4 Funds That Focus on Alternative Energy

The promises made on the campaign trail aren't always kept once a politician takes office. This time around, though, there seems to be bipartisan support for one particular vow: weaning the U.S. off its dependency on foreign oil. Both parties agree accomplishing such a feat is a priority.

No doubt part of the solution to that problem is alternative-energy sources. Indeed, President-elect Barack Obama said during the campaign he would create five million jobs by heavily investing in this sector. Some of that spending could come in the form of a massive stimulus program expected to cost around $850 billion, one that could include infrastructure projects with a green bent. The prospects for the sector, though, don't rest solely on the shoulders of a new administration. Alternative energy is growing both here in the U.S. and overseas as products become more sophisticated and more affordable.

Alternative energy is a burgeoning class of mutual funds. In fact, it's so new it doesn't have its own classification in our Lipper database. That means we had to perform our fund screen this week using slightly different methods. We pulled a select group from other categories and then looked for those that had decent fees, performance track records and manager reputations. Four funds made our list. They are included below in order of return over the trailing 12-month period.

Even though alternative energy is a relative new fund category, the industry itself is quite vast. It encompasses the obvious, like solar panel makers and wind farm operators, but it also includes software designers working on "smart" power grids and even utilities that generate megawatts from hydro or geothermal assets. Alternative-energy stocks range from behemoths like General Electric (GE), which competes in the water and power sectors, to American Superconductor (AMSC), a small manufacturer of high-temperature superconductor wires that can carry 10 times the electricity of traditional cables.

It used to be investors looking for exposure to this industry had to look to socially-responsible mutual funds that used alt-energy as a substitute for "dirty" energy plays that didn't clear their screens. Now, though, stocks like First Solar (FSLR), a fast-growing maker of thin-film modules, can be found in mainstream funds like Fidelity Magellan (FMAGX) and Harbor Capital Appreciation (HACAX). Alternative-energy firms are no longer seen as pushing pie-in-the-sky type ideas about the future of the country.

Recently we've come across a few advisers who are building small "satellite" positions in alternative energy as complements to a well-diversified portfolio. That sounds like a smart strategy to us. Energy demand has been curtailed during the recent global recession. But once economies around the world get back on their feet, especially those in emerging markets like China and India, we would expect to see energy become a hot topic once again. That kind of a catalyst could easily propel the fortunes of this industry.

However, there are some caveats we should mention, too. Alternative-energy stocks tend to fall in and out of favor depending on the price of crude. When the per-barrel price approached $150 midsummer -- and gasoline crossed $4 a gallon -- alternative energy benefitted because Americans quickly realized they couldn't afford to burn so much money at the pump. First Solar saw its shares soar to over $300 a piece in May, an almost five-fold increase from where they traded the previous year. As oil prices have slipped below the $40 mark, First Solar has seen its shares dip to as low as $87. In other words, America seems to forget about energy efficiency when oil and gas are more affordable.

We are always wary of an industry whose prospects, in part, rely on government help. Both here in the U.S. and across the globe, solar and wind projects usually receive some kind of government subsidy to get them off the drawing board. But earlier this fall several solar stocks sold off over concerns that several countries in Europe, a key market for panels, were considering cutting back on some of these deals. And there's no guarantee the Obama administration's proposed infrastructure stimulus will include a major effort to boost alternative-energy projects on a grand scale. OPEC is also unpredictable at times. 

Investors need to keep in mind that alternative-energy plays are more on the growthier side of the investing spectrum. That makes these stocks and funds susceptible to headline risk. If a widely followed firm like Energy Conversion Devices (ENER) or Evergreen Solar (ESLR) happens to miss or beat on its earnings, we would expect to see an exaggerated response up or down. Investors need to marry what look like rich valuations for some stocks with realistic earnings estimates. 

If you're sold on this sector you might want to look into exchange-traded funds. Market Vectors Solar Energy (KWT) and Claymore/MAC Global Solar Energy (TAN) concentrate on the solar power industry. PowerShares has a range of products that focus on clean technology, water and wind. These ETFs alleviate investors from having to make a bet on any one particular stock, while still providing the trading flexibility and healthy volumes to buy or sell shares throughout the day.

That said, whenever we encounter an investing area that seems to be on the cutting edge or a bit out of our expertise, we always think it's a wise decision to pay up for a good actively-managed mutual fund. The alternative-energy space is one of those times. But a word of warning: These funds have been trounced this year in the pullback in the broader energy sector. Building a position means you're looking toward the future.

The longest-running mutual fund geared exclusively to alternative energy and the environment is New Alternatives (NALFX). The fund, launched in 1982, specializes in areas like solar, wind, biomass, fuel cells and ocean energy. The portfolio currently consists of around 50 stocks, including American Water Works (AWK), the large utility, and Ormat Technologies (ORA), a company that builds geothermal power plants. The fund is cheap at a 0.95% annual expense ratio. And it has returned 4.4% on average the last five years, putting it in the top 5% of Morningstar's world stock category.

One fund we are keeping an eye on is Guinness Atkinson Alternative Energy (GAAEX). Launched in 2006, the fund is still relatively new. And at a 1.64% annual expense ratio it's a little pricier than what we usually prefer. Plus, it has gotten pummeled, losing 67.9% year-to-date. But manager Tim Guinness has a long track record of investing in the energy space. This fund will typically hold between 40 and 60 stocks that generate at least 50% of their revenues from alternative-energy sources or alternative-energy technologies. Currently about two-thirds of the portfolio is focused on wind and solar. Holdings include Suntech Power (STP), Ormat and Echelon (ELON).

Other alternatives include Firsthand Alternative Energy (ALTEX) and Calvert Global Alternative Energy (CGAEX).

The Criteria: The alternative-energy funds on our list are culled from various Lipper categories. Since this fund niche is relatively new, we suspended some of our usual cut-offs involving performance and fees. The funds below are listed starting with the one with the best one-year track record. We allowed load funds this week.