TAN - GRID: Smart Grid Captures Themes In Clean Energy And Disruptive Technology

2023-05-16 17:55:28 ET

Summary

• The Smart Grid represents the modernization of electrical power networks by incorporating new technologies.
• First Trust NASDAQ® Clean Edge® Smart Grid Infrastructure Index Fund ETF has outperformed peers over the past year through a unique portfolio composition.
• We are bullish on the GRID fund, with the smart grid theme capturing several long-term growth tailwinds.

First Trust NASDAQ® Clean Edge® Smart Grid Infrastructure Index Fund ETF ( GRID ) invests in companies with exposure to the equipment and software critical to electric power networks. This is a thematic fund attempting to capitalize on secular growth in next-generation energy management technology as renewables and electric vehicles gain importance globally.

The attraction of the fund is the strategy's relative diversification across high-quality global utility sector leaders alongside some more high-growth names with end-user applications. Indeed, that combination of balancing some risk has proven to be a winning strategy, with the fund outperforming alternative "clean energy" exchange-traded funds, or ETFs, historically and over the last year.

Overall, GRID offers a unique exposure that could work for investors to complement a broader equities exposure. We believe clean energy and smart grid infrastructure stocks are well-positioned to continue generating positive returns over the long run.

What is the GRID ETF?

GRID is designed to passively track the NASDAQ Clean Edge Smart Grid Infrastructure Index as a benchmark for the grid and electric energy infrastructure sector.

Compared to "utilities," the idea of the smart grid is the broader ecosystem of technology and specialized machinery including electric meters, devices, networks, and storage platforms intended to transmit and distribute power more efficiently.

Getting past the soup of buzzwords, smart grid infrastructure companies stand to benefit from the ongoing global effort to modernize energy infrastructure. The definition of the smart grid from the U.S. Department of Energy summarizes the theme well:

Today's grid is designed to support large power plants that serve customers through a system that is essentially one-way. A smart grid is a two-way system where power generated by multiple sources is distributed across a grid based on a network rather than a hierarchical structure. By adding digital communications to the infrastructure of the smart grid, the flow of energy can be managed to run more efficiently and can integrate more renewable energy sources.

According to GRID's index methodology, companies' primary business is evaluated based on its connection to the smart grid, electric infrastructure, or other grid-related activity. From that group, companies recognized as a "pure play" on the theme are given a collective weighing of 80%, while there is some room for more diversified securities to represent 20% of the index and fund.

The criteria here require a $100 million minimum market capitalization with holdings following a float-adjusted modified market-cap weighting. Notably, the index is rebalanced quarterly alongside a semi-annual reconstitution.

GRID ETF Portfolio

While the GRID ETF features 85 current equity holdings, the fund is relatively concentrated, with the top 25 stocks representing 90% of the fund. That said, we can point to the wide range of types of companies with the theme covering industries from electrical components, industrials, utilities, and renewable energy equipment makers, to semiconductors, and even electric vehicle names encompassing the full vertical integration.

The fund's latest positions between National Grid Plc ( NGG ), Schneider Electric S.E. ( SBGSF ), ABB Ltd ( ABB ), and Eaton Corporation plc ( ETN ), all with an approximate 8% weighting, are good representatives of smart grid infrastructure as either a utility name or manufacturer of critical electrical transmission equipment.

Enphase Energy, Inc. ( ENPH ) and SolarEdge Technologies ( SEDG ) with a 4% weighting each highlighting the importance of solar. Smaller positions in notable mega-cap tech names including Honeywell International Inc. ( HON ), NVIDIA Corporation ( NVDA ), and even Tesla, Inc. ( TSLA ) go back to the pure play and diversified selection criteria where there is some room to include stocks with only a peripheral connection to "smart grid infrastructure."

GRID Analysis

What we like about the GRID ETF is that the "smart grid" theme ends up encompassing a relatively more defensive or less risky side of technology, compared to other clean energy segments. The combination of cash flow-rich utilities alongside disruptive innovators forms a distinct profile that may be more resilient across different economic cycles.

In contrast to other industry-specific clean energy ETFs covering just "solar," "wind," or electric vehicles, GRID has exposure to the best of everything. That type of diversification helps explain how it has been able to outperform what we would consider more targeted funds "clean energy funds," like the Invesco Solar ETF ( TAN ) and iShares Global Clean Energy ETF ( ICLN ) over the past decade.

That dynamic is particularly important in the current market environment, defined by high-interest rates and ongoing macro uncertainties. Simply put, the type of companies within the GRID portfolio benefit from both organic growth tailwinds and the incremental momentum of smart grid technology adoption.

According to the International Energy Agency ((IEA)), average annual investments in electricity grids will need to accelerate over the next decade for global "net-zero" or carbon-neutral policies. Governments around the world are incentivizing these types of infrastructure modernization efforts, which we see as translating directly into the market opportunity for GRID stocks.

GRID Price Forecast

We are bullish on First Trust NASDAQ® Clean Edge® Smart Grid Infrastructure Index Fund ETF and see the GRID fund trading higher going forward. With a positive macro outlook where global inflation normalizes lower and interest rates stabilize, a rebound in risk sentiment through 2024 should reward companies that power the next generation of technologies.

In terms of risks, the concern would be for a deeper deterioration of economic conditions. A scenario of a deepening recession would likely add to financial market volatility by forcing a reset of near-term earnings expectations.

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