Green and renewable energy ETFs have performed exceptionally well so far this year, with the majority of outperformance coming after May. At a base case level, we believe that investor sentiment toward this investment theme may be reflecting the shifting outlook (a Biden win) for the upcoming U.S. elections, which could have a significant impact on the industry. Beyond November’s election results, we expect the U.S.—along with other countries—to enact sizeable fiscal stimulus that targets green energy projects. Over the long-term, we believe favorable changes in public opinion and economic fundamentals are likely to benefit the industry, as costs relative to traditional energy sources have declined dramatically. In our view, these developments may help fuel robust performance for the green and renewable energy theme in the years ahead.
Political Tailwinds for Green Energy?
During the first five months of 2020, three First Trust ETFs focused on green and renewable energy—the First Trust NASDAQ® Clean Edge® Green Energy Index Fund (QCLN), the First Trust Global Wind Energy ETF (FAN), and the First Trust NASDAQ® Clean Edge® Smart Grid Infrastructure Index Fund (GRID)—performed relatively well compared to the S&P 500 Index (Chart 1). However, relative performance for these ETFs accelerated from June through September.
Chart 1: Price Performance Relative to the S&P 500 Index (12/31/19 – 9/30/20)
In our view, one factor that may help to explain the outperformance of these ETFs since May is the improving odds that Joe Biden could win the U.S. presidential election. While President Trump led in the Real Clear Politics (RCP) average betting odds at the end of May, odds had moved decisively in Biden’s favor by the end of June (Chart 2). Biden supports reducing U.S. emissions through substantial investments in green initiatives, outlined in a $2 trillion climate plan unveiled earlier this summer. While performance of green and renewable energy ETFs may be driven by election expectations in the near-term, we believe two important factors may drive long-term growth for this theme: public-sector investments— accelerated by COVID-19 stimulus—and improving affordability.
Chart 2: Real Clear Politics 2020 Presidential Election Average Betting Odds (3/31/20 – 9/30/20)
The Green Coronavirus Response
To revive economic growth in the wake of the COVID-19 crisis, governments around the world are planning to commit trillions in fiscal stimulus to this effort, much of which is going toward clean and renewable energy projects. In July, the European Union passed an economic stimulus package and long-term budget which included more than €500 billion for renewable energy and related uses.1 Europe already has ambitious emissions targets on the horizon such as carbon neutrality by 20502 and a significantly higher renewable energy generation by 2030.3 These commitments are likely to result in elevated investment in new energy beyond the coronavirus pandemic, in our opinion.
Environmental initiatives are also being targeted with stimulus spending outside Europe. Earlier this year, China announced it will invest $1.4 billion in electric vehicle charging and renewable energy plants1 and is reportedly considering greater emissions cuts and additional green spending.4 President Xi Jinping has even publicly urged nations to undertake a greener economic recovery.5 Although there remains a high degree of uncertainty surrounding additional fiscal stimulus in the U.S., funding for clean energy has been a prominent component in proposed recovery packages thus far.6 Given the political willingness for direct spending on green initiatives, we expect fiscal tailwinds to remain in the years ahead.
Cost Reductions Fuel Transition to Renewable Energy
While it took many years to get here, renewable energy has reached a tipping point, becoming economically competitive with traditional energy sources such as coal and natural gas. Advances in manufacturing have resulted in solar module prices falling roughly 80% since 2010, while the cost of electricity generated by wind power has fallen approximately 30-40%7 due to efficiencies in energy storage and transmission. Today, the unsubsidized cost of wind and solar power is less than that of coal, according to Bloomberg.
Chart 3: Estimated Unsubsidized Cost of New Energy Projects (1H 2014 – 1H 2020)
As the cheapest source of electricity in many parts of the world, wind and solar power generation has increased substantially over the last several years. In the first half of 2020, renewable power generation rose 14% compared to the same period last year, and now accounts for approximately 10% of worldwide power generation.8
Chart 4: Share of Global Electricity Generation (2000 – 6/30/2020)
Domestically, the lower cost of renewable energy—as well as natural gas—has resulted in a steep decline in the coal industry. Coal production fell to the lowest level in 40 years in 20199 , while more U.S. energy was consumed from renewable sources than coal.10 Coal plant closures under President Trump are expected to exceed closures during the last four years of the Obama Administration,11 despite the President’s support for the industry. On the other hand, investments in clean energy in the U.S. also jumped to a record $56 billion in 2019, higher than Europe and second only to China.12 The outlook for renewable power demand appears robust as well, with 16 U.S. states13 and over 160 U.S. cities14 making commitments to 100% clean and renewable energy in recent years.
Chart 5: U.S. Coal and Renewable Energy Consumption (Annual BTU, quadrillions, 1950 – 2019)
Investing in Green Energy
As mentioned above, First Trust offers three ETFs designed to provide exposure to the green and renewable energy theme: The First Trust NASDAQ® Clean Edge® Green Energy Index Fund (QCLN) tracks U.S.-listed pure play companies active in the clean energy market, including but not limited to renewable electricity generation, energy storage, and electric vehicles. The First Trust Global Wind Energy ETF (FAN) provides a targeted approach to companies involved in the wind energy industry, with 88.5% of its holdings domiciled outside the U.S. as of 9/30/20. The First Trust NASDAQ® Clean Edge® Smart Grid Infrastructure Index Fund (GRID) tracks companies active in smart grid infrastructure, smart meters, energy management, connected mobility and related activities.
1 Bloomberg 7/21/20
2 Wall Street Journal 12/12/19
3 Europa 1/2020
4 Bloomberg 9/22/20
5 Bloomberg 9/17/20
6 Politico 6/8/20
7 IRENA 6/2/20
8 Bloomberg 8/12/20
9 EIA 7/28/20
10 EIA 5/28/20
11 Reuters 1/13/20
12 Bloomberg 1/16/20
13 Energy Sage 5/2/19
14 Sierra Club
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Industrials companies are subject to certain risks, including the general state of the economy, intense competition, consolidation, domestic and international politics, excess capacity and consumer demand and spending trends. They may also be significantly affected by overall capital spending levels, economic cycles, technical obsolescence, delays in modernization, labor relations, and government regulations.
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Smart grid companies can be negatively affected by high costs of research and development, high capital requirements for implementation, government regulations, limited ability of industrial and utility companies to implement new technologies and uncertainty of the ability of new products to penetrate established industries.
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Performance Summary (%)
Performance data quoted represents past performance. Past performance is not a guarantee of future results and current performance may be higher or lower than performance quoted. Investment returns and principal value will fluctuate and shares when sold or redeemed, may be worth more or less than their original cost. You can obtain performance information which is current through the most recent month-end by visiting www.ftportfolios.com.
^QCLN Expenses are capped contractually at 0.60% per year, at least until April 30, 2021. FAN Expenses are capped contractually at 0.60% per year, at least until January 31, 2021. GRID Expenses are capped contractually at 0.70% per year, at least until January 31, 2021.
*NAV returns are based on the fund’s net asset value which represents the fund’s net assets (assets less liabilities) divided by the fund’s outstanding shares. Market Price returns are based on the midpoint of the bid/ask spread on the stock exchange on which shares of the fund are listed for trading as of the time that the fund’s NAV is calculated. Returns are average annualized total returns, except those for periods of less than one year. The fund’s performance reflects fee waivers and expense reimbursements, absent which performance would have been lower.
Performance information for the indexes is for illustrative purposes only and does not represent actual fund performance.
**Indexes do not charge management fees or brokerage expenses, and no such fees or expenses were deducted from the performance shown. Indexes are unmanaged and an investor cannot invest directly in an index. The Russell 2000® Index is comprised of the smallest 2000 companies in the Russell 3000 Index. The MSCI World Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of 23 developed markets around the world. The Russell 3000® Index is comprised of the 3000 largest and most liquid stocks based and traded in the U.S. The MSCI World Industrials Index is a free float-adjusted market capitalization weighted index that is designed to measure the industrials sector performance of 23 developed markets around the world. The S&P Composite 1500 Industrials Index is a capitalization-weighted index of companies classified by GICS as industrials within the S&P Composite 1500 Index. The S&P 500 Index is an unmanaged index of 500 stocks used to measure large-cap U.S. stock market performance.
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