With the high cost of oil and global warming competing for headlines, Wall Street is busily nurturing a crop of new exchange-traded funds (ETFs) comprised of companies looking to profit from those concerns.
    The handful of alternative energy ETFs now available invest in companies involved in the production and distribution of renewable energy, such as solar, wind, hydro and geothermal. Some of the funds include companies that make environmentally friendly products such as hybrid automobiles, or that are involved in efforts to reduce or clean up pollution from traditional sources of energy.
    The question for financial advisors is whether concern for the environment translates into investment opportunities, and if so, whether these ETFs are the best way to tap them. A number of trends are favorable for this group, including rising oil prices and the increased public focus on global warming issues. Institutional investors are pressing for stronger climate control policies and incentives for companies to shore up their clean technology efforts. A recent ruling by the Supreme Court that classified greenhouse gasses as pollutants gave a powerful boost to alternative energy stocks, and legislative announcements in the future promise to have a similar effect.
    While the need to develop and expand renewable sources of energy and products that utilize them seems clear, investing in small companies that derive most of their revenues from renewable energy technologies, whether through an ETF, mutual fund or individual stocks, involves a lot of risk. Many of them are small and have short public track records. Their fortunes rise and fall sharply with the price of oil (rising prices are good for them, declines are bad), and the stocks are usually very volatile. Some of the stocks are so small and illiquid that it is often difficult to price them with any degree of accuracy, and more than a few companies have circled the drain.
    But reducing risk often means migrating away from the purest plays to larger companies with a hand in renewable energy or environmental management. Some of the new ETFs are peppered with more established companies, including utilities with strong records of renewable energy development and distribution, or companies such as General Electric or Toyota that have gone the extra mile to develop products that use alternative energy sources. The bigger companies may add ballast to a portfolio of alternative energy stocks, but their alternative energy business typically is a footnote on their balance sheets.
    Still, financial advisors who have carved a specialty niche in this area say investing in larger companies with a strong presence in clean technology is better than ignoring the issue altogether, and investor support encourages environmentally responsible practices among blue chip firms. "There is no problem filling a diversified portfolio with large, stable companies that can also benefit from rising energy prices and regulation of carbon emissions," says Tom Konrad, a Denver investment advisor who specializes in managing portfolios for individuals seeking alternative energy exposure. He reserves the smaller, pure plays on renewable energy for clients willing to accept greater risk.
    The grandfather of alternative energy ETFs, the PowerShares WilderHill Clean Energy Portfolio  (PBW), offers exposure to the latter group by investing in smaller companies that produce renewable energy. Based on an index devised by Robert Wilder and Josh Landess, the ETF was launched in March 2005 and has grown to $950 million. It fell 11.15% last year when alternative energy stocks skidded, but has had a 9.64% annualized return from its inception through the first quarter of 2007. About 70% of its assets are in small-cap stocks, with companies having an average market capitalization of $3.7 billion.
    Two other, much smaller PowerShares funds have a somewhat different focus. PowerShares WilderHill Progressive Energy Portfolio  (PUW) invests in companies that are working to reduce pollution from traditional energy sources such as oil, nuclear and coal. It began trading in October 2006 and has a significantly higher average market capitalization than does Clean Energy. The PowerShares Cleantech Portfolio (PZD), also launched in October 2006, consists of companies involved in alternative energy, cleanup and other businesses that stand to benefit from the transition to cleaner energy and conservation.
    First Trust Nasdaq Clean Edge(r) U.S. Liquid Series Index Fund (QCLN) entered the alternative energy space in February 2007, and focuses on emerging clean energy technologies such as solar photovoltaics and biofuels. In May 2007, the introduction of the Van Eck Market Vectors-Global Alternative Energy (GEX) fund expanded the space's geographic reach and exposure to large caps. It is based on an index comprising publicly traded stocks of 30 of the largest, most actively traded companies from around the world that derive at least half of their revenues from alternative energy. Van Eck also offers an Environmental Services ETF (EVX) that focuses on cleanup and waste management companies.
    Several indexes, such as three developed by New York-based Jefferies & Co., lay the foundation for new products in the future. One is a composite of 50 small and midsized clean-tech companies, one focuses on energy generation and another on energy storage. The WilderHill New Energy Global Innovation index includes foreign stocks.
    Paul Mosier, president of Invest Green in Phoenix, says he uses the PowerShares WilderHill Clean Energy Portfolio for about one-third of his clients as a pure play on alternative energy. He's also been considering the new Van Eck Market Vectors-Global Alternative Energy offering to gain access to alternative energy stocks that trade outside the U.S.
    "My clients who are interested in this area of investing are really a diverse group," he says. "Some of them are retirees who had solar panels back in the 1970s. Others are just out of college and have a personal or professional interest in promoting alternative energy. A number of them drive hybrid cars, or are thinking about buying one."
    While he acknowledges the volatility of the group, he believes that devoting a small percentage of a diversified portfolio toward it is a sound long-term strategy. "These stocks ought to do well over the next ten or 15 years," he says. "And if they don't, that's not a good sign for the environment."
    Konrad doesn't use any of the new ETFs because he's familiar with alternative energy companies and prefers to assemble his own actively managed portfolios of individual stocks. Still, he says, "A small allocation to an alternative energy ETF may be appropriate for the average advisor with a client who is concerned about global warming and other environmental issues."
    For many of his older or more cautious clients, however, he feels that investing in small, profitless start-up alternative energy companies is inappropriate, even through a diversified ETF. Such individuals will probably be more comfortable investing in larger blue chip names with quality businesses in alternative energy, such as General Electric, Johnson Controls and Waste Management. To Konrad, these companies make up in stability what they lack in singular alternative energy or environmental focus. "I don't look for companies that are perfect in this area, but more for ones that are headed in the right direction," he says.