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Should You Buy an Alternative-Energy ETF?

From the clever-ticker-symbol file: FAN, which is the ticker for the First Trust ISE Global Wind Energy Index Fund (FAN), a fund that could be worth a look as oil prices stay high and the wind power/alternative energy theme becomes increasingly popular.

FAN is truly a global fund, with 16% allocated to the U.S., but it also has mid-teen weightings to Denmark, Germany, the U.K. and Spain. The sector make-up concentrates heavily in industrials at 58% and utilities at 29%.

You may know a couple of the larger names in the fund, like Vestas Wind (VWDRY) from Denmark and Gamesa (GCTAF) from Spain, but many of the other holdings are more obscure.

Also mixed in are some of the world's biggest companies, like BP (BP) and General Electric (GE).

Don't be too quick to dismiss the fund for owning those names. The methodology of the index, simply stated, puts companies into two categories; exclusives (the pure plays) and significant participants (the mega caps with some wind exposure). The exclusives comprise 66% of the fund and dominate the fund's composition. The largest weight given to a significant participant is 1.6% to Royal Dutch Shell (RDS.A), compared with 10% for Vestas and 8.8% for Gamesa.

The fund has 52 holdings, the expense is capped at 60 basis points, it has a median market cap of $25 billion and trades at 25 times earnings.

As you might expect, the First Trust literature has plenty of compelling information to make the case for wind energy, beyond the obvious that oil is expensive and we need to do something.

Global wind power capacity has skyrocketed during this decade from less than 20,000 megawatts in 2000 to 94,000 as of year-end 2007.

Projections call for continued increased capacity reaching 240,000 megawatts by 2012. If this comes to pass then the industrial companies in FAN that make the turbine components and the utility companies that distribute the power stand to do very well. Obviously, where wind is concerned, greenhouse gases are not an issue.

A similar case can obviously be made for solar as well as wind, but solar is much more expensive than wind. As mentioned, the PE for FAN is 25 compared to 44 times for the Claymore/MAC Global Solar Energy Index ETF (TAN).

Vestas and Gamesa, two of the larger components in FAN, trade at 53 and 38 times earnings, respectively, while First Solar (FSLR) trades at 109 times and Energy Conversion Devices (ENER) is not profitable (FSLR and ENER are the two largest components in TAN).

Both technologies are important, but the cheaper valuations for wind should provide a better margin of safety.

Anyone adding FAN to their portfolio should probably view it as a higher-beta industrial-sector holding. FAN catches a tailwind because there are problems (real or perceived) with access to and consumption of energy.

These problems are not likely to go away anytime soon. A potential headwind comes from the general state of the stock market, which I do believe is in a bear phase. Adding volatility (and to be clear, I would expect FAN to be quite volatile but less so than a solar ETF) during a bear market is usually the wrong trade.

The decision to buy FAN right now boils down to what you think is more important -- top-down problems in the market, or the bottom-up urgency to find alternative forms of energy.

Anyone wanting a lower beta exposure might look at stocks such as FPL Group (FPL), a Florida-based utility with a large wind-power-generating presence and also a component in FAN.

At the time of publication, Nusbaum was long FPL on behalf of clients, although positions may change at any time.

Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback; click here to send him an email.

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