance (ESG) scores as part of it's construction process.
Concentrated parcels of growth companies
The strict screens and narrow investable universe give both funds three characteristics: the holdings tend to be smaller, growth oriented and concentrated in a few sectors.
Morningstar data places both funds on the smaller end of the market capitalisation spectrum, with CLNE tilted the furthest away from the large end of town. Holdings in both funds are more likely to be classified as “growth” than “value”.
Size and growth may reflect the newness of the clean energy and climate change thematic. The world’s first offshore wind farm was commissioned in 1991 in Denmark, but the US only followed suit in 2016. JinkoSolar, one of the world’s largest solar panel manufacturers, went public in 2010.
Newer companies in a growing space may rise quickly. They may also be more volatile. The BetaShares product disclosure statement warns investors about the volatility that comes from the fund’s greater exposure to small and mid-capitalisation companies.
The narrow universe means both funds are highly concentrated across three or four sectors. In the case of CLNE, 95% of the holdings operate in the technology, utility or industrial sectors.
Investors get the benefit of pure exposure in exchange for the risk that changes in economic or political conditions could impact many of the holdings at once.
Clean energy investors are buying lots of utilities
Investors looking for a concentrated parcel of clean energy names will find lots to like in CLNE. Those after a broader range of companies connected to sustainable activities may want to look at ERTH.
Neither fund holds any Australian companies.
CLNE’s holdings are rounded out with a global line up of renewable energy players, such as Austrian electricity provider Verbund AG. One consequence of the focus on energy is a large portfolio of utilities. These defensive stocks make up roughly a third of the fund. For example, CLNE holds narrow-moat hydroelectric giant Meridian Energy (ASX: MEZ), New Zealand’s largest electricity generator.
Utilities are better known for stable earnings and dividends than double digit growth, says Morningstar senior equity analyst Adrian Atkins. And renewable generation is an increasingly competitive business, he says.
“Everyone can install solar farms and wind farms. What’s your competitive advantage? You produce power at the same time as everyone else because that’s when the sun is up.”
Heightened competition is already squeezing returns in the offshore wind business, says Morningstar wind energy analyst Tancrede Fulop. CLNE holding Orsted (ORSTED) pioneered wind farms in the 1990s and initially enjoyed high returns thanks to subsidies and few competitors. Today, subsidies are falling, and the market is maturing.
“Even with better technology the returns on new projects are lower than the mid-2010s,” says Fulop.
Hydroelectric generation is a strong candidate among the renewable generators, says Atkins. Dams release water to match demand. The steep building cost limits competitors and the main input—water—is free.
“New Zealand utilities are a good idea for ESG investors. They’re clean and genuinely good quality companies,” says Atkins.
Climate change solutions are a broad church
ERTH’s broader remit and larger portfolio of companies translates into a wider range of holdings than CLNE.
The fund’s portfolio of 99 companies operates across 36 different Industry Classification Benchmark (ICB) sectors, a classification methodology developed by FTSE and Dow Jones. CLNE’s covers 5.
Many investors will recognise electric vehicle makers Tesla (TSLA) and its Chinese competitors NIO and XPeng. Green transport also includes rail equipment manufacturer Alstom (ALO) and Japan’s largest railway operator East Japan Railway (9020).
Then there are companies such as DocuSign (DOCU), which offers electronic signatures and contracting or meal-kit provider Hellofresh (HFG). Both claim to cut down on waste, from paper and packing to food.
Even climate change funds are not free of controversy and two of ERTH's holdings are embroiled in alleged labour disputes relating to China's Xinjiang province.
ERTH holds small positions, totalling less than 1% of the fund, in Chinese wind turbine manufacturer Xinjiang Goldwind and solar panel maker JinkoSolar. Both were implicated in the use of forced labour in China’s Xinjiang province according to Sustainalytics, an ESG data provider.
Both firms have denied the allegations.
Performance and fees
Performance has fluctuated across each fund since they launched in March. CLNE is down 8% for the year as of 15 December while ERTH has notched an 8% gain.
Both funds were hit by sharp declines in December. The average holding in ERTH was 32% off its 52-week high, rising to 43% for the companies in CLNE. Performance at both ETFs moves in similar waves, although CLNE has tended to suffer deeper declines.
Investors in a thematic fund are faced with the question of how to evaluate performance. By design, these ETFs are distinct from broad market indexes.
Morningstar places each fund in a different global category. ERTH is matched against the Morningstar Global ex Australia index, up 21% over the equivalent period. CLNE’s energy bent sees it paired against the Morningstar Global Base Materials Index, up 22% this year. Neither is a perfect match and investors will need to weigh returns against their other objectives.
Investors in each fund will pay a 0.65% management fee, roughly in line with the average 0.66% charged across thirteen other Australian thematic funds.
It’s not enough to get the thematic right
For investors the logic of the climate and clean energy thematic may appear watertight in a world where iron ore miners such as Fortescue and oil and gas companies like Woodside are spending billions to cut emissions and develop clean energy.
BetaShares and VanEck quote data from the UN, business groups and research houses to support the investment case: the cost of producing solar energy is down more than 80% since 2010, trillions of investments are required each year to achieve a zero-carbon economy.
But it’s not enough to pick the right theme, says Morningstar’s director of ETF research Ben Johnson. Investors hoping to profit off structural change need to get two more picks right, he says. Their fund needs to hold the right companies—not everyone rides the thematic wave equally—at the right price.
“The odds of winning these bets are low, but the payouts can be meaningful,” he says.