Staring in the early 2000s, renewable energy investing began to capture investor interest. The development of renewable energy represented not just an important solution for climate change but has also proven to be a story that is fundamentally about technology. Now, as the world economy prepares for a true transition to decarbonization, interest in renewable energy has re-emerged as an important topic for investors.
Rene Reyna is head of thematic and specialty product strategy for the Exchange-Traded Funds (ETFs) and Indexed Strategies teams at Invesco.
Mr. Reyna joined Invesco in 2010. Prior to his current role, he was head of product strategy and development for Invesco’s Unit Trust business. He served as a Unit Trust product specialist prior to that role. Before joining the firm, Mr. Reyna was an investment representative with JP Morgan Chase. He has been in the financial services industry since 2005.
I spoke with Rene on November 22.
Thematic investing is not a new concept, but investor demand to directly invest in a theme such as clean energy has grown considerably over the last five years. Why has there been such a rise in popularity for thematic investing?
That's a great point. Thematic investing has been around for quite some time and has changed drastically over the years. If we turn back the clock 30 years, investors were reaching for a stock to access a theme. But that lacked diversification. If we look back 15 years, investors may have reached for a sector ETF to invest in a theme, but typically they wound up investing in a myriad of other themes at the same time. Today, and especially over the last few years, investors have had the opportunity to invest directly into a theme such as clean tech or water, and this can provide diversification and a targeted focus. This targeted approach to investing has seen rapid growth. If I look at the data going back five years, we've seen thematic investments grow substantially.
We've seen over 100% compounded annual growth rate over the last six years, with $734 million in flows in 2016, and it accelerated to $48 billion in 20211. It's been a massive swing. The reason why thematic investment has gained such popularity is investors are more focused than ever on aligning their investments with their values and passions, and they are looking to express a view. These types of strategies allow investors to do so. This year has been a risk-off environment. It's a first year we've seen a little bit of decline over the last six years, but it's fragmented. We still see some of these themes like sustainability, for example, continuing to grow. But that's why there's been such a rise in popularity.
The clean energy theme is also not new and long-term investors in the theme may have experienced both boom and bust. How has the clean energy space evolved over time? Why is the theme back in vogue?
The clean energy theme is not new. For long-term investors, this theme has felt like a boom and a bust if you've been holding ETFs or individual stocks. If we revisit the past, it's no secret the 20th century was dominated by fossil fuels. But during that time, there was a lot of strides and advancements in science. Renewable energy looked promising. When we entered the 21st century, the technology and its viability were thought about seriously. There was a significant catalyst: the price of oil. Oil prices kept rising in the early 2000s. They peaked in June 2008, when they were at $140 a barrel. Then there was the fear that we would use all oil reserves within 100 years or so.
Renewable energy was viewed as a solution. Investors wanted to get access to the best growth engine. Part of why we see some of these thematic growth opportunities is because our investors are asking, "How can I get in early?" Clean energy was one of those themes that investors thought was an opportunity, based on what I saw in asset managers’ launches of clean energy ETFs in the mid 2000s and the flows that followed. About a decade ago, we saw some of the industry's first clean energy launches in the ETF marketplace. This was the first boom, but it was followed by a bust. Ultimately, we saw a shale revolution here in the U.S. We saw large reserves of U.S. oil change the outlook for fossil fuels. If I look back at that time, the economics for renewable energy were just not quite there. There was a big tradeoff if we go back to the early 2000s.
An example would be residential solar power. If I wanted solar panels on a home, the cost was very expensive. The breakeven was forecast around 15 to 20 years. Many investors were opting to take a pass. Now we fast forward and say, "Well, what has changed? Why is this theme back in vogue?" There have been three primary reasons. There has been significant technology advancement. Think about the electric-vehicle market as an example; that has become scalable. Costs have come down and are now competing with internal-combustion-engine vehicles. Technology innovation has been a part of the story here. As more utilization occurs and as technology advances, costs have come down, and in many cases, very significantly. If you look at the cost of solar PVs or lithium batteries, they've declined 80-plus percent over the last 10 years. Now the tradeoffs or break-evens look more attractive.
The last part of why the theme's back in vogue is climate change. It's resulting in social awareness. There are investors who are concerned and looking to express a certain view. You have the policy element. Think of the Paris Accords; multiple countries came together and agreed to transition away from fossil fuels and hit some of those net-zero targets. There are incentives to do so, and this is part of why this theme is back in vogue.
You mentioned technology advances as one of the three drivers, along with economies of scale and climate change. What are some of the most exciting technological advancements in the renewable energy space? Is the technology scalable?
I look at this space in two ways. The scalable ones that are most exciting – solar power, electric cars, grid-scale batteries, and heat pumps. We're approaching a point where there's mass adoption across the world. To put that in perspective, there are 87 countries that are drawing at least 5% of their electricity from wind or solar2. We're seeing advancement and scalability. If you look at the U.S. as an example, in 2011, 5% of our energy was coming from renewables. In 2021, it surpassed 20%. It is realistic to think half of the U.S. power-generating capacity can come from wind or solar over the next 10 years. These areas are the most exciting3. We're seeing a lot of advancement, and as utilization increases, it's going to drive down costs.
There are more cost reductions that have to take place, such as for heat pumps. Heat pumps are one of the exciting advancements. They're being used more widely across the globe for water heaters and washing machines. But what seems to be holding back consumers and scalability are some of those higher upfront costs. It's a mixed bag in some cases. There are some advancements being made in green hydrogen, but we're just not quite there. It is very expensive and challenging for storage. That's a technology that's not quite scalable.
Another area where we've seen a lot of advancements in the science is fusion. But we're years away and I know investors have heard this story before. There are a lot of companies that are getting private investments, trying to create a new technology, and trying to scale up. It's going to take some time. But those are some exciting areas. It speaks to the innovation that's taking place in this renewable theme.
Over the past few years, we've seen a growing commitment from major economies, including the U.S., to reach carbon neutrality. That was one of the themes in the COP27 conference4 that just concluded. Is the clean energy secular growth opportunity dependent entirely on government policy?
Policy certainly helps. If you think about my answers to why this theme is back in vogue, I certainly think that's one of the drivers. The train has left the tracks. Policy can be the icing on the cake or a tailwind. At times, it could be a headwind. Especially when you think about the U.S., where polarization is infiltrating our political system, it can be challenging. But generally speaking, it's viewed as net positive. But policy certainly can help. If we look at what's taking place away from policy – less government and more on the corporate side – we're seeing more and more companies make a commitment to net zero. If we look at automakers, for example, 17 companies across the globe have pledged to phase out sales of the internal-combustion engine vehicle and 20 national governments have also agreed to phase them out5. You're seeing some alignment between government and corporate policy.
Those are some trends that we're seeing that are helping the U.S. and other countries reach this goal. Amazon is another company that is targeting 2040 to be net zero, which aligns with the Paris Accord.
It's one of those areas where policy can certainly help, but it's not the only driver. Going back to my comment around tailwinds, if we think about the Inflation Reduction Act, we've seen the largest commitment from policy incentives to transition or focus on climate solutions. It's going to be a great time for individuals looking to transition, whether it's residential solar or electric vehicles. It is going to accelerate some of the transition that's already taken place. It's not entirely dependent on policy, but it certainly can help.
Although many countries have committed to an energy transition, investors are concerned about the economic pressures associated with inflation, rising interest rates and geopolitical conflicts such as the Russia-Ukraine War. Should investors perceive those economic pressures as an impediment or as an accelerator to the energy transition?
It is a mixed environment considering the last three years. This contributes to the boom and bust. Leading up to the last presidential election cycle, we saw Biden's climate agenda and policy plans. We have seen an acceleration around clean energy stocks and securities. In 2020, solar and clean energy ETFs had returns over 200%, which was massive6. That was the boom. Looking back, the technicals went beyond the fundamentals. Price got ahead of itself, and we ended up in an environment where we saw a little bit of a downturn. But now we have inflation, rising interest rates, and supply chain issues. For the first time in a long time, we've seen costs on solar PV panels, for example, increase.
The one thing that we've recognized, especially during the geopolitical conflicts like the Russian-Ukraine war, is that it's reshaping the global energy landscape. Our expectation is that it's going to speed up the transition away from fossil fuels. In the near term, where investors may have been concerned, countries have had to turn on old, retired coal plants to look at other options should Russia completely stop shipping oil or through the certain countries. There's been concern with some of these old technologies being revamped. But if anything, it's accelerated this transition. Our expectation in the next few years, we are going to continue to see countries, and Europe specifically, start ramping up and looking for new energy sources because of this geopolitical conflict.
What always helps is cost reduction. We're seeing that across areas that are not as impacted by some of these geopolitical conflicts. India's a prime example. Its solar exports reached $176 million in Q3. That was 70% more than the full year of 20217. Look at some of the other countries that have embraced renewable energy. Japan replaced nuclear power with solar following the Fukushima disaster. In Australia, a third of the homes have rooftop panels. This utilization is going to drive down costs. Some of these geopolitical headwinds are going to help accelerate the transition.
What are the best ways to gain exposure to the clean energy theme?
Thematic investing has grown in popularity. We've seen thematic investing grow in terms of vehicle types with ETFs. The ETF marketplace is interesting in the sense that you can gain exposure to some of these themes in a very targeted way. Solar is a prime example. If you want to own the entire solar value chain, you can do so with an ETF. There's also a very broad clean energy fund. If don’t have a conviction in wind or solar or electric vehicles, lithium batteries, what have you, and you just want to try and get exposure to the theme, an ETF can allow you to gain targeted exposure to this theme.
The number of thematic products, specifically focused on the clean energy transition, have continued to grow. New launches are taking place year after year. If we look at flows into these funds, they are continuing to grow. We see it as one of the easier ways to gain exposure. If you're have a relationship with a financial professional, you can have conversations about what's the most suitable type of ETF for your exposure to the theme.
How should advisors incorporate thematic investments into their broader allocations? Where do you see the allocations typically coming from?
We generally see investors look at thematic investments as a compliment to a core. Those are general frameworks. Some investors approach energy and use sector ETFs, but the energy landscape is changing. Another example we've seen is investors taking their energy exposure and rebalancing away from traditional fossil fuels with some of these renewable energy options, such as solar and wind, to represent the energy landscape. That's another way we see these fit into a broader portfolio.
I mentioned the boom-and-bust cycles. If we look at where some of the valuations are, it could be a good time to look at clean energy. The pullbacks we've seen have created better values, but more importantly, we see this as a long-term option. The energy transition's going to take place over time, and getting ETF exposure, using it as a compliment to your core, may be a good way to broaden your portfolio. Thematic ETFs are generally used as satellite positions (1-10% allocation) to compliment core portfolio holdings. Core portfolio holdings tend to track major indices such as the S&P 500 Index.
How has Invesco approached clean energy?
Invesco has a suite of clean energy products, including solar specific and broad exposure to areas such as water. We've been committed to this space for quite some time. We had some of the first clean energy funds, water funds and solar funds. For investors looking for options to get exposure to this space, I encourage them to look at our funds.
Disclosures:
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1Source: Bloomberg LP
2Bloomberg Article, “Clean Energy Has a Tipping Point, and 87 Countries Have Reached It”
3Bloomberg Article, “Clean Energy Has a Tipping Point, and 87 Countries Have Reached It”
4The 2022 United Nations Climate Change Conference or Conference of the Parties of the UNFCCC, more commonly referred to as COP27, was the 27th United Nations Climate Change conference, held from 6 November until 20 November 2022 in Sharm El Sheikh, Egypt.
5Bloomberg LP, BloombergNEF
6Bloomberg LP in 2020 Invesco Solar ETF (TAN) had a total return of 233.95% (market price) and Invesco WilderHill Clean Energy ETF (PBW) had a 2020 total return of 204.83% (market price). See standardized performance. Performance data quoted represents past performance, which is not a guarantee of future results; current performance may be higher or lower than performance quoted. Investment returns, and principal value will fluctuate, and shares, when redeemed, may be worth more or less than their original cost. See invesco.com to find the most recent month-end performance numbers. Market returns are based on the midpoint of the bid/ask spread at 4 p.m. ET and do not represent the returns an investor would receive if shares were traded at other times. An investor cannot invest directly in an index. Index returns do not represent Fund returns. High, double-digit and/or triple-digit returns are highly unusual and cannot be sustained.
7Bloomberg BNEF Research, “Strong US Demand Drives Surge in India’s Solar Exports”
