More investors are using ETFs for exposure to the mining industry’s green metals movement. But approach with caution, writes Tony Featherstone.
Exchange Traded Funds (ETFs) have transformed investing in global technology stocks. Now, ETFs are doing the same for the green-metals boom.
At least six green-metal ETFs were launched on the ASX in the fourth quarter of 2022. More are on the way as investors position their portfolios for decarbonisation.
For the first time, investors can buy a portfolio of global copper producers that will benefit as demand for electric vehicles (EVs) soars. Or focus on lithium, nickel, cobalt or other metals vital for clean-energy infrastructure and technologies.
ETFs are investment funds that track an index over equities, bonds, commodities, currencies or other assets. Bought and sold like a share, ETFs aim to replicate the price and yield return of their underlying index.
For example, an ETF over the S&P/ASX 200 Index provides exposure to stocks in the index and seeks to closely match the return of the ASX 200.
The main benefits of ETFs are diversification, low fees and simplicity. In a single trade, investors can gain exposure to hundreds of stocks. Some ETF fees are less than 0.1 per cent.
The main drawback of ETFs is that they are passive investments (although some investors use them actively to trade markets). Unlike active managed funds that handpick stocks and aim to beat an index, ETFs simply track that index.
ETFs have become a global investment phenomenon as more investors desert higher-cost active funds, most of which underperform their index over time. Increasingly, retail investors are using ETFs rather than investing directly in stocks.
Green-metal ETFs are a type of thematic fund. Thematic ETFs typically provide exposure to investment megatrends or emerging investment themes. During the tech boom in the previous decade, thematic ETFs took off on the ASX.
ETFs over cloud computing, artificial intelligence, cybersecurity, video games and other tech sub-sectors were launched. These ETFs provided diversified exposure to tech megatrends that have low representation through ASX-listed companies.
A similar trend is emerging in green metals. As investors seek exposure to resource companies benefiting from rising demand for green metals, ETFs are filling a void.
Consider copper. After BHP’s expected takeover of OZ Minerals, there will be few large ASX-listed copper stocks left. Investors who want exposure to copper, which is used in EVs and other clean-energy technologies, have to buy global copper producers.
Thematic ETFs can seduce investors who believe backing megatrends, such as green metals and decarbonisation, is a sure-fire way to make money. But care is needed.
ETF issuers have a habit of launching thematic ETFs after a sector booms or a trend captures investor imagination. Thematic tech ETFs were all the rage when the global tech sector was hot, but most have had heavy losses in the past 12 months.
Sustainability ETFs that invest in companies developing climate-change solutions also took off a few years ago. They also disappointed last year after the sell-off in global tech stocks and other speculative growth companies.
Academic research shows thematic ETFs mostly underperform over longer periods. A 2021 US study, Competition for Attention in the ETF Space, found that thematic ETFs lose an average of 30 per cent in risk-adjusted terms over their five years after launch.
Underperformance of thematic ETFs was “driving the overvaluation of underlying stocks (in the ETF’s index) … Overall, (ETF) providers appear to cater to investors’ extrapolative beliefs by issuing specialised ETFs that track attention-grabbing themes.”
In other words, thematic ETFs on average underperform over five years because issuers usually launch these funds after stocks take off. Investors believe the boom will continue long into the future but end up owning an index of overpriced stocks.
This is especially important for green-metal ETFs. Few investment megatrends are as compelling as decarbonisation. As the transition from fossil fuels to clean energy quickens, the price of green-metal commodities should have strong support.
Lithium is an example. Early investors in the global lithium market achieved staggering gains. Grand View Research, a prominent US research firm, predicts the global lithium-ion battery market will be $US135 billion by 2030.
If Grand View is correct, the lithium market will have compound annual growth of about 18 per cent this decade. Few sectors have such growth prospects.
Green metal ETFs arrive
In Australia, the Global X Battery Tech and Lithium ETF (ACDC) has starred. Launched in August 2018, ACDC had $530 million in assets in December 2022, ASX data shows.
The ETF, which invests in local and global resource companies that supply materials for batteries, has a three-year annualised return of 22 per cent. That makes it the top-performed ETF over that period, although ACDC’s one-year return is negative.
ACDC’s success has encouraged other green-metal ETF launches. In November 2022, Global X launched the Global X Copper Miners ETF (WIRE) on the ASX.
WIRE provides exposure to 40 global copper producers in Canada, Australia, China, Japan and other markets. They include Freeport-McMoRan, Ivanhoe Mines, First Quantum Minerals and other well-known copper producers.
Copper has appealing long-term prospects. The metal is becoming harder to find and mine and there has been underinvestment in new copper mines. At the same time, copper demand has solid fundamentals as more people switch to EVs.
In October, BetaShares launched the BetaShares Energy Transition Metals ETF (XMET). XMET tracks an index of 36 global companies that provide raw materials for renewable-energy generation, battery storage and EVs.
About a third of XMET is invested in Australian green-metal stocks such as Pilbara Minerals, IGO and OZ Minerals.
Global X in October launched the Global X Green Metal Miners ETF (GMTL) to provide exposure to 46 global resource and chemical companies. Around 40 per cent of GMTL is invested in China, giving the ETF a more speculative flavour.
In June, BetaShares launched ETFs over companies involved in solar and uranium. The BetaShares Solar ETF (TANN) provides exposure to a range of solar-energy suppliers, producers and manufacturers.
The BetaShares Global Uranium ETF (URNM) provides exposure to companies involved in uranium exploration and production, modern nuclear energy and/or companies that hold physical uranium or uranium royalties.
URNM is an interesting, albeit speculative, idea for investors who believe nuclear energy will be increasingly accepted as a safe, reliable and low-carbon energy source, whereby uranium would be the key raw material.
Although these and other green-metal ETFs have a strong sales pitch, much can go wrong. Global X in October 2020 launched the Global X Hydrogen ETF (HGEN) to much fanfare, amid booming interest in hydrogen as an emerging clean-energy source.
HGEN has burnt investors since launching. The ETF lost 36 per cent over 12 months to end-December 2022, ASX data shows. Hydrogen has interesting long-term prospects, but as an investment it is too early and speculative for most people.
Long-term prospects appeal
Nobody doubts demand for green metals will rise as the world transitions towards clean energy. More copper will be needed to make EVs; more lithium and nickel will be needed for batteries; and more uranium for nuclear energy.
But investors who buy thematic ETFs in green metals today do so after a strong rally in parts of that market. Buying into a sector after it booms is often a recipe for short-term losses, meaning investors need to take extra care with green-metal ETFs.
Underlying commodity prices for the companies owned by the ETFs can be highly volatile and hard to predict, at least in the short term. There is little room for error when stocks trade on high valuations in anticipation of higher commodity prices.
Nevertheless, green-metal ETFs are a useful tool. Prospective investors who use them should have at least a 3-5-year investment horizon, preferably longer. They should also have the ability to withstand short-term losses and high volatility, should they occur.
The key is positioning green-metal ETFs in investment strategies. Green-metal ETFs should be considered a portfolio “satellite” that can produce higher returns (with higher risk) than portfolio “core” investments, such as an ETF over the ASX 200 Index.
Investors should also consider how they combine portfolio exposure to fossil-fuel producers and green-metal companies. In the next few years, the smart play could be higher exposure to coal and energy producers, with a view to transitioning gradually from fossil fuels to green-metal companies, depending on price movements.
The key is watching and waiting for better value. Buying green-metal ETFs during market or sector corrections makes a lot more sense than chasing them higher after price rallies. For now, green-metal ETFs should have a spot on portfolio watchlists.
The good news is that Australian retail investors finally have more tools to invest in global resource stocks in green metals and other mining sub-sectors. The lack of resource ETFs made no sense in a sharemarket with such a high weighting in resource stocks.
Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs.
Before acting on information in this article consider its appropriateness and accuracy, regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at January 11, 2023.
This feature appeared in the February issue of Australian Resources & Investment.