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There’s a bonanza of fund offerings in the alternative energy, clean water/air, environmental services and related industries for those who are either a) worried that humankind is devastating planet earth beyond the point of no return or b) see the “green revolution” as a worthy investment theme for a globally diversified portfolio. Count me as someone highly interested in both arguments.

Cleantech: The New Biotech

I think we’re now at a point where we all have to become, at the very least, better educated on this global, multi-generational crisis. However, I’m not an environmentalist (by education or training). Thus, I’ve kept and will keep my comments to the second point: the investment theme.

There are many diverse arguments for green-based investing. For example, the Powershares Cleantech ETF (NYSEARCA:PZD) can be viewed as one of the new emerging tech plays, similar to biotech or nanotech. I have commented in the past on the volatility of highly specialized sectors like clean tech. As good a diversifier as they may be (but this should not be assumed; calculations are required), significant inherent volatility can still cause stomach aches. If you're risk averse, use caution in asset allocations and the allowable risk budget for these very focused investments.

So, the industry has determined that there’s a market for funds specifically focused in this new space. Here’s a quick review of green ETFs that have been launched, many in the past month:

First there was the Powershares Wilderhill Clean Energy (NYSEARCA:PBW) which was actually launched in March 2005. PowerShares followed this up with two more ETFs in the alternative energy space less than a month ago: PowerShares Cleantech Portfolio (PZD) and PowerShares Progressive Energy Portfolio (NYSEARCA:PUW).

In a recent article I’ve also covered the Market Vectors Environmental Services ETF (NYSEARCA:EVX). In addition, there is the Claymore LGA Green ETF which tracks the “Light Green Eco Index” Finally, indices tracking carbon emissions could lead to ETFs allowing more investors access to the emerging area of carbon trading.

The latest related offering is an ETF from First Trust Advisors linked to the NASDAQ(r) Clean Edge(r) U.S. Liquid Series Index (CELS) that is to be launched in January 2007.

Here’s a description of the tracked index from the press release:

The NASDAQ Clean Edge U.S. Liquid Series Index (CELS), developed jointly by NASDAQ and Clean Edge, is designed to track the performance of clean-energy companies that are publicly traded in the U.S. The NASDAQ Clean Edge U.S. Liquid Series Index includes companies engaged in the manufacturing, development, distribution, and installation of emerging clean-energy technologies such as solar photovoltaics, biofuels, and advanced batteries. The four major sub-sectors the index covers are Renewable Fuels and Electricity Generation, Energy Storage & Conversion, Energy Intelligence, and Advanced Energy-Related Materials.

ETF Bubble?
Clearly, we’re beginning to see some overlap among ETFs in this space. Very quickly, it seems as if the alternative energy ETF market is becoming more like the traditional energy ETF market. I’m talking about a sudden increase in competing offerings in the same industry sector. Previously I thought that energy related ETFs were a concern, but with the recent increased pace of ETF offerings in alternative energy, I foresee this being the new crowded market.

I would be concerned if I were a product developer planning to launch a similar product in the next quarter, never mind the individual who may be working to submit a preliminary prospectus to the regulators. Look for more offerings in this area, likely with even greater degrees of specialization (carbon trading, uranium/nuclear plant management, variety of service providers in all of the above sub-sectors).

You have to wonder: At what point do we have so many ETF offerings that we call this an “ETF bubble”? I don’t think we’re there. I think we’re seeing a significant shift in assets from the mutual fund industry to the ETF industry. With this shift, Wall Street is trying to keep up on the “supply side” to satisfy the “demand side”. There is a similar shift, again away from mutual funds and into hedge funds.

Investors are reaching for the extremes to get low cost beta (market risk exposure) and higher cost alpha (manager-based return exposure). The problem is that the beta side is beginning to shift further away from the low cost model. We can only hope that competition and continued technological innovations in the financial services industry drive costs down in the ETF marketplace.

PZD vs. PBW vs. EVX vs. PUW 1 month chart:

Cleantech chart

Source: Tree Huggers Unite! A Survey of Cleantech ETFs