QCLN - QCLN Should Be Your Preferred Bet If You're Interested In Clean Energy

2023-09-20 12:31:59 ET

Summary

• The Inflation Reduction Act (IRA) has sparked a massive surge in investment in clean energy projects, the EV value chain, and hydrogen projects.
• Clean energy could contribute close to 600GW of energy by the end of the decade, with a significant increase in investments across the EV value chain.
• We measure QCLN's qualities versus its largest peers.
• We like the current risk-reward on the charts.

IRA Has Transformed The Status-Quo

Clean energy has had its fair share of naysayers over the years, but amidst all the skepticism, it's difficult to dismiss the role that the Inflation Reduction Act (IRA) has played in galvanizing interest in this space. Since the IRA became effective in August 2022, we've seen a surge in investment announcements ($271bn during the first 50 weeks) in terrains such as wind, solar, storage projects, etc.

With $400bn of benefits likely to come through by way of funding and tax credits, BloombergNEF now believes that clean energy could contribute close to 600GW of energy by the end of this decade; put another way, close to half the energy mix could come from these sources alone.

The euphoria isn't limited to just the growing share of renewables in the energy mix. Nearly a year into the IRA, we've even seen a notable step-up in investments ( $72bn of private sector investments) across the EV value chain, notably in the field of battery manufacturing.

Meanwhile, the hydrogen industry as well announced plans that could see a tremendous surge in the capacity of blue hydrogen (potential growth of 30% through 2030) and green hydrogen (3.5x growth through 2030) by the end of this decade.

Think also of the manifold ways in which all these clean energy technologies (solar, energy storage, EVs, etc.) could come together and raise the sustainability quotient across the average home (the image below helps provide some context).

QCLN Snapshot

If you're looking to capitalize on these winds of change, and are looking for suitable products, the First Trust NASDAQ Clean Edge Green Energy Index Fund ( QCLN ) is one option you may look at. QCLN has been around for a while now (established in Feb. 2007), and focuses on stocks that are involved in the manufacturing, development, distribution, or installation of clean energy technology such as advanced materials, energy intelligence, renewables, or energy storage and conversion. Prospective stocks are required to generate at least 50% of their revenue from these activities.

QCLN Vs. Its Largest Peers

To better understand QCLN's qualities, it would make sense to contextualize it against two of its oldest and largest (by AUM) peers from the clean energy space. In that regard, we've looked at the iShares Global Clean Energy ETF ( ICLN ), and the Invesco WilderHill Clean Energy ETF ( PBW ).

PBW is the oldest ETF amongst the lot, but its weak structural qualities (the main edge that PBW offers is a superior yield compared to the other options, and a lack of top-heaviness), and weak performance have resulted in its AUM lagging the other two options. QCLN is certainly more popular than PBW (as exemplified by a higher AUM, and slightly better dollar trading volumes on a daily basis), but it comes up short versus ICLN, whose AUM is over 2.5x greater than QCLN's and witnesses almost 5x the daily dollar volumes of its smaller peers. Needless to say, this also translated to much tighter spreads, although QCLN's spreads aren't too far behind.

What certainly also works in ICLN's favor is its relatively low expense ratio which is around 17bps better than QCLN's. Investors may also perhaps appreciate the broader exposure that ICLN offers. Firstly, it offers coverage to the widest pool of names (122 stocks, almost twice as much as QCLN's portfolio), and secondly, it is more geographically spread out. QCLN is rather US-centric (95% of total holdings), and ironically this heightened exposure may have worked very well for it in recent periods (given the IRA effect).

When you look at the return profile over time (the starting date is ICLN's listing date as it is the youngest ETF out of the three), there's only one winner - QCLN. In fact the other two options have failed to generate any positive returns since then.

Look, it isn't just the relative difference in the absolute returns, even if one considers the quality of risk-taking, be it over the short-term (three years) or long-term (15 years), QCLN comfortably trounces the other two options. The Sharpe ratio provides some context on the ability of these portfolios to generate excess returns per unit of total risk. Here QCLN comes out on top. The Sortino ratio focuses on how these ETFs fare during harmful volatility; once again, it is QCLN with the gold medal.

So, what is it that QCLN does so well? Well, besides the heightened exposure to the US clean energy stocks (which have received a leg up from the IRA), it also helps that QCLN is very much a growth-centric ETF (tech and consumer cyclicals account for almost two-thirds of the total portfolio) and we've seen how well growth has done in the last decade and in recent years.

It also helps that QCLN is more exposed to the mid and small-cap segments, and keeps its micro-cap and large-cap exposure quite low. This way, one sort of gets the best of both worlds. You get solid enough earnings growth potential from small and mid-caps, and you don't overly expose yourself to troubled companies (that are most often found in the micro-cap space, something which PBW is heavily exposed to) which could suffer when there's a change in risk sentiment.

It also helps that QCLN is a little more stable than the other two options (it typically only churns out 1 in 3 names annually, whereas the other two options turnover 1 in 2 names annually)

Closing Thoughts - Technical Considerations

Since 2021, QCLN hasn't been doing particularly well, trending lower in the shape of a descending channel. Whilst the channel pattern certainly isn't ideal, within this structure, we like the current risk-reward on offer as the price is only around 12% off the lower-end of the channel and around 35% from the upper end of the channel.

Meanwhile, if one looks at how US clean energy stocks are positioned relative to the total US stock market, we can see that now there's some decent scope for mean-reversion as the current relative strength ratio is trading around 40% below the mid-point of the long-term range.

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