This article first appeared in Personal Wealth, The Edge Malaysia Weekly on December 4, 2017 - December 10, 2017

Lithium, the core component of batteries found in smartphones and laptops, is almost ubiquitous in our technology-driven lives. The increasing popularity of electric vehicles (EVs) and autonomous cars is driving even greater demand for the metal. Thus, companies in this sector could present opportunities for investors.

The only exchange-traded fund (ETF) in the market that tracks the whole lithium cycle, from mining and refining to battery production, is the Global X Lithium & Battery Tech ETF. The index it tracks is provided by Germany-based Solactive and is listed on the NYSE Arca. According to its fund fact sheet (as at Sept 30), the index has gone up 4.36% since its inception in 2010 and 51.34% year to date. 

Jay Jacobs, vice-president and head of research at Global X Funds, says the ETF saw over US$750 million in net new assets this year, bringing its total assets under management to more than US$1 billion. “We have seen periods of inflows and interest in the fund since inception. But 2017 has been a banner year, ramping up over the last few months. This indicates that investor interest in the lithium story is really coming alive, particularly as the movement towards EVs reaches an inflection point,” he adds. 

“We have found that funds such as the Global X Lithium & Battery Tech ETF or the Global X Robotics & Artificial Intelligence Thematic ETF appeal to a wide range of investors looking to access these burgeoning technologies. These are tangible ideas that make inherent sense to retail investors, and the fundamental research appeals to intermediaries looking to enhance the growth potential of their portfolios.”

The Global X Lithium & Battery Tech ETF was launched in 2010 to ride the growth of personal electronics such as smartphones, tablets and laptops. According to the Solactive website, the index it tracks fell from a peak of 150 points in 2011 and only began to rebound last year. The index is almost back at its peak level. 

Solactive head of research Timo Pfeiffer says last year was the best time to invest in the theme. “Overall, the ETF has had a constant and positive performance over time. If you had bought into the ETF in 2010, yes, you may have started sweating a bit in 2012 and 2013. You would not have been that happy. But now, looking back, this is a long-term investment trend. We are looking at 4% to 5% per annum, which I think is a decent return.”

According to the Global X website, the fund’s average annualised returns were 66.46% over one year, 19.05% over three years and 7.63% over five years as at Oct 31.

POLICIES, EXCITING TECHNOLOGY AND CHANGING HABITS

The surge of interest in EVs is being driven by falling battery costs and government regulations across the globe encouraging the adoption of these vehicles for environmental reasons. 

“For example, the Organization of the Petroleum Exporting Countries (Opec) forecasts an estimated five times more EVs in 2040 than originally expected while the International Energy Agency recently doubled its forecast,” says Jacobs.

“Among the biggest changes have been countries such as France, the UK, China and India all announcing that they will eventually ban the sale of combustion engine vehicles, resulting in significant optimism over lithium’s future as it is used in EV production.”

Norway aims to end the sale of petrol and diesel-powered vehicles by 2025, India by 2030 and France by 2040. “As more and more EVs come into the market, more lithium batteries will be needed,” says Jacobs.

“As more countries ban combustion engines and electric trucks are introduced into the market, the demand will rise exponentially. High-end EVs use about 10,000 times more lithium than a smartphone, so one million EVs will see as much demand as every smartphone ever made.”

Elon Musk’s Tesla may be the company that comes to mind when EVs are mentioned. Its premium electric cars and, most recently, trucks have grabbed global attention. 

While the company may be the most innovative in developing new versions of EVs, auto manufacturers globally are developing hybrids or EVs to meet the demand. “Tesla is the one that comes to mind because it is doing this right now. It is probably the hottest car manufacturer out there. But it is also the least established one,” says Pfeiffer.

“This is the future for players such as Toyota, Volkswagen, BMW and Mercedes-Benz. All these companies have big projects going on. They have some prototypes out there and you can already buy hybrid models.”  

For instance, Volvo Cars announced in July that every vehicle it launches from 2019 onwards will have an electric motor.

In addition to batteries for EVs, utility-scale batteries to store wind and solar energy could be another source of demand for lithium. Tesla, for instance, just completed the construction of the world’s largest lithium ion battery to store wind energy in Australia.

Even if governments do not follow through on their pledges to ban diesel emissions, the changing mode of transport will still drive the growth of EVs and autonomous vehicles, says Pfeiffer. Popular ride-hailing companies such as Uber have already changed the concept of car ownership. In November, it signed a deal to buy 24,000 autonomous vehicles from Volvo, offering a glimpse into a future where people may not own cars anymore. 

“That is the thinking right now. Will I still drive my own car in 10 or 15 years? How will I drive it? Will we share an electric vehicle? Will we not have vehicles at all because my car is not used 23 hours of a day? So maybe, we will have 80% fewer cars and they are all electric. But obviously, the mobility for us here in large cities is going to change,” says Pfeiffer.

KEEPING IT CLOSE TO THE METAL

The Solactive Global Lithium Index, which is adjusted every six months, had 34 constituents on Nov 28. The companies it tracks are in three stages of the value chain — lithium mining, refinery and battery production. 

More focus is given to the first part of the value chain. Exposure to lithium-mining companies is capped at 20% while exposure to those involved in refinery and battery production is capped at just under 5%. The biggest holdings of the index are Albermarle Corp (19.17%), FMC Corp (16.57%), Sociedad Química y Minera de Chile SA (6.69%) and LG Chem Ltd (5.46%). Tesla is its 10th largest holding at 4.14%.

“It is because the focus of this particular theme and construction of this particular index were supposed to be as close to the actual commodity, lithium, as possible. That is why we are overweight on the early part of the value chain,” says Pfeiffer.

“If you go to the other end of the value chain, where you actually think of battery producers, you have the likes of Samsung, Panasonic and Tesla. That is why those that fall under the producer segment have a lower exposure cap.”  

The filters Solactive applies to select stocks that go into the index are the size and liquidity of the equities. “We do a market capitalisation filter and an average daily volume (ADV) filter to make sure the stocks are actually large enough from a market-cap perspective and they are liquid enough so that the ETF has the liquidity needed on a daily basis to buy those stocks. It should be a minimum of free float to market cap of US$25 million and the ADV over the last month needs to be in excess of US$150,000,” says Pfeiffer.

The remaining stocks are ranked by market cap within the weighting constraints imposed on the stocks, depending on which stage of the lithium cycle the company is involved in.

INVESTMENT RISKS

A risk in terms of betting on the rise of EVs is that it may just be a fad or technology hype that fails to materialise due to various factors. Pfeiffer warns that investing in a theme that gains popularity rapidly in the last 12 months comes with risks and potential volatility.

“Right now, a lot of the news is positive for this particular segment, but it may change quickly,” he says. “For example, in the coalition talks in Germany, the Greens party is driving a lot of the environmental and new technology aspects. But it may have to give in to a compromise and not be able to ban petrol and diesel-powered vehicles by 2030, giving traditional cars more time than we expect. That would be a risk to such an index and such an investment.” 

Another potential risk investors have to take into consideration is that for EVs to take off, relevant infrastructure will have to be built and maintained. The vision for electric and autonomous vehicles is still far from reality based on the existing facilities.

“If we produce the coolest batteries on the planet and there is strong demand for lithium, but we don’t have sufficient charging networks or stations across cities, then it is pointless,” says Pfeiffer.

Will fuel stations reinvent themselves? Will battery suppliers and producers create deals with the likes of Walmart or other large supermarket chains so that people can do their shopping and also charge their cars? These are important issues, he says. But if such developments are disrupted, take longer or not work at all, they will pose investment risks.

Jacobs says investors have to understand that there is a lag in the market between the increase in demand for lithium and the speed at which new supply can come on stream. “It can take up to seven years from the time a lithium producer seeks to increase output and the new lithium supply actually hitting the market. While there are significant projects underway to ramp up production, we do not expect them to have a major impact on prices for a while. And once the supply hits the market, perhaps it is downward pressure on spot lithium prices, but the producers can still potentially grow their earnings through increases in volume,” he adds.

The Solactive Global Lithium Index is targeting a very specific segment, even though it is diversified in the companies it targets across the lithium cycle. Thus, Pfeiffer suggests that investors not use this index as their core investment or main holdings in their portfolio, but as a very specific addition to a selected theme.

The exposure to multiple companies at various stages of the lithium cycle can provide diversification and protect investors from some of the risks, he adds. “We believe a diversified approach helps reduce specific company risks while maintaining high exposure to the underlying theme of lithium. 

“Investing in only one company can expose an investor to a variety of risks, whether they are geographical or operational in nature. So, it is possible for an investor to get the theme right, such as correctly identifying the opportunity to invest in lithium, but pick a company that suffers from a fire, poor management or loss of its mining licence. By spreading the risks, the ETF can help mitigate these company-specific risks.”

Some companies in the US and Singapore are already conducting trial runs for autonomous vehicles while EV chargers are becoming a common sight in Malaysian malls. Whether it is EVs or electronics and household goods, the demand for lithium will persist as long as there is a need for batteries that use the metal, which is still the preferred choice in battery production, says Pfeiffer.
 

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