President Obama reiterated a dedication to clean energy in his State of the Union address in late January, proposing to produce 80 percent of the nation's electricity from clean sources, such as renewables, nuclear energy, or "clean coal," by 2035. While that seems like a long way off, the prospect of government subsidies and incentives in an industry so reliant on public funding could mean opportunity for investors. "A number of [sectors] have the potential to be quite large if the U.S. makes a long-term regulatory commitment to [alternative energy]," says Les Satlow, portfolio manager at Salem, Mass.-based financial services firm Cabot Money Management. "It's important that it's long-term because then you don't get the fits and starts and booms and busts that we've seen with these industries for the last 20 years."
There's been no shortage of ups and downs in the alternative energy industries, which have exhibited roughly twice the volatility of the S&P 500 over the past several years, according to Morningstar analyst Kathryn Young. However, using actively managed mutual funds and taking a long-term outlook can mitigate some of the risk and volatility associated with investing in alternative energy, she adds. We asked a few experts to weigh in on the best ways to play alternative energy in your portfolio.
Gabelli SRI Green (symbol SRIAX). Although this fund's name implies a focus on "green" investing, manager John Segrich says the concentration is more on sustainability. "We take that concept and lay it across traditional industries," he says. Segrich cites the clean transportation industry to illustrate the fund's approach. "We try to break down that whole industry all the way down to the components and look at what goes into, for example, an electric car," he says. "The idea is that by breaking apart the industry through the lens of sustainability, we think we can find areas of constraint and then we try to focus on investing in those."
For example, rather than owning shares of the electric car company Tesla, Segrich says he prefers to invest in components further upstream, such as the battery separator firm Polypore International. Polypore manufactures filters for liquids used in lithium and lead acid batteries, which have been gaining popularity for use in portable electronic devices and energy-efficient automobiles. "We would want to capture exposure to electric vehicles, but we're going to do that by owning, for example, a traditional company that makes separators that go into lithium ion batteries," he says. "Our view is that Polypore is a great business that we can own as a standalone company. The economics make sense. And by the way, they're getting designed into all these new lithium ion batteries, so if that really takes off, it becomes an extra driver of growth."
The fund, which launched in 2007, has experienced its fair share of extreme ups and downs during its short existence. The fund sustained fewer losses in 2008 at the height of the financial crisis and capitalized on the market's upswing in 2009, posting a whopping 68 percent gain. Its three-year trailing returns rank in the top 1 percent of Morningstar-rated mid-cap growth funds.
Calvert Global Alternative Energy (CGAEX). Here's a fund for investors seeking targeted, exclusive exposure to renewable-energy firms. Management typically concentrates on the technology, industrial materials, and utilities sectors, which accounted for more than 90 percent of total assets as of December 2010. The team-managed fund makes riskier bets in those industries, generally investing in far smaller, less-profitable companies than those that make up market indices such as the S&P 500 Index.
But with the niche focus comes more risk, says Morningstar analyst Kathryn Young. "Those conditions make the fund highly vulnerable to both market-wide and industry-specific shocks," she says. The fund's standard deviation—a measure of volatility—has been nearly twice that of the S&P 500's over the past three years, Young says, and a 20 percent cumulative loss over that time period hasn't endeared the fund to investors, either. Nevertheless, Young expects better performance from the fund in the next few years and is confident in the fund's subadvisor, Dublin-based Kleinwort Benson Investors International (formerly KBC Asset Management), which has one of the longest track records in alternative energy investing.
Portfolio 21 (PORTX). Management takes a unique approach to investing in alternative energy, only considering companies that integrate environmental sustainability into their business practices. Carsten Henningsen, director of the Portland, Ore.-based Portfolio 21 Investments, uses the image of a funnel on its side to explain the fund's approach. The side sloping downward represents the declining supply of natural resources, while the side sloping upward represents the growing global population. "The planet is finite," Henningsen says. "Neoclassical economics only understands unlimited growth, but it's not physically possible to have unlimited growth." Companies that take steps to adapt to that environment have a competitive advantage going forward, he says. "We have a narrowing bandwidth in which to operate a business, so we're looking for companies that are positioning themselves to move through the funnel," Henningsen says. "They might see their competition not paying attention or hitting the walls of the funnel, but we're really looking for companies with a higher probability of adaptation within the context of ecological limits."
Portfolio 21's manager Jim Madden cites the fund's stake in Google as an example. According to Madden, Google has committed to cut the energy consumption of its data centers, installed solar panels, and virtualized servers to increase efficiency. "If [Google's] competitors don't do that and [energy] prices continue to rise, it's going to be a larger component cost wise for competitors," Madden says, which could affect revenues and a company's bottom line. "So comparatively, Google fares much better."
This strategy has resulted in a broader, more diverse mix of holdings for the fund, which includes European companies such as Swiss pharmaceutical giant Novartis and Spanish telecom firm Telefónica, along with U.S. companies such as IBM. "The portfolio has turned out to be global with a preference for Northern Europe," Henningsen says. "It shows you where the government leadership has been on the issue of sustainability. Government leadership often drives regulation, which drives public policy." The long-tenured and experienced management team also evaluates a firm's record on employee relations, human rights, community involvement, and product safety before investing, and avoids companies with involvement in nuclear energy, tobacco, gambling, or weapons.
Like most other funds in its group, Portfolio 21 has encountered some bumps since its 1999 inception, but has a relatively good record over the long term. Its 4.7 percent annualized return over the past five years ranks the fund in the top 29 percent of Morningstar-rated world stock funds.