A Clear Play on Clean Energy

05/27/2009 12:00 pm EST

Focus: ETFS

Paul Justice

Associate Director of North American ETF Research, Morningstar, Inc.

Paul Justice, ETF Strategist for Morningstar, writes in that firm’s ETFInvestor about a fund that lets investors get some exposure to emerging energy alternatives.

Investors buying PowerShares WilderHill Clean Energy Fund (NYSEArca: PBW) likely agree with most of the following theses: Carbon dioxide emissions must be curbed, developed countries will vigorously pursue energy independence, research and investment financing will be available at reasonable rates, and governmental subsidies will remain large and persist long enough for alternative technologies to reach cost competitiveness.

[But] while the thought of environmentally friendly renewable power sources that would grant the industrialized world energy independence is a laudable goal, the economics and feasibility of the technologies proposed remains questionable.

Speculative financing is scarce, and the fossil fuels that were so expensive just one year ago are no longer at stratospheric levels. Our equity analysts believe that solar and wind power industries show the most promise, but even some companies in those sectors are facing a treacherous road to financial success.

On one hand, wind, and solar have virtually no variable cost inputs, which gives them a leg up on coal and natural gas generation facilities. However, the price of electricity fell in the second half of 2008 along with fossil fuel costs. That translates into a direct loss for solar and wind generation facilities attempting to recover their high fixed costs over the life of the assets. Our analysts are more pessimistic on the biofuels industry, with a particularly skeptical view of ethanol as a viable replacement for gasoline.

This fund tracks the WilderHill Clean Energy Index, which encompasses 55 or so firms that stand to benefit from the gradual shift toward cleaner energy and conservation. These include firms that focus on renewable energy production (including the solar photovoltaic industry), energy conversion, pollution prevention, energy storage, and improvements in energy efficiency and power delivery. Though the fund holds a smattering of large-cap names, smaller firms are more common: The fund invests more than half of its assets in small- and micro-cap stocks.

With nearly four times more assets under management than its closest competitor, this fund is the most liquid option available in this narrow sector. Furthermore, [its] net annual expense ratio of 0.7% [puts it] on par with other narrowly focused ETFs and considerably cheaper than its mutual fund peers.  (It closed around $9.50 Tuesday—Editor.)

If you’d rather focus on global names, you may want to consider Market Vectors Global Alternative Energy (NYSEArca: GEX). The 30 global holdings in this index are market-cap weighted, which will give you more exposure to the biggest companies in the industry. With a fee of just 0.62%, this alternative has lower costs, and it has sufficient market liquidity to trade efficiently. (It closed above $25 Tuesday—Editor.)

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