Solar 'Adolescence' to Produce Big Winners

NEW YORK ( TheStreet) -- Alternative energy is in a transition between downturn and growth, making industries such as solar attractive for long-term investors, says Anna Davydova, who helps manage the Fidelity Select Environment and Alternative Energy Fund ( FSLEX).

The mutual fund has fallen 7.1% this year, compared with a decline of 16% for its peer group. The Fidelity Select Environment and Alternative Energy Fund has beaten the S&P 500 Index in seven of the past 10 years.

Welcome to's Fund Manager Five Spot, where America's top mutual fund managers give their best stock picks and views on the market in a five-question format.

How bullish are you on alternative energy?

Davydova: I'm bullish on the environment and alternative energy sector in the long term. I also pay close attention to sector-specific cyclicality, as it can outweigh the secular drivers over periods of time. This is what we've experienced more recently with the group succumbing to cyclical pressures due, in part, to economic weakness and the low costs of fossil-fuel electricity. However, I expect some of these pressures to ease as we progress through the economic cycle. Overall, I believe that these cyclical speed bumps tend to offer good buying opportunities for patient investors.

Longer term, I see three secular drivers for the sector. First is the industrialization of massive populations in the emerging markets. As countries such as India and China continue to develop, their increased resource consumption will put an incredible strain on existing supplies. I believe this will drive the global need for a more diverse and sustainable energy portfolio, as well as increased focus on energy independence and pollution control as concerns about air and water quality rise.

This ties in with the second secular driver, which is the political and social focus on environmental protection and reduction in fossil-fuel emissions. All over the world, people are concerned about the consequences of fossil-fuel consumption for their health and the environment. Investors need to look no further than the Gulf of Mexico oil spill or the coal-mine disaster in West Virginia for evidence of this trend.

The third driver is the rapidly developing technologies that will support positive environmental change and more compelling energy solutions. So, in the long run, I expect to see continued growth in this space, with some cyclical fluctuations, and see a number of attractive investment opportunities.

What are you seeing in the market right now?

Davydova: There are many cross-currents in the market right now, and the environment and renewable energy sector continues to experience significant volatility. On the one hand, the sector is starting to benefit from cyclical-demand recovery in a number of the end markets.

On the other hand, economic issues in Europe and the recent cut backs in subsidies for renewable energy are weighing on the group. Offsetting that somewhat is the increased focus on renewable energy policy and environmental protection in the U.S. in light of recent events in the Gulf.

However, depressed coal and natural-gas prices do not bode well for renewable energy demand in the near term. Adding to the overall volatility in the group are the currency and technology risks. Overall, the sector seems to be in a transition period emerging from the cyclical downturn but not quite yet in the next phase of growth. I believe a time like this can present a number of attractive investment opportunities for patient investors.

What is your top industry pick?

Davydova: One of our long-term picks is the solar sector. This is also an example of an industry with a strong secular backdrop that has faced some cyclical pressures. However, I believe that this transition period, or as some like to call it solar adolescence, will present opportunities to invest in long-term winners.

At the same time, due to the increasing scarcity of easily accessible fossil-fuel resources, traditional energy companies are forced to drill and mine at ever-greater depths, often times in complex and hazardous conditions. It is not an easy or risk-free proposition and tends to have negative cost implications -- be it the cost of extraction, or social costs, or the environmental costs that have moved center stage more recently.

The solar industry, on the other hand, has been reducing costs of manufacturing at an impressive pace and is working toward becoming competitive with the price of fossil-fuel electricity. These cost reductions have already driven strong positive-demand response, and I expect this trend to continue in the long run as the industry innovates its way to subsidy independence.

For example, the price of a solar module is down over 50% in the past two years, and I see more room for cost reductions in the coming years that will make solar a more viable alternative to fossil-fuel electricity. Cost competitiveness will drive significant growth for this sector that currently accounts for just around 0.1% of global electricity production.

However, this is a stock pickers' group, and, as with any young and evolving technology, not every company will make it to the finish line. So I am being selective here.

What is your outlook on how incentives and stimulus packages will affect the rest of the industry?

Davydova: There's no doubt that government incentives have been very supportive to the sector, and that it's likely we'll see them scaled back in the long run. Ultimately, I expect technology to drive adoption and to determine the long-term winners in this space, though I don't think we should completely rule out additional government support over the next few years.

While several European countries have been on the forefront of environmental policy and are now scaling back after years of generous support, other countries, like the U.S. and China, have expressed serious environmental ambitions. Overall, I expect regulatory changes to still play an important role in the sector over the next few years, while technology will drive the long-term outlook for these companies

What's your investment approach?

Davydova: With the high volatility associated with this sector in mind, I'm working to construct a portfolio that is diversified globally and provides exposure across environmental sectors, including alternative energy, energy efficiency, waste management, water infrastructure, pollution control and other environmental services. In addition to this diversification, we look to transform the many inefficiencies in the young and evolving environment and renewable-energy universe into alpha for the fund's shareholders.

The complex technologies that will determine the long-term winners are developing rapidly, creating attractive opportunities for investors who can stay ahead of the curve. So that's our focus. I work closely with our team of analysts conducting in depth top-down and bottom-up analysis.

To get an edge, I maintain a broad network of contacts and am in frequent contact with the management teams of these companies. I am traveling all over the world to see their operations first hand, to meet with their customers and competitors.

I also adhere to a disciplined valuation approach, looking for companies with superior relative-earnings growth trading at attractive multiples. Ultimately, I'm looking to construct a diversified portfolio of environment and alternative-energy stocks that should benefit from significant long-term growth while balancing secular tailwinds in the asset class with sector-specific cyclicality.

-- Reported by Gregg Greenberg in New York.

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Before joining, Gregg Greenberg was a writer and segment producer for CNBC's Closing Bell. He previously worked at FleetBoston and Lehman Brothers in their Private Client Services divisions, covering high net-worth individuals and midsize hedge funds. Greenberg attended New York University's School of Business and Economic Reporting. He also has an M.B.A. from Cornell University's Johnson School of Business, and a B.A. in history from Amherst College.

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