NEW YORK (TheStreet) --- Stellar rallies in many alternative energy stocks are drawing attention to a sector that is looking to reassert its credibility with investors and shake off a reputation as volatile and risky.
As alternative energy becomes cost-competitive with traditional sources and a rising number of companies book profits, investors burned by sector bubbles are slowly being drawn back.
The cynicism of those with long memories is understandable. Take solar stocks: First Solar (FSLR - Get Report) and SunEdison (SUNE - Get Report) have rallied 138% and 359%, respectively, over the past year. But both are still around 77% off their all-time highs in 2007-2008 when overcapacity saw the profits of many operators plunge.
More recently, alternative energy subsidies in European markets were scaled back amid the sovereign debt crisis of 2010 and have only been returned over the past year to 18 months.
The performance of many alternative energy funds reflects this: The Calvert Global Alternative Energy Fund shed nearly 4% annually over the past three years and booked returns of just 2% annualized over five years. In 2013, the fund rebounded 23%.
Portfolio manager Treasa Ni Chonghaile said the past year has seen alternative energy sources become more cost-competitive, even as subsidies have been reinstated. "It is traditionally a high-risk and volatile sector but longer term it will have a more defensive profile," she said. "There are still lots of costs to be taken out and they will be as scale increases, it's only a matter of time."
Henderson Global Investors Global Care Growth fund co-manager, Hamish Chamberlayne, said the sector has moved away from being "overly reliant" on European subsidies. The downside, he noted, is margin compression for companies that are just beginning to see a pick-up in volumes. "I am quite optimistic about the next few years," the London-based manager said.
Chonghaile said broad-based price competition with traditional energy sources is still three to five years off, even as many alternative operators begin to secure long-term contracts and create dividend streams with their assets. This is expected to reduce price volatility, while country concentration risk is also falling as alternative energy becomes a global sector.
Beyond alternative energy providers, companies that operate more broadly in the industry are benefiting. Johnson Controls (JCI) is the largest holding in Calvert's alternative portfolio; it's an American company that offers products and services to improve the efficiency of buildings and car batteries. The stock has jumped 34% over the past year and hit its all-time high in January. But like many in the sector, the stock has not been without volatility -- it trades at around $47 now, up from a low of $8.68 in early 2009.
Chamberlayne holds SMA Solar, a German stock he expects to break even in 2014 with a healthy revenue outlook. He has also held First Solar in the past, though describes its business model as "challenging" to understand and admitted he wishes he had held SunEdison more recently.
The strong returns from many alternative energy stocks over the past year also have been bolstered by the rally in small caps generally, fund managers said, given that few companies have yet to crack blue-chip status. Chonghaile said there are hundreds of "investable" opportunities remaining in the sector, with around 85% of the stocks in her portfolio booking profits.
Many traditional fund mangers remain skeptical on the investment story in alternative energy, pointing to a lack of liquidity in addition to the sector's traditional volatility.
Fort Pitt Capital Corp Senior equity analyst and vice president, Kim Forrest, voiced the view of many value-oriented managers. She avoids alternative energy companies on the basis that many are not yet profitable and points to alternative energy subsidies as an additional stock risk.
"But I believe strong alternative energy companies will create fantastic science, and deliver to the marketplace," she said of the longer-term view.
-- Written by Jane Searle in New York