New-Power Generation? Fund Firms Bet Alternative Energy Will Be the New Sector Boom

It looks like the fund world might have found its next "new new thing" to pick up where the Net-fund boom left off: Energy tech funds.

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Over the past 90 days, fund companies have either launched or filed paperwork with regulators for the first four mutual funds focusing on the new-power/alternative energy industries. Unlike broader energy funds, this pack will focus to varying degrees on a thinner band of the energy/utilities sector, namely companies that either sell power at steep prices to utilities unable to keep up with their customers' demands, and those developing new ways to keep the lights on or maybe even run your car.

Like Net funds back in 1996, these rookies will probably hold several stocks with compelling stories and no profits, and the funds will only be worthy of 5% or less of your portfolio. The bottom line is that a broader energy or utilities fund might make more sense for most investors, but those adventurous souls looking for the next highflier might find it here.

To many, this will look like a familiar trend, where new funds have rolled off the assembly line to focus on a hot sector, slicing that sector more thinly to stand out from the crowd. Energy funds of all flavors have had a nice run, thanks to rising demand and high energy prices, so it's not a surprise that about one-third of the energy funds out there have launched since 1998.

Power Funds These four funds are getting in early on the alternative energy sector
Fund	Launched/Filed	Focus
Merrill Lynch New Energy Technology*	Launched Oct. 30	"will invest globally in companies which have a significant focus on alternative energy or energy technology."
Munder Power Plus	Filed Dec. 13	"will invest at least 65% of its total assets in companies that are primarily engaged in non-regulated energy and power activities."
Turner New Energy & Power Technology	Filed Dec. 15	"invests substantially all (at least 80%) of its assets in equity securities of energy and power companies that are traded in the United States and that are using new or advanced technology to produce or deliver their product."
Kinetics Energy fund	Launched Dec. 31	"invest(s) in large, medium and small cap companies-including alternative energy companies"
Sources: Company Web sites and 10kwizard.com. *A closed-end fund for non-U.S. investors.

This crop of new-power funds includes offerings from Munder Capital and Kinetics Asset Management, the firms that brought you two of the first Net funds, way back in 1996, the (MNNAX Quote)Munder NetNet fund and the (WWWFX Quote)Kinetics Internet fund, respectively.

Neither shop has been shy about rolling out niche funds that sometimes seem driven more by marketing opportunism than investment savvy -- like the Kinetics Middle East Growth fund, initially named the Middle East Peace fund. Both firms have rolled out several tech funds to clone their initial success with the now-battered Net funds that put them on many investors' radar screens, so some might write off this new-power theme as a "ripped from the headlines" gimmick.

After all, these new funds appear well-timed to coincide with California's current energy debacle. Consumers are realizing we might not have enough power to run this digital economy and investors are figuring out that deregulation might create new opportunities for competition, consolidation and earnings growth.

But Kinetics and Munder aren't alone here. Turner Investment Partners is developing a fund, too. And at the end of October Merrill Lynch launched the closed-end New Energy Technology fund in the U.K. That might sound like a distant event, but remember the firm launched an offshore Net fund for foreign investors before rolling out its (MANTX Quote)Internet Strategies fund last March. And in Janus' most recent report to shareholders, its stock pickers touted budding opportunities in the energy sector as demand rises.

Each of these funds will invest along the idea that a global information economy will need more power.

"It boils down to how much juice are some of these new businesses sucking out of our infrastructure and did our technology grow beyond our power capabilities. To me the answer is a resounding yes," says John Hammerschmidt, who will be the lead manager of the Turner New Energy & Power Technology fund when it launches this year. He says that a server farm, which takes just nine months to build, "uses as much power as a Bethlehem steel plant."

One way skippers could invest in this trend is to buy shares of utilities that sell their excess power at peak times.

"I'd emphasize companies with excess power generation because they can charge high prices to companies that couldn't meet the power needs of their customers," says Robert Loest, who's played this theme in his (IPSMX Quote)IPS Millennium fund. "With that in mind, I like Duke Energy(DUK Quote), Dynegy(DYN Quote), Calpine(CPN Quote) and Enron(ENE Quote). These are great companies growing faster than their average peer that have excess power and we own all of them."

Another route is to look at alternative-power shops that are often short on profits, but promising because they're boosted by environmental regulation and could be a tech shop's way of shoring up unreliable power service.

"If you're running a semiconductor facility or a server farm, you're running a business that requires reliability," says Roger Mortimer, co-manager of the (GTNAX Quote)AIM Global Resources fund. "These companies are driving demand for technologies and systems that provide uninterrupted power, like energy storage facilities from Active Power(ACPW Quote), energy generation from microturbines from Capstone Turbine(CPST Quote) or from fuel cells from Ballard Power Systems(BLDP Quote) or FuelCell Energy(FCEL Quote)."

Though these are pragmatic growth stories that make sense, there's a slew of risk here, too. Many alternative energy prices aren't making money yet and profits might be years away.

Alternative energy ideas "sound neat, but anytime you're dealing with a new technology you need to be prepared for things not to work out. As an investor you've got to keep in mind that these things take years to develop," says Justin Craib-Cox, an energy analyst at Morningstar. "Anybody who is interested in this area is probably better off with a broader sector fund."

Many of these companies are quite young, too. In its prospectus, the closed-end Merrill Lynch fund says that the fund's managers track 300 companies, but less than a third are publicly traded. And those that are public are hardly sleepers. Several stocks in these industries are coming off sizzling returns. FuelCell Energy, for instance, gained more than 440% last year and has posted annual losses since 1998, according to Morningstar.

Following Hot Returns Some of the stocks that will probably end up in these funds are coming off outsize gains in 2000

Source: Morningstar

To be fair, these funds aren't necessarily going to own only alternative energy stocks. Turner's Hammerschmidt says that he sees the likes of General Electric(GE Quote) and Emerson Electric(EMR Quote) as "new-power" plays. Then again, aggressive investors are probably more intrigued by the prospect of owning riskier fare.

Only time will tell if these funds follow in the mercurial Net funds' footsteps, but it's probably best to see this as a good place for money you probably won't miss.

The Junk Pile

If you think sector-fund investing has taken off, you're right. Asset allocation models not found in MAD magazine typically advise investors to limit their sector-fund investments to 5% or 10% of their portfolios. The logic here is that they already have exposure to those sectors in the other funds they own, so loading up on a sector fund can ramp up volatility.

Well, it looks like investors have been blowing right through that 10% guideline. Between 1990 and 1998, sector funds never accounted for more than 4.8% of net cash flows to U.S. stock funds. In 1999 that figure jumped to 19.9% and through the end of November last year, it was 29%, according to the latest data from Boston-based Financial Research.