Has The Wind Gone Out Of Alternative Energy?

This year has seen alternative energy assets go up like a rocket and down like a stick.

Following strong inflows and price increases last year, alternative energy ETFs have seen significant price falls over the course of this one. While the S&P 500 is up about 18% year to date, Lipper’s Equity Theme, Alternative Energy, is down about 3%, and the world’s largest alternative energy ETF has fallen more than 30%.

Sector assets snowballed from the second quarter of last year as alternative energy ETFs rallied hard following the first quarter’s pandemic meltdown. More than £13bn has gone into Alternative Energy ETFs over 12 months to end July. And, despite the correction assets are still growing, with the classification being the third most popular European ETF classification for Q1 2021 (table 1).

Table 1: Global Alternative Energy ETF flows over 12 Months (GBP bn)

Source: Refinitiv Lipper, 25 August 2021

What Went Wrong?

There are two aspects to this unwelcome volatility—as I explain with lots of unnecessary handwaving here.

First, there’s the macro aspect. On the face of it, President Biden’s advocacy of a Green New Deal, the EU’s similar Green Deal, not to mention the urgency added by the recent IPCC report, are all massively positive for the sector. Or so you’d think. But all that green infrastructure spending is potentially inflationary, which puts pressure on rates. The threat of rising interest rates increases the cost of capital, to which many of the small- and mid-cap firms that make up this sector are very sensitive. Renewable energy projects have a high up-front investment that pays off over the long term. Higher interest rates decrease future cash flows, so renewables stocks are sensitive to the threat of higher rates.

Another factor this year was the return to favor of “dirty” stocks. The prospect of a broad post-COVID recovery pushed oil and gas prices higher than before the pandemic, attracting investor attention at the expense of renewables.

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