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The solar energy industry had a breakout year in 2020. Increased demand for renewable energy, a corporate focus on sustainability, and low interest rates culminated in massive growth across the industry. But since early 2021, the industry has been under pressure.

Russia's invasion of Ukraine emphasized energy security over sustainability and led to a recovery in the oil and gas industry. Inflation and higher interest rates have reduced the return on invested capital in commercial and residential solar projects, making the industry less attractive.

Despite the multi-decade tailwinds, there's no sugarcoating the grim reality that the solar energy industry is in a downturn -- with many companies forecasting bleak short-term outlooks.

Investors looking for ideas to invest in a recovery have come to the right place. Exchange-traded funds (ETFs) can be a simple yet effective way to play a rising tide lifting boats across the industry rather than betting on an individual company.

The Invesco Solar ETF (NYSEMKT: TAN) is down 67% from its all-time high and is hovering around a four-year low. Here's why the ETF has a lot of potential upside, as well as some risks worth considering.

Global exposure to a variety of companies

The Invesco Solar ETF has just under $1 billion in net assets and 38 holdings. The fund classifies 46.5% of its holdings as information technology companies, 27.5% as utilities, 20.1% as industrials, 3.5% as financials, and 2.5% as materials.

If you're familiar with the industry, you'll recognize many names among the fund's holdings. Solar module manufacturer and technology company First Solar (NASDAQ: FSLR) is the largest holding at 9.4% of the fund followed by inverter and energy systems company Enphase Energy (NASDAQ: ENPH) at 9%. The fund holds multiple renewable utilities, such as Clearway Energy, which invests in renewable energy projects and generates income from power purchase agreements. Solar panel, tracker, and other solutions are made by Nextracker, Array Technologies, Sunrun, and SunPower -- all of which are holdings in the fund.

Perhaps the greatest advantage of the ETF is that it offers exposure to companies not listed on U.S. exchanges that would otherwise be difficult to buy shares in. Over 27% of the fund is in foreign listed companies -- which provides exposure to the growth of solar in key markets like China and Europe. However, many non-U.S. companies are listed on U.S. exchanges.

Invesco categorizes just over 50% of the fund's allocation in North America, about a fourth in Europe, and a fourth in Asia -- giving the fund balanced exposure to some of the hottest regions for increased installations and manufacturing capacity.

Credit where credit is due

Despite being far more cost-effective and profitable than in years past, the industry is still heavily dependent on credit markets, which can vary wildly.

First Solar and Enphase Energy have seen their cash flow and margins benefit by focusing heavily on U.S. manufacturing and staying nimble. In its recent quarter, Enphase shipped 506,000 microinverters from its U.S. contract manufacturing facilities. These microinverters qualified for the 45X production tax credit under the 2022 Inflation Reduction Act.

Meanwhile, SolarEdge Technologies (NASDAQ: SEDG) -- a competitor of Enphase in the inverter, power optimizer, electric vehicle charging, and solar system space -- has kept its international manufacturing capacity at expanded levels in the hopes that demand recovers. The decision has backfired and led to steep negative operating cash flow -- which is one of the reasons why SolarEdge has underperformed Enphase and is down over 90% from its all-time high.

SolarEdge used to be a top holding in the Invesco Solar ETF, but now makes up just 3.2% of the fund -- illustrating that ETFs with diversified holdings can still post sizable losses if there is a major drawdown in a big holding. Investors who believe in the growth of U.S. solar may want to pass on the ETF due to its high international exposure and focus on top domestic plays instead.

Comparing ETF fee structures

Another drawback of the Invesco Solar ETF is its 0.67% expense ratio. Investors used to passively managed ETFs may be accustomed to seeing expense ratios of 0.1% or lower. Many top low-cost Vanguard ETFs have expense ratios under 0.05%.

A 0.67% expense ratio isn't terribly high, but it certainly adds up. A higher expense ratio can be particularly annoying when an ETF is losing value. For example, if you had bought the fund a few years ago, you would have unrealized capital losses from the investment declining in value and added losses from fees.

Oftentimes, you can offset fees by collecting a yield on a fund. But companies like First Solar and Enphase Energy don't pay dividends, so the yield of the Invesco Solar ETF is quite low. If you're buying a passive ETF in the Vanguard S&P 500 ETF, for example, the 1.3% dividend yield will more than offset 0.03% in annual fees.

The Invesco Solar ETF's fee is high, but it is arguably worth it if you're looking for a geographical and industry mix within the solar industry.

A diversified approach to a risky industry

The key to compounding wealth over time in the stock market is knowing what you own and why -- and remaining patient. The Invesco Solar ETF isn't perfect, but it is simple. Buying it as a catch-all way to invest in solar over the long term could be a brilliant move, especially considering there are reasons to believe the slowdown could be reaching an end.

However, the longer the downturn lasts, the more strained companies could become. Companies can only burn cash for so long. If the whole industry is in a hole, then there could be few creditors willing to lend a helping hand. In this vein, one of the greatest benefits of the Invesco Solar ETF is its diversification and protection from a handful of companies going bankrupt.

Another strategy is to do some additional research and find solar energy companies that you're particularly confident about. Buying a mix of companies or pairing individual stocks with an ETF can be a great way to build a solar portfolio that caters specifically to your interests.

In sum, the Invesco Solar ETF is a good starting point, especially for investors looking to spread risk across the industry.

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Daniel Foelber has positions in Enphase Energy and SolarEdge Technologies and has the following options: short July 2024 $30 calls on SolarEdge Technologies. The Motley Fool has positions in and recommends Enphase Energy, Nextracker, and Vanguard S&P 500 ETF. The Motley Fool recommends First Solar and SolarEdge Technologies. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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