Although the urgency of the climate problem is undeniable, oil, gas and coal cannot be banned overnight. To increase the range of responsible and sustainable solutions available to investors, Invesco launched the Solar Energy UCITS ETF this month. But surprisingly, even this ETF is only “light green”, under the Sustainable Finance Disclosure Regulation (SFDR).
Although the fund offers exposure to companies in the solar energy supply chain, it is “only” classified as an Article 8 fund under the SFDR. “We are conservative in our approach to the SFDR designation,” said Christopher Mellor, who is responsible for equity and commodity ETFs in Europe, the Middle East and Africa at Invesco, a global, US-based independent investment management firm.
“The regulations surrounding the classifications between ‘grey’ Article 6 funds, ‘light green’ Article 8 funds and ‘dark green’ Article 9 funds are new and complex. To be able to call an ETF an article 9 fund, you must offer significant exposure to social and/or eco-friendly companies. There must also be clear governance oversight.”
A complicating factor, according to Mellor, is the “do no significant harm” principle. According to this principle, sustainable investments can only be labelled as such if they do not harm other ESG objectives.
“This ETF probably meets these objectives, but before we can take a firm stand on this, we need to be sure that we meet all the other legal requirements. The risk of incorrectly categorising products is that you could be accused of greenwashing.”
“I can imagine a lurid headline following a fund provider being forced to re-label a group of Article 9 funds to Article 8 or 6. The devil is in the detail.”
Disappointing 2021
The results for investors in wind turbines and solar panels are disappointing this year after a record year in 2020. While the S&P Global Clean Energy Index was still at a record high of over 2,000 points in January, it fell below 1,500 in the first quarter of 2021. That is still higher than before the Covid-19 crisis, but the upward movement seems to have levelled off.
Mellor explained: “In the last twenty years, we have seen two interesting periods. Between 2005 and 2008, the price of shares in the MAC Global Solar Energy Index, the benchmark for this ETF, increased sevenfold. Solar energy was then already relatively cheap compared to coal, oil and gas. On top of that, there were subsidies from governments that caused demand to soar.”
He continued: “This growth was then cancelled out by the economic crisis. Subsidies decreased because the economy had to be saved. We are now seeing significant improvements in technology and thus significantly lower costs. This means that solar energy is now 80 per cent cheaper than ten years ago. It is actually one of the cheapest sources of energy on the market.”
More urgency than ever
Once again, an interesting period has arrived, according to Mellor. The urgency is greater than ever, as the latest IPCC climate report shows that the objectives of the Paris Agreement will not be achieved at the current rate of transition. Mellor stated: ”If we want to combat global warming, solar energy has to be part of it. That is a fundamental driver for the demand for equities that we invest in.”
Today, 11 per cent of the global energy mix consists of energy from solar panels. Estimates from the Bloomberg NEF New Energy Outlook put the figure as high as 38 per cent by 2050. “Alongside a growing global energy demand, the tendency to satisfy it with solar energy is becoming stronger. So the potential of solar energy is being driven on two sides,” Mellor noted.
Long-term
“Investors can use this product to enhance the long-term growth potential of their portfolio. If the market takes a hit, so does this ETF.” Therefore, according to Mellor, it is also specifically about the longer horizon. The fact that the prices of solar shares have risen sharply in a short space of time is not a cause for concern for Mellor. “Multiples always look to the past. If you look at the potential of this market, the multiples will never reflect the full potential of earnings growth and revenue growth. That is inherent in thematic growth sectors.”
More exciting than the price of the shares, according to Mellor, is the multiple an investor is willing to pay for the growth potential of this market and what discount rate is used. The MAC Global Solar Energy Index (SUNIDX) tracked by the fund currently trades at a factor of 40.6 times earnings, roughly double the price-earnings ratio of the broader global equity market represented by the MSCI World index (MXWO).
“At the end of last year, the index’s multiple was over 100 times earnings,” said Mellor. “Valuation multiples are now much lower, suggesting that a good deal of exuberance has gone out of the market”.
What investors are looking for when investing in clean energy stocks, he said, is exposure to the growth potential of future demand for clean energy solutions. In the case of this fund, it offers exposure to 48 stocks from all parts of the solar value chain, from the producers of polysilicon that make the raw materials for solar panels, to the installers and distributors of solar energy systems.