Is there alternative beta in alternative energy?
Nov 26th, 2007 | Filed under: CAPM / Alpha TheoryWe’re always on the look-out for new and different market risk factors or betas here at the AllAboutAlpha global headquarters. So with all the talk recently about alternative energy (such as a session at this Toronto energy conference next week hosted by AllAboutAlpha media partner Lipper HedgeWorld), we started wondering if there was actually a market risk factor associated with so-called “clean energy” companies that was separate and distinct from the energy factor itself.
We found this article in Forbes late last month exemplified the general level of excitement about alternative energy. It cites impressive YTD growth of several alternative energy ETFs such as the US$660 million PowerShares WilderHill Clean Energy ETF (PBW). This makes immediate sense. After all, clean energy is the next big thing, right?
It turns out that PBW daily returns have a 64% correlation to the S&P Energy Select SPDRs (XLE), an ETF containing old-fashioned energy companies (calculated using data available at Google Finance). That’s not really that high. Here’s what the one year scatter plot of PBW and XLE daily returns looks like:
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[...] Don’t expect alternative betas from alternative energy. “When you look at a two-year horizon, it would appear that the PBW is essentially an XLE with “noiseâ€.” (All About Alpha) [...]
There’s one other thing you’re buying with clean energy: the ability to feel better about your investments. It may not make you extra money (although I believe it will with increasing GHG regulation), but knowing you’re doing the right thing is worth a lot to some of us.
I disagree that PBW is XLE + noise. Beyond a clean energy play, ETFs like PBW reflect the need for energy development in general. It is likely we will be using more energy from all sectors in a growing global economy. The future will be more cars, planes, trains, houses, iPods… using energy more efficiently. We will need every solar panel, every acre of sow bean, every nuclear power plant, every wind turbine and every barrel of oil that can be extracted out of the ground. The rate limit to the next large scale global growth will be true fundamentals — water, soil, land, industrial materials. Very few current in-place energy systems will be replaced. We will mostly add to the existing supply of energy. In regions of the world where it is expensive and time consuming to create large distribution networks for gas pipelines and electric grids – pocket-sized small regional grids with windpower and solar will be installed quickly and get people up-and-running much faster than a coal burner or a gas pipeline. As commodity prices continue to rise both XLE and PBW and others like them will rise with the rising tide of worldwide energy demand. Personally, I was hoping that Chavez would refuse to sell oil to the US as it would send markets even higher for both sectors and force a better energy security development for resource-poor nations (such as the US). As usual, politics will play a complicated and complicating role in the modification of these models. Much of the world’s oil is in the hands of people that are highly motivated to deploy their own agendas. Alternative energy technology development is in the hands of scientists and engineers who are rapidly working the problem and are highly motivated. Altertive energy sources will play an increasing role in energy deliver as oil becomes more expensive to extract from more difficult locales. In aggregate both sectors will go up as demand contnues to grow.
[...] In a posting on November 26, 2007 (“Is There Alternative Beta in Alternative Energyâ€) AllAboutAlpha’s “Alpha Male” states that alternative energy returns over the past year have been both significantly correlated to general energy prices, and highly volatile. This is true. But as Alpha Male admits, alternative energy may provide alpha and alternative beta in the future in ways that we have not seen in the past. For good reason, it will. This is precisely why active management will yield significant benefits in this sector.  [...]