Features

• An alternative energy ETF is a basket of stocks in companies that produce renewable energy and related technology. The actual shares are owned by an institution that then sells shares in the fund in large blocks. These large blocks ultimately find their way into the open market and trade on the public exchanges very much like actual corporate stock. Some of the ETFs simulate the performance of an established index, while others select companies according to the same categories used by mutual funds (growth versus value, small cap versus mid or large cap).
  
  

Identification

• The first alternative energy ETF, listed in early 2005, was the PowerShares WilderHill Clean Energy Portfolio (PBW). The fund holds stock in 40 U.S. companies, with a focus on small cap information technology. Other prominent alternative energy ETFs include the Van Eck Global Alternative Energy ETF (GEX) and First Trust NASDAQ Clean Edge ETF (QCLN). The 30 publicly traded companies in GEX derive at least half of their revenue from alternative energy activity. QCLN contains more than 40 small cap stocks from a wide swath of alternative energy industries.
  
  

Considerations

• The growing popularity of alternative "green" energy has tempted some financial institutions to profit from the trend by obscuring the definition of alternative energy. For example, PowerShares WilderHill Progressive Energy Portfolio (PUW) and Cleantech Portfolio (PZD) both own stock in companies that focus on increasing the efficiency of traditional fossil fuel use--a worthwhile enterprise, but also a dubious claim to the mantle of "alternative" energy. But even more obviously questionable is the Claymore/LGA Green ETF (GRN), which holds shares of large cap companies like Mobil, Citigroup and General Electric under the dubious rationale that these companies devote a portion of their R&D budgets to green energy technology.
  
  

Warning

• With the broad spectrum of investments that fall under the "alternative energy" rubric, it behooves investors to perform due diligence before investing in an ETF simply because of its name. Particular attention should be paid to the constituent stocks and the factors that affect their price. Alternative energy investments, for example, tend to do well when the price of oil rises because their high costs become less prohibitive. At the same time, small cap companies can be very susceptible to fluctuations in the economy, credit markets and input prices of their materials.
  
  

Potential

• There has long been a will amongst the scientists, investors and people of the United States to dramatically increase utilization of alternative energy sources. What has often lacked, however, is the political will to make it a reality. With every new presidential election, there is talk of an aggressive initiative, like the one that resulted in the moon landings, to recreate the landscape of alternative energy. If this happened, the massive government funding could catapult alternative energy ETFs. But, until this push materializes, however, many innovators have had to focus on advancing technology by incremental steps based on existing practices and business models. The field of alternative energy remains highly sensitive to political risks.