Cleantech seemed like a no-brainer investment when it burst onto the scene last decade. What wasn’t to like about a sector aimed at making the world more resource efficient and less polluted, while simultaneously offering people a chance to make gobs of money by investing in cutting-edge and, in some cases, potentially transformative companies?

It looked good on paper, but then the Great Recession came along and ruined the party. Yet even before the market crashed in 2008, the sector was blinded by hype as a lot of good money chased a number of bad investments. Add it up, and many investors in the cleantech space––across venture capital, private equity and the public markets––got singed during the dark days of ’08-’09. In the process, cleantech became a dirty word in certain circles.

These days, cleantech is re-emerging. Many stocks and funds focused on the space have done well this year, while people in the know on the private investment side talk about a new wave of cleantech investing that’s less consumed with shoot-for-the-moon projects and more focused on companies with practical, nuts-and-bolts ideas that create incremental changes that can come to market more quickly. Some people call this new phase Cleantech 2.0.

“Cleantech 1.0 was a golden, euphoric moment that was a bubble created by the amount of money, dreaming and optimism that poured into the space,” says Robert Fenwick-Smith, founder and senior managing director at Aravaipa Ventures, a venture capital fund that invests in early stage efficiency-tech companies in Colorado.

“Cleantech 2.0 is about coming back down to earth and accepting the realities,” he continues. “People in the space are looking for less capital-intensive and more pragmatic plays we believe we can turn into profitable companies. The incremental aspects, when you put them all together, will change the world substantially.”

That last statement might seem highfalutin, but the fact is the need for resource efficiency is intensifying, greater numbers of companies are working on cleantech innovations, and the long-term investment opportunity still exists. For investors who got burned by the so-called first iteration of cleantech, the question now is how can they play this space and get better results the second time around.

Makes Good Business Sense
Cleantech is an umbrella term covering a range of businesses. Cleantech Group, a San Francisco-based research and advisory company, defines cleantech as a diverse group of products, services and processes designed to provide superior performance at lower costs while greatly reducing or eliminating negative ecological impact and improving how people use natural resources.

Cleantetch Group categorizes this broad area into 18 sectors that run the gamut from advanced materials and smart-grid technologies to solar and wind power. The overarching themes of cleantech entail cleaner air and water, sustainable land use and cutting-edge technologies that reduce resource consumption.

“We think cleantech is still evolving,” says Amanda Faulkner, senior research analyst at Cleantech Group’s i3 research platform. “It has evolved from solar and wind and biofuels to incorporate a lot more companies dealing with resource efficiencies.”

In a recent report, Cleantech Group said solar formerly accounted for nearly 40% of money invested in cleantech. These days, sectors including transportation, biofuels and biochemicals, energy efficiency, water and wastewater, and advanced materials now make up larger proportions of investors’ portfolios.

And whereas cleantech might have had a faddish air about it last decade, it’s now increasingly viewed as something that makes good business sense. Faulkner notes that a growing number of large corporations––either via strategic investments or through their own venture funds––are investing in cleantech companies as a way to gain access to external innovation.

Rob Day, a partner at Black Coral Capital in Boston, says the days of raising a ton of money and throwing it at a technology development effort are over. Some VC types still look to hit home runs by investing in proprietary technologies, but cleantech’s second wave is about adoption of technologies and creating practical ways to get people to actually use these innovations. Some of these companies are developing Web-based tools or service models that require a lot less capital to produce a return on investment.

“There are more companies being launched that are focused on putting new channels and marketplaces into effect,” says Day, whose firm co-founded the Cleantech Syndicate, a consortium of 13 family offices with more than $1 billion in assets devoted to cleantech investing.

Windows, Cows And Trucks
The frontline of Cleantech 2.0 can be found in places such as Denver’s sprawling east side, where during an afternoon this summer Robert Fenwick-Smith led a field trip to two of the Aravaipa venture capital fund’s portfolio companies.

The first stop was RavenBrick, a maker of thermochromic window filters that respond to temperature changes by channeling heat to interiors on cold days and blocking heat on hot days. The patented filters, which target the $10 billion solar control glass market, are designed to reduce heating and cooling expenses by 30% to 50%.

Last December, RavenBrick moved from a 6,000-square-foot R&D facility into a 60,000-square-foot building that’s being retrofitted with manufacturing capacity to meet demand for its filters. RavenBrick co-founder and CEO Alex Burney says the company’s revenue projection for 2014 is $14 million, with much of that pre-sold. They’re shooting for $100 million in sales in five years.

“We have a lot of demand,” he says. “We just have to show the supply.”

The tour next visited a small, nondescript strip of offices that’s home to Silver Bullet, the developer of a patented electrochemical water conditioning system involving ultraviolet light and oxygen that generates negatively charged hydrogen peroxide, which acts as a biocide and anti-scaling agent without the use of toxic chemicals.

Silver Bullet originally targeted commercial and industrial cooling towers, where it says its system reduces water use. It does this by keeping calcium and other minerals that accumulate in tanks in a dissolved state, which enables the towers to use water for longer periods and cuts down on the need to flush out the towers with fresh water. And the system promises to save energy because the reduction in scaling increases heat transfer efficiency.

Silver Bullet subsequently found a second, potentially huge market involving livestock drinking water. Livestock evidently don’t like drinking chemically treated water, but non-treated water can have a lot of bacteria that can make animals sick. Silver Bullet’s biocide process has no taste and smell. So the more water livestock drink, the healthier they grow.

The company says it has more than 300 systems in place in cooling towers and feedlots throughout North America. “We’re a disruptive technology to the water industry,” says David Sunshine, Silver Bullet’s president.

The tour was conducted in a green airport shuttle bus retrofitted with a hydraulic hybrid system made by another Aravaipa portfolio company, Lightning Hybrids in Loveland, Colo.

Lightning Hybrid’s system employs a hydraulic pump and accumulators to capture and store braking power. As the vehicle sped along I-70 and traversed various side streets, a colorful display above the driver’s seat showed in real time the movement of hydraulic fluid from the high-pressure to the low-pressure tank as the vehicle accelerated or put on the brakes, as well as the fuel savings and miles per gallon being achieved.

Fenwick-Smith, a native Brit and an enthusiastic proselytizer of the Cleantech 2.0 mantra, notes that the Lightning Hybrid system is designed to cut fuel spend by at least 25% and reduce emissions by 50%. Its target market is large fleets of vehicles, such as delivery trucks and airport shuttle buses, that do a lot of stop-and-go driving.

“It’s important doing fuel efficiency for this kind of vehicle rather than a general car because they’re much further away [regarding fuel-saving technologies] and are driven 60,000 to 80,000 miles a year, says Fenwick-Smith.

Fenwick-Smith, who has more than 20 years of global entrepreneurial experience in a variety of industries, founded Aravaipa in 2008 to invest in cleantech start-ups that are proliferating along Colorado’s Front Range. Its focus is on low-capital-intensive companies that need less than $5 million in funding to reach profitability, and it targets niche markets he believes offer the potential for sizable profit margins.

The fund aims to raise $20 million (it was 60% toward its goal as of mid-September) and is open to accredited investors who can afford the $100,000 minimum investment. While Fenwick-Smith sees financial advisors and their clients as a key target group, he says the fund has made the most inroads with family offices. 

Fenwick-Smith says he has a lot of his own skin in the game regarding the Aravaipa fund, and is unabashedly bullish about the prospects of its portfolio companies. Still, he acknowledges that like with any venture fund there are no guarantees, and that Aravaipa should represent just a portion of an investor’s portfolio. “It’s still early stage and all of our companies are still losing money,” he says. “You can’t characterize it as anything but high risk.”

Not Sexy Can Be Sexy
On both the private and public side during the past five years or so, the risk/reward profile of many cleantech investments has largely lacked the reward part of the equation. In the period from 2000 through this year’s first quarter, cleantech investments in private companies made by venture capital and private equity funds tracked by Cambridge Associates produced a gross internal rate of return of 6.6%. In comparison, the aggregate gross company-level IRR for more than 38,000 global venture capital and private equity investments made over the same time period was 15.2%.

“While the sector is young, so far overall cleantech returns have been below what institutional investors expect from their private investments,” Cambridge said in its report.

Regarding investments on the private side, Rob Day from Black Coral Capital says investors in Cleantech 2.0 should steer clear of “hot” sectors because sectors fall in and out of favor. Instead, they should focus on two themes––distributed assets and company management.

The former refers to business models focused on distributing cleantech products and services to the marketplace, including such areas as power distributors or energy production from rooftop solar installations. The latter is self-explanatory because great ideas don’t sell themselves. “We have a rigorous methodology involving many interviews [with management] before we write a check to a company,” Day says.

On the public side, perhaps the best proxy for the cleantech sector is the PowerShares Cleantech Portfolio exchange-traded fund (ticker symbol PZD), which tracks the Cleantech Index developed by Cleantech Group. The fund has generated annualized returns of about 3% since its October 2006 launch, including a massive peak-to-trough tumble during the ’08-’09 market crash. The ETF’s price had doubled between early 2009 and April 2011, and then fell another one-third in value by July 2012. Since then, it has jumped nearly 50% (as of early October). In other words, it can be volatile.

Following the recent upturn in the sector, many cleantech companies have followed a similar riches-to-rags-to-riches saga. And some relatively recent initial public offerings from the likes of solar energy systems installer SolarCity and electric vehicle maker Tesla Motors have soared.

But some investors during Cleantech 1.0 were burned by similar highflyers that ultimately crashed. Rebecca Henson, senior sustainability analyst at Calvert Investment Management, says some of the best opportunities in cleantech are less-sexy companies focused on energy efficiency.

“Johnson Controls and Eaton Corp. are examples of companies we think make a strong story for cleantech, whether you want to call it Cleantech 1.0 or Cleantech 2.0,” says Henson, whose company’s suite  of sustainability-focused mutual funds includes the Calvert Global Alternative Energy and Calvert Global Water funds.

Johnson Controls makes and services automatic temperature regulation systems for buildings, while Eaton is a diversified power management company. “Johnson Controls helps make the Empire State Building 40% more energy efficient,” Henson says. “I think that’s pretty sexy.”

Cleantech has taken investors on a wild ride in recent years, but hopefully that has made investors all the wiser regarding the sector. “People are going into cleantech with their eyes wide open and are asking a lot of questions about technology and business plans,” says Amanda Faulkner from Cleantech Group. “The hurdles are higher, which means the sector as a whole will be better off.”

Investors in Cleantech 2.0 hope she’s right.