The 2022 passing of the Inflation Reduction Act wasn't totally about reducing inflation. Under the surface, the bill was actually the biggest green energy subsidy in history.
Since the green energy tax credits within the bill are actually uncapped for the next 10 years, estimates for the bill's total overall transfers from the federal government to individuals and businesses vary. Estimates provided by various financial institutions and think tanks range from $780 billion all the way to $1.2 trillion.
Who will be the beneficiaries of all this largesse? It will actually be a wide variety of consumers and businesses across end markets. And with the U.S. being just one year into the 10-year period for these generous tax credits, it's not too late to bet on the big beneficiaries of this bill.
Making this all especially intriguing is that the green energy sector was actually down significantly in the first year of the IRA in 2023, due to the rapid rise in long-term interest rates. Therefore, these clean energy companies may look especially enticing at their multi-year low valuations today.
To play for an upturn in leading clean energy stocks with IRA subsidies at their back, one broad-based green energy exchange-traded fund (ETF) seems like the best way to play it.
After several years of underperformance, this clean energy ETF looks like it may be turning up. Image source: Getty Images.
All green everything
In order to calculate who benefits from the IRA, you need to understand what the IRA actually subsidizes. It's a lot, and goes well beyond a single, narrow sub-segment of the green energy market.
For individual residents or small businesses, the Residential Clean Energy Credit provides credits against the installation of new green energy equipment such as solar panels, wind turbines, heat pumps, fuel cells, and battery storage. In addition, the Energy Efficient Home Improvement Credit subsidizes an array of home energy efficiency upgrades as well as home energy audits. Finally, there is a tax credit for up to $7,500 for the purchase of qualifying electric vehicles.
Meanwhile, for larger businesses and utilities, there is both an investment tax credit (ITC) on green energy equipment installed during a single year, and/or a production tax credit (PTC) in which a tax credit is given based on the amount of renewable electricity produced per year over the next 10 years. Some technologies such as batteries or microgrid controllers are eligible for the ITC, while energy-producing projects such as biomass or hydroelectric plants qualify for the PTC. And some technologies such as solar and wind can qualify for either (but not both).
This ETF plays into this broad spectrum of beneficiaries
While some ETFs give investors exposure to a single one of these end markets, such as solar energy, or utilities, or electric vehicles, the First Trust NASDAQ Clean Edge Green Energy Index Fund(NASDAQ: QCLN) would be my pick to play the benefits from the IRA.
Why this particular fund? It comes down to its diversity, the quality of the companies within the ETF, and its fairly reasonable expense ratio of 0.59%. That's above what you'll pay for a general market index fund, but pretty reasonable for a sector-specific one.
The QCLN describes its holdings as dispersed among four general buckets: Advanced Materials, Energy Intelligence, Renewable Electricity Generation & Renewable Fuels, and Energy Storage & Conversion. To qualify, a company must have a market cap over $150 million and have its stock priced over $1. In terms of ETF security selections, each business must receive more than 50% of its revenue coming from clean energy or low-carbon activities. The ETF is rebalanced twice a year, and weighted based on a "modified" market cap methodology. However, no security can account for more than 8% of the fund on rebalancing, so the top five names are all weighted around that level.
The four broad groups tend to capture the bulk of what will be subsidized by the IRA, and which should power the energy transition over the next decade. Top holdings include leaders across a variety of end markets. No doubt, solar and electric vehicles contribute heavily here. The top five holdings include solar panel manufacturer First Solar(NASDAQ: FSLR), solar inverter leader Enphase Energy(NASDAQ: ENPH), electric vehicle producer Tesla(NASDAQ: TSLA), power and silicon carbide semiconductor company On Semiconductor(NASDAQ: ON), and lithium miner Albemarle(NYSE: ALB).
These are all high-quality leaders across virtually all parts of the solar and EV value chain: panel-makers, inverters, an auto OEM, a semiconductor stock, and a miner of raw materials.
But what I also like about QCLN is that among its top 10 holdings is a company like Acuity Brands(NYSE: AYI), which offers intelligent lighting solutions, and plays into the energy efficiency and retrofitting angle as well.
The rearview mirror is somewhat underwhelming, but the windshield...
To be sure, the QCLN has had underwhelming performance over the past one, three, five, and 10-year periods, lagging behind the small-cap index Russell 2000 over each of those time periods, and it was down each of the last three years and early 2024.
However, this three-plus-year period of underperformance also came after stratospheric gains in 2019 and 2020, when QCLN appreciated 42.7% and 183.4% back-to-back. But the last time the index had a three-year losing streak? That was from 2014 to 2016. In 2017, the ETF appreciated 31.7%.
While history may not repeat itself, and it was clear index was frothy in 2020, after several years of declines, the stage could be set for another boom year. While the IRA did begin to kick in in 2023, the last two years have also seen a very rapid rise in interest rates, which tend to especially hurt renewable energy project economics as well as auto purchases. Yet with inflation seemingly on the way down and the Federal Reserve likely to lower rates at some point later this year, that big headwind may be easing.
Given the boom-bust nature of the ETF, this could be an opportune time to invest, Valuations are much lower, interest rate pressures may be easing, and we still have nine years left of the IRA tax incentives ahead of us. For contrarian investors, the QCLN is worth a good long look.
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Billy Duberstein has positions in ON Semiconductor. His clients may own shares of the companies mentioned. The Motley Fool has positions in and recommends Enphase Energy and Tesla. The Motley Fool recommends First Solar and ON Semiconductor. The Motley Fool has a disclosure policy.
