An alternative index
The predicted, inevitable rise of alternative energy sources has brought a new indexing service to the market to guide investors, writes NJ Watson
ONE OF the vogue sectors among investment funds, alternative energy is experiencing a 1990s-style technology and dotcom boom – complete with hyped IPOs and soaring share valuations.
Ardour Global Indexes, a US company that develops benchmarking tools for the global alternative energy industry, is trying to make sense of it for investors. Richard Phillips, responsible for Ardour's series of indices, accepts the comparison. "You can liken the alternative energy sector to the internet in the 1990s. The bottom half of our composite of 128 stocks [Ardour Global Index] won't be in business in a couple of years. There will be a shakeout. But our Extra Liquid index – of the top-30 stocks – that's like a blue-chip tech index going back to 1990s."
Once a company has a foothold in the industry, they are generally unable to keep up with orders. "In our blue-chip Extra Liquid index, almost every one of the 30 companies has an order backlog ranging from three months to one year," Phillips says. "Five years ago, there were not really that many companies in the business that were profitable; now 27 or 28 of the 30 stocks in the Extra Liquid series are profitable."
Promise attracts cash
Such promise attracts cash. There's a total of $25.1 trillion invested in the US marketplace today. Phillips estimates investments in US mutual funds dedicated to alternative energy amount to $3bn – not including investments into funds that have some alternative-energy stocks, but don't qualify as dedicated funds. That may seem small, but it's growing fast. "Inflows into US funds, even in the present downturn, are running at $0.50bn-0.75bn a year, and it's accelerating. It's the main growth industry of the 21st century."
A similar amount is estimated to be invested in European capital markets, probably more. Climate Change Capital, a London-based investment firm that runs private-equity funds dedicated to alternative energy, has seen its assets under management double to over $1.7bn, from $0.83bn in September 2006.
A big part of that growth is down to the relative performance of many of the mutual and private equity funds involved in the business, which is benefiting from being at the confluence of three trends – global warming, increasing demand and high oil prices. According to the personal finance site Socialfunds.com, New Alternatives Fund – a long-running mutual fund investing in alternative energy – is by far the best performing US equity social fund this year, returning 53.73% as of 31 August: an outstanding performance considering the dramatic falls in the world's stock markets over the course of this year. As well as relative returns, some of these funds, particularly the exchange-traded funds, have proved to be a hedge against rising conventional energy prices, rising in tandem with the price of a barrel of oil.
"The main driver for the alternative energy space is the electricity price. Long-term electricity prices look set to continue to rise as conventional electricity generation becomes more expensive. Over the first half of this year, there have been sharp rises in the price of coal, natural gas and oil, continuing the trend of the last five years," says Matthew Page, co-manager of Guinness Atkinson Alternative Energy Fund.
It is that kind of thinking that led Ardour Capital Investments, an investment bank specialising in alternative-energy finance, to join up with S-Network Global Indexes to create the indices in 2005. "We looked at the global economy and at the potential drivers of global growth in the years ahead and we came up with a shortlist: globalisation, increased global trade, climate change and population growth. Of those, the most compelling sector and least transparent related to climate change," says Phillips.
The future of energy
He quotes some simple statistics to explain Ardour's belief in the future of alternative energy. The International Energy Agency estimates that by 2050, global energy consumption will be 130% higher than today; the G8 says carbon emissions should be cut by 50% over that same period. Part of the solution for reconciling these two seemingly contradictory targets lies with alternative energy, which accounts for just 2% of global power production today.
The next step was arriving at the "universe" of stocks that might warrant inclusion – no easy task, because many of the companies that ended up being included were not, at that time, categorised anywhere as alternative-energy companies.
Ardour defines an alternative-energy company as one that generates at least half its income from renewables, or biofuels and the supporting technologies for those industries. On that basis, 250 companies around the world qualified. These were whittled down to 128, 30% of which are US stocks. Other countries with substantial weightings include Denmark (15%), Germany (13%), China (13%) and Spain (8%). "It's fairly well diversified," says Phillips.
The 128 stocks in the Ardour Global Index Composite are also broken out into four sub-indices: North America, with 70 constituents; Europe, the Middle East and Africa, with 34 constituents; Extra Liquid, with the largest 30 constituents; and Ardour Solar RX, with 34 firms in that field. Ardour reviews its indices quarterly, taking account of companies entering or leaving the sector, and mergers and acquisitions.
Customers for Ardour's indices or rival offerings, such as Standard & Poor's S&P Global Alternative Energy Index, the Credit Suisse Global Alternative Energy Index or the World Alternative Energy Index, include US and European financial institutions putting together exchange-traded funds, investment banks such as UBS and Merrill Lynch with note-issuance programmes, and mutual funds that use the indices as a benchmark for the performance of their own alternative energy funds. "Our Extra Liquid index has much more liquidity than the composite index and so is used by investment managers as a basis for investment products," says Phillips.
Given the expected growth in the alternative-energy industry, Ardour claims the demand for its products is pretty inelastic. And with old Republican oilman T Boone Pickens jumping on the alternative-energy bandwagon – his company Mesa Power has invested $2bn in the world's largest wind farm in Pampa, Texas – the signs are that this bubble still has some air left in it. n