Let The Sun Shine Through: Solar ETFs Compared
April 23, 2008
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The boom in alternative energy stocks has given rise to a boom in alternative energy ETFs. More than a half-dozen funds launched in the past two years, and more are on the way.
The newest wrinkle is funds that focus on specific technologies. Specifically, two ETFs have launched in the past month that provide access to the solar energy market.
How should investors choose between the Claymore MAC Global Solar Energy Index ETF (NYSE Arca: TAN) and the Market Vectors - Solar Energy ETF (AMEX: KWT)?
The choices aren't obvious. Both funds offer exposure to the global solar energy market and both charge 0.65% in expenses.
But if you dig deeper, there are important differences that will translate into different performance in different cycles.
Let's take a look.
TAN And KWT Compared
The place to start is with the index methodology. The Claymore ETF (TAN) tracks the MAC Global Solar Energy Index, while the Market Vectors ETF (KWT) tracks the Ardour Solar Energy Index.
Both indexes aim to provide global exposure to the solar energy market. Both hold stocks listed on exchanges in developed markets around the world, although many of those stocks are headquartered in emerging markets like China.
Creating A Pure-Play Index
The challenge in creating a good solar energy index is that many players in the solar market are conglomerates: giant companies like GE that get just a small fraction of their income from solar energy.
The success or failure of the solar market won't have much of an impact on these diversified behemoths. So, including them in an index in theory at least makes the index less sensitive to the solar market.
To avoid this problem, both indexes have screens and/or weighting systems in place to emphasize "pure plays."
The MAC Global Solar Energy Index (and TAN) requires components to generate more than a third of their revenue directly from the solar industry. The index then uses a unique weighting methodology to further emphasize the "pure plays." Those are:
The Ardour Solar Energy Index takes a simpler and more restrictive approach. Companies must generate 66% or more of their revenues from solar energy to be included at all. In other words, all the companies in the Ardour index (and KWT) are pure plays.
Which is a better approach? It's not an easy answer. The gut response is the Ardour Index. After all, the more pure-play exposure the better, right?
But sometimes, as new industries develop, pure-play companies lose out to larger conglomerates, as those conglomerates bring scale and scope to the emerging industry. With a higher concentration of large-caps, the MAC Global Solar Energy Index would benefit if this happens.
Will that happen in solar? There's no way of telling at this point.
Really, both methodologies work. An educated guess is that the Ardour index (and the KWT ETF) will be more sensitive to developments in the solar energy market, offering both more upside potential and higher risk. The MAC index (and TAN) will be less volatile and offer steadier exposure to a broader market.
Such an early assumption of risk is backed up by index-level fundamentals. The Ardour Solar Energy Index is the more growth-oriented index, with an average P/E ratio of 65.61 compared with 44.8 for the MAC index. Similarly, the average price-to-book ratio for Ardour is 5.75 compared with 5.2 for MAC.
On a country-level basis, the weights are similar, but not the same. The Ardour Index has slightly more exposure to Germany, and slightly less to China. Both are significantly international, as shown in Figure 1
Typically for ETFs, it might be wise to refrain from looking at component-level data. Generally, you're looking for well-diversified exposure to an asset class.
But the solar energy market is a small market, and these are very focused ETFs, holding just 27 companies each. As a result, it makes sense to evaluate the ETFs on a company-by-company basis.
The two indexes have significant overlap, sharing 20 components (albeit at different weights) with seven distinct components each.
Figure 2 lists the 20 components held in both indexes, along with their weights. The table is ranked by the difference in weighting between the two indexes.
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