S&P Dow Jones Indices (SPDJI) is proposing to increase the number of holdings of its clean energy index from 30 to 100 following a consultation with the market, in a move to address liquidity risk and constituent concentration.
The proposed changes to the S&P Global Clean Energy index are a sharp move away from the previous consultation in January which planned to increase the index’s total holdings to a minimum of 35.
In the latest consultation, SPDJI is now planning to increase this minimum to 100, more than tripling the current number of companies featured in the index. This will have a major impact on the exposure of the world’s largest clean energy ETFs, the $7bn iShares Global Clean Energy UCITS ETF (INRG) and the $7bn iShares Global Clean Energy ETF (ICLN).
Such concentrations mean that not only have these small companies had their valuations over-inflated by the popularity of clean energy strategies but both clean energy ETFs and their holdings are vulnerable to dips in their counterpart’s performance.
Expanding the underlying index will mean that INRG and ICLN will have less concentrated baskets, allowing them to rely less heavily on a handful of small companies. This will likely be to the benefit of not just the ETFs and small companies themselves, but also investors, as the products they are invested in will become less volatile, especially if the huge inflows seen over the past year reverse.
To make these changes possible, SPDJI has laid out a series of alterations to its index methodology.
Roadmap to a less concentrated index
The first adjustment will involve the introduction of an additional 0.75 exposure score level. Previously, companies either received a 0, meaning they had no exposure to clean energy, 0.5, meaning they were a multi-industry with some clean energy exposure, and 1, which signified a company with clean energy as its core business.
Now, the additional score of 0.75 will represent companies deemed to have significant clean energy exposure but not as their primary business.
This new score is significant because of the second new change. Previously, only companies with a score of 1 – that being companies whose primary business was clean energy – were eligible for inclusion. Now, if not enough stocks with a score of 1 can be selected to make up the target of 100, the remaining number is made up of companies with scores of 0.75, which are ranked by market cap.
If at this point the target constituent target has not been reached, the largest-cap stocks with a score 0.5 are selected until either; the 100 target is reached, all companies with scores of 0.5 and above have been exhausted, or the index’s weighted average score falls below 0.85.
Finally, SPDJI said it will make changes to its weightings, corresponding to a mixture of a constituent’s market cap and clean energy exposure score.
Constituents with exposure scores of 1 are capped at 8%, while 0.75 are limited to 6% and those with 0.5 are capped at 4%. Within each stratum, companies are ranked based on either their exposure score or five times their liquidity weight.
Furthermore, all stocks within SPDJI’s index with a weight greater than 4.5% cannot collectively make up more than 40% of the index, a significant change given INRG’s current 9.7% weighting in Plug Power.
Panacea or band-aid?
These changes will be welcome relief to many INRG and ICLN investors who decided to hold despite the 17.7% performance dip since the start of February.
Though the April rebalance may still be an uneasy time for those holding the popular BlackRock products, some consolation should be taken from the fact that they will be in a more stable – and crucially – less volatile position than they began the year.
While the new constituent target should take INRG and ICLN well beyond the 47-constituent average for clean energy ETFs in February, it is worth noting that the 100 target is still short of the 117 constituents currently held within the Invesco Global Clean Energy UCITS ETF (GCLE).
Also, GCLE is comprised entirely of pure-play clean energy equities – with a total of 255 unique clean energy stocks held by all clean energy ETFs.
With that being said, INRG and ICLN slightly diverging from pure-play clean energy could ease over-concentration and liquidity concerns – which could give them an edge over their rivals.
What is yet to be seen is how long investors will have to wait before oil majors transitioning into clean energy will be eligible for the SPDJI index, and how significant such an inclusion would be for clean energy investment as a whole.