Russia's invasion of Ukraine hasn't just lifted global commodity prices. It’s also thrown energy into the spotlight—including the stark divergence between clean and traditional energy, at least in the results of the exchange-traded funds that track them.
Take the Energy Select Sector SPDR Fund (XLE), which tracks energy stocks inside the S&P 500. This fund has soared this year, returning 33% as of Friday. And yet ETFs focused on renewable or “clean energy” sources are retreating. That includes the ALPS Clean Energy ETF (ACES), which has slid 4% this year. Both ETFs have “energy” in their name, but there’s a huge gap in their returns.
The transition toward global de-carbonization was well under way before the Russian invasion. And now that the conflict has upended global commodities markets with nosebleed prices, particularly for oil and gas, it's provided another good reason to accelerate the transition away from fossil fuels to alternative energy sources, say the latter’s adherents.
“It’s important to position for the energy transition as much as it is to position for some future state of energy markets,” said Paul Baiocchi, the chief ETF strategist at SS&C ALPS Advisors. “We will need a tremendous amount of natural gas, for example, to bridge that gap.”
To that end, combining traditional energy investments with up-and-coming energy plays is one financial strategy advisors might consider.
For clients who need income, the Alerian MLP ETF (AMLP) could be a good fit.
The $6.2 billion fund invests in energy infrastructure master limited partnerships (MLPs) that earn most of their cash flow from midstream activities such as the transportation, storage and processing of energy commodities. The Alerian fund carries a 30-day SEC yield of 6.29% and distributes its dividends quarterly. For taxable accounts, the fund simplifies tax reporting by avoiding K-1 reports.
Rather than paying high dividend income, most clean energy ETFs are invested in growth stocks tied to solar, wind and geothermal themes.
For example, just over 80% of the holdings in the ALPS Clean Energy ETF are allocated to mid- and small-cap stocks, while large companies have the remaining minority share. Among the top 10 holdings are ChargePoint Holdings, First Solar, Enphase Energy, Plug Power and Tesla.
Some energy trades are more aggressive—such as the strategy pursued by the Direxion Daily Global Clean Energy Bull 2X Shares fund (KLNE). This fund uses 200% daily leverage; if its underlying index climbs by 1% on any given day, the fund’s performance should be up 2%. Conversely, if it declines by 1%, its share price would fall by 2%.
Despite this year’s setback in clean energy stocks, advisors must focus on the bigger picture. The long-run game of a cleaner future awaits the global energy market. And it could be better to invest accordingly now rather than chase the trend later on.
For sure, buying into out-of-favor clean energy ETFs like the ALPS fund isn't for the faint of heart. But the payoff, with enough patience, could be huge. Investing great Sir John Templeton once observed, "To buy when others are despondently selling and sell when others are greedily buying requires the greatest fortitude and pays the greatest reward."
In retrospect, the Russia/Ukraine war could turn out to be among the most bullish developments for the clean energy sector ever. You heard it here first.