New Solar ETF Helps Spread Sector's Risk

Claymore Securities just listed the Claymore/MAC Global Solar Energy Index ETF(TAN Quote), and it seems to have potential. Solar has been an interesting place to invest because of the importance of the products and the wild volatility in both directions that is likely to continue for the foreseeable future.

It should be clear from the chart of the top three holdings, First Solar(FSLR Quote), Renewable Energy Corp. of Norway and Q-Cells of Germany, that the names underlying the fund are unambiguously volatile.

The fund really is global: China is the largest country represented in the fund, at 29.91%, followed by Germany at 29.01% and the U.S. at 26.33%. Still, ex-U.S., TAN invests in only five countries.

The methodology for index construction is to select from companies that "specialize in providing solar energy products and services," subject them to common liquidity screens and then weight them by market capitalization (actually a modified market-cap weighting so that no one company has too great a weighting).

The fund has a weighted average market cap of $5.8 billion, a P/E of 44, 25 holdings and a cap on the expense ratio of 0.65%.

Smoking-Hot Solar Small-Cap Stocks

One little quirk is that there is no published back-test information (verified with a call to the fund).

Over the last couple of years, the solar space has obviously been a very hot area -- but from late December to mid-February there was a nasty correction, and it would be worthwhile to know how the index did during that decline in terms of giving some idea of worst-case trading.

Singed by Solar The sector had a recent rough patch

Click here for larger image.

The fund literature does spell out of the bullish case for solar and, of course, the presumption is that the stocks should benefit.

According to index provider MAC Indexing, the world will need $4 trillion in new electricity generation over the next 22 years. Solar-industry revenue grew by 50% last year, but solar accounts for only 0.06% global electricity consumption; that should mean solar will have tremendous growth ahead of it.

That sort of information makes the case for the solar industry, but it also tells me that there will be a lot of upheaval in terms of companies doing well, and failing, and new companies coming to the fore as capitalism does its thing in an industry that, by the numbers, is in its infancy.

Earlier this year, I wrote a couple of articles about my expectation that the landscape for the stocks could look much different a few years from now as the industry evolves. I would expect some survivors, several failures and some new names to play prominent roles in the space as the world hopefully will gravitate toward alternative sources of energy.

The timing of those articles caught some of the momentum down, and since that downtrend bottomed out shortly thereafter, some of the names in the space rallied, and some went sideways.

The "infancy" state of the industry makes the case for using an ETF to avoid single-stock risk. A bet on the industry is much easer to make than being sure you have selected the correct couple of stocks.

From the top down, TAN is 80% industrial stocks. The industrial sector is currently 11.74% of the S&P 500, so I might think that anyone wanting solar exposure could allocate 3% (or less) and fill out the rest of their industrial exposure with holdings that would be less volatile.

I would also add that buying solar is buying a call option on the future. Despite the growth, solar's piece of the energy pie is so small that it might as well not exist yet. It seems clear that the technology will matter, but the microscopic use for now is where the risk lies.

Whether you invest in the stocks or the ETF, it's a bet that solar will grow into wider use.