Why Has the Guggenheim Solar ETF (TAN) Underperformed? was the title of an article we published more than three years ago. My how things have changed. Since the beginning of this year, TAN is up +96% compared to a Nasdaq return of +24% over the same time frame. There’s no longer any competing solar ETF (the VanEck Vectors Solar Energy ETF – KWT -shut down), and the Guggenheim Solar ETF has now been renamed to the Invesco Solar ETF.
The biggest renewable energy ETF at the moment is the iShares Global Clean Energy ETF (ICLN) which has amassed $1.38 billion in assets under management (AUM).
The second biggest renewable energy ETF – and the only pure-play solar ETF at the moment – is the Invesco Solar ETF with $1.25 billion in total assets. We previously wrote about how these two ETFs differ. Since we’re already invested heavily in wind energy with Next Era Energy (NEE), our investment objective is solar energy exposure. (Solar and wind are the two renewable energy sources that now generate electricity at the lowest cost, even with subsidies removed.)
The price movements of TAN over the year tell a story. In mid-February, the ETF hit new highs on increased volume shortly before “the Rona” reared its ugly head. By summertime, TAN had recovered to its previous high, and that’s when the catalyst for the meteoric rise was announced.
X marks the spot – Credit: Yahoo Finance
In early July, the two biggest residential solar installers – Vivint Solar (VSLR) and Sunrun (RUN) – decided to merge. The business model of both these firms is to install solar panels on residential homes. News of two companies merging rarely results in shares of both companies increasing several hundred percent, but that’s what happened. Since the merger announcement, shares of Vivint and Sunrun have increased by +290% and +260% respectively. This makes no logical sense at all.
News of the merger talks about a paltry $90 million in cost synergies to be realized between two solar installers hardly merits $9.5 billion worth of market cap appreciation, even after the initial pop that took place following the news of the merger. As long-time investors in TAN, we’re left with a bit of a dilemma.
Breaking Down TAN’s Returns
An ETF is a collection of stocks that each contribute a portion of the overall return. In looking at the top-10 solar companies in the Invesco Solar ETF, we can see Sunrun in position three and Vivint in position seven for a combined weighting of around 12%.
|SolarEdge Technologies Inc||SEDG:US||US||9.65%||+130%||12.55%|
|Enphase Energy Inc||ENPH:US||US||8.15%||+199%||16.22%|
|Xinyi Solar Holdings Ltd||968:HK||China||6.98%||+94%||6.56%|
|First Solar Inc||FSLR:US||US||6.56%||+17%||1.12%|
|Scatec Solar ASA||SSO:NO||Norway||4.42%||+66%||2.92%|
|Vivint Solar Inc||VSLR:US||US||4.23%||+443%||18.74%|
|JinkoSolar Holding Co Ltd||JKS:US||China||3.98%||+68%||2.71%|
|Canadian Solar Inc||CSIQ:US||China||3.74%||+54%||2.02%|
As with any ETF, stock weightings will change based on relative stock price appreciation/depreciation, but we can still guesstimate each stock’s year-to-date (YTD) contribution by multiplying its weighting by the YTD return. It’s intuitive that both Vivint and Sunrun have contributed meaningfully to the rise of TAN over 2020, even more so in the last several months. Since the ETF is simply based on the underlying MAC Solar Index, we can turn to the index provider to see what rules they have in place to trim positions.
If necessary, the raw weighting factors are modified through a weighting-gap rebalancing algorithm to ensure that, at the time of rebalance, no security in the Underlying Index has an individual weighting greater than 10% and that the aggregate weighting of securities in the Underlying Index with individual weightings of more than 4.5% is no more than 45.0% of the total Underlying Index.
Credit: MAC Solar Index
Both Sunrun and Vivint still have plenty of room to run before their weightings are adjusted. The last quarterly index review was on September 18th, so even if adjustments are warranted, they won’t be happening until next quarter.
Trimming Our TAN Position
Our solar thesis hasn’t changed. We’re still bullish on the solar industry and don’t have a problem stomaching normal market volatility. While our investment strategy is to not time the market, we don’t want to sit idly by and watch these two solar stocks drive up the price of this ETF based on what appears to be nothing but hype. We’re planning to trim our position in TAN based on two fundamental principles:
- The Efficient Market Hypothesis – All information is priced into stocks. When a stock price soars drastically with no new additional information, it is usually hype or manipulation responsible for the rise.
- The Historical Success of M&A Synergies – Studies by McKinsey have shown that most large mergers fail to achieve expected synergies. The problem is particularly pronounced on the revenue side per the below:
Wall Street wisdom warns against paying for revenue synergies, and in this case it is right. The greatest errors in estimation appear on the revenue side—which is particularly unfortunate, since revenue synergies form the basis of the strategic rationales for entire classes of deals, such as those pursued to gain access to a target’s customers, channels, and geographies.
Credit: McKinsey Quarterly, Where mergers go wrong
It is very suspicious that both solar companies that have decided to merge – Sunrun and Vivint – have increased more than several hundred percent since the merger was announced. It leads us to believe that no reasonable thesis is driving the movement of these two stocks, and that the unexplained irrationality could be compounded by short squeezes that send prices even higher.
If most mergers fail to achieve their stated revenue synergies, then it’s conceivable that the merged entity would be worth only slightly more than the sum of its parts owing to cost synergies, but certainly not 3X as much. Ideally, we want to keep the solar energy exposure we have in TAN, but capture some of the upside from the inexplicable rise of Vivint and Sunrun.
For novice investors who feel comfortable taking action here, the simple trade is to trim your position in TAN a bit. You could then buy back those shares once Vivint and Sunrun settle back down to earth. For advanced investors, you might consider trying to play Vivint and Sunrun on the downside. We’d advise against shorting, since some of the most sophisticated institutional long/short traders are probably getting their asses handed to them right now. The irrationality of the Robinhood trader types will far exceed your margin account limits. Instead, you might consider put options.
We strongly advise our readers never to dabble in options because it’s the domain of extremely sophisticated institutional investors. With that said, buying a put is a much better way to capture a stock’s downside than being short. More sophisticated investors may consider hedging TAN’s appreciation by purchasing puts against Vivint and Sunrun, allowing plenty of time for the trade to mature. Just remember, the person on the other side of the trade you’re making is probably a computer algorithm that’s considering far more variables than you can possibly imagine. Whatever money you put up on an options trade, you should be prepared to lose.
While our overall conviction on solar investing hasn’t changed, we’re trimming our position in TAN a bit based on the fact we believe the two major contributors of return are extremely overvalued for no apparent reason. Today’s markets may be showing more irrationality than we’ve ever seen, much of it owing to the emergence of the Robinhood gamblers who have commandeered today’s market. Eventually, hype will dry up, and we’ll be left with the pure-play exposure we’re looking for from the only solar ETF out there – the Invesco Solar ETF.
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