Energy ETF Cleans Up as Crude Oil Rises

NEW YORK ( TheStreet) -- Clean energy is destined to gain favor in the next decade.

Demand for energy will surely increase, but the use of carbon-based fuels will make the planet dirtier. The hard part is knowing which technology to invest in. Solar, wind, geothermal and others are options, though trying to pick the ultimate winner may not appeal to everyone, which is where a broad-based exchange traded fund like iShares S&P Global Clean Energy Index Fund ( ICLN) comes in.

The ETF covers a lot of ground. The iShares Web site breaks down the holdings by industry group, which may not tell the whole story. The fund allocates 45% to solar, 33% to producers and transmitters of energy, 15% to wind power as well as a few battery makers and a geothermal company. The U.S. is the largest country in the fund, at 24%, followed by China (solar stocks), 17%, Spain and Germany, 14%, and Norway and Chile each get 5%. There are 12 countries in all.

The fund has been volatile since it debuted in June 2008. At its worst, it was down 80% from its peak, compared with about 45% for the S&P 500 Index and about 55% for the Energy Select Sector SPDR ( XLE). All three bottomed in March. But since then, iShares S&P Global Clean Energy is up 70% versus 60% for the S&P 500 and not quite 50% for the Energy Sector SPDR. The iShares fund has a beta of 2.01. (Beta is a measure of volatility wherein the S&P 500 equals 1; the higher the number, the more volatile the fund.) Surprisingly, the ETF yields a relatively high 2.46%, which is attributable to the utility (producers and transmitters) components.

An issue with alternative-energy funds is that the world is still trying to sort out which parts of the theme make the most sense economically and where the long-term winners will come from. That creates a fundamental disconnect, meaning that, for now, investors should expect stocks and funds to trade on emotion and be subject to the whims of the oil market. The thinking here is that if oil prices spike, that creates a perception of urgency, and so the alternative-energy stocks rise. Conversely, if oil drops in price, the need to find alternatives, sentiment-wise, gets put on the back burner, and the stocks fall.

At some point, company fundamentals such as revenue and earnings will connect with stock prices. Ardent supporters of alternative energy would likely tell us that the fundamentals are the most important thing now, but the trading history doesn't corroborate that notion.

In integrating a fund like the iShares Global Clean Energy Index ETF into a diversified portfolio, the majority of the groups listed above make it a proxy for the industrial sector -- and as a source for volatility. Because of the volatility, I would think most investors would prefer a small weighting to this fund or any proxy for alternative energy. While it seems unlikely that the broad market will fall by half again during this economic cycle, if that were to happen, the iShares Global Clean Energy would probably go down even more.
At the time of publication, Roger Nusbaum had no positions in the securities mentioned.

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.