In May 2007 I put up two posts on this blog related to uranium.  The first was “Uranium Mania” which discussed the astronomical price chart for uranium prices.  One of the easiest ways to gain exposure to the commodity price, as opposed to the producers, is via Uranium Participation Corp (U).  Interesting how that post was written very close to the peak of uranium prices.

At that time, my thinking was that any exposure to uranium would best be accomplished with a combination of U plus Cameco.  Here’s the chart for Cameco over the past three years:

Very different performance patterns between the commodity and one of its major producers.  But it wasn’t until mid-August of last year that Van Eck came out with the first nuclear energy related ETF, the Market Vectors Nuclear Energy ETF (NLR).

For some reason, BGI with its newly listed iShares Global Nuclear Energy ETF (NUCL), must feel like being “second to market” ain’t half bad if the longer term outlook is strong.  I’m posting this blog after having seen this article in Canada’s Financial Post which gives some bullish views given the recently depressed price and a demand situation here in Ontario.  My interest is more related to significant energy policy shifts in the US (regardless of who wins the White House) and even more importantly, the choices made in the emerging world.  The developed world (well, mainly the US) complains about the relative lack of participation of the developing world in environmental policies such as Kyoto.  However, evidence from the annual reports of major uranium producers suggest that the market for them is the emerging world and that’s where they see the future growth.  Who would call that surprising?  Aside from foreign policy roadblocks for concerns that perceived unfriendly regimes would produce weapons grade materials, the necessity for the developing world to access nuclear energy is clear.  How can they compete with the US, China and larger (& more powerful) nations for oil?  I think they need alternative energy sources even more than the big guys.  I’m still a longer term bull for uranium.  The question is whether the exposure should be to uranium prices, the producers or a combination.

Well, aside from Uranium Participation Corp traded in Toronto, there are also uranium futures traded on the NYMEX.  The futures contracted started trading about the same time as my blog from May 2007 … as usual product development seems to be a decent market top provider.  And yes, it’s cash settled … no jokes about delivering 250 pounds of uranium.  That’s about it.  I’m kind of surprised that firms like ETF Securities in London or PowerShares (with their association to Deutsche Bank) haven’t created a uranium price tracker given their expertise in ETFs with futures based underlyings.  It’s just a matter of time.  I’m thinking that it would be nice to have this now and NOT near the next intermediate term top.

To go after the producers, like I said before, we now have two ETFs.  From a year ago, my simplified approach was to put it all in Cameco but for the passive fan, the ETFs would be the way to go.  Since NUCL only came out only about two weeks ago, we can’t do much comparison shopping.

Both have global exposures.  The newer NUCL is about 20bps cheaper in fees but with less holdings at 25 versus 38 for NLR.  The list of holdings for NUCL and NLR show some clear differences in the top 10’s in each as well as proportional weightings.  But what seals the deal for NLR over NUCL is the sector allocations.  Take note that for NLR, the breakdown of the top three sectors is 31% nuclear generation, 29.5% plant infrastructure, 28.8% uranium mining, with the remainder in uranium storage, nuclear conglomerates, uranium enrichment and nuclear fuel transport.  NUCL’s top exposure is in utilities (54.2%).  Their remaining catergory names are relatively generic like “energy”, “industrials” and “financials” (in that order, actually) and so part of their flaw is not doing a better job educating investors on the real uranium sub-sector breakdowns.  Hey, isn’t BGI the experts in ETF education?  You know I just like pickin’ on the big guy.

So, bottom line, this might be a decent time to get in to nuclear/uranium as an alternative energy and emerging market play.  The holdings list does not give enough information on its own so a bit of homework is required to see how much of each name is actually going out to places where energy infrastructure for the longer term is a concern.  Because the uranium producer space is limited to a few big names and many microcaps, it’s a tough call.  Pick a few of the big producers and you’ll do fine but if you’re from the industry or are a commodity freak, hopefully you’ve got some talent in picking the future successful producer (who will likely get acquired by one of the big guys).  Since that’s a tough sport, I think the focus should be on the uranium price for the longer term.  With limited instruments available, the challenge now is to decide between Uranium Participation Corp and uranium futures.  Until, that is, an ETF or ETN for this commodity gets launched.

Roughly a year ago, I wrote a post discussing the concept of alpha (that rare and valuable thing) which becomes less rare and eventually commoditized into beta in time. Here’s a bit of what I said at that time:

Isn’t alpha supposed to be the returns from a strategy that is based on market inefficiencies? If so, then shouldn’t these market inefficiencies disappear as other players enter the field? This line of thinking is discussed in this paper available on SSRN:

By the way, this paper was written by market participants. At the time of its publishing, the authors worked for ABP Investments which, according to its website, is the 2nd largest pension fund in the world. This paper discusses how investment processes can be divided into two groups:

Traditional beta which they call “commoditized beta”. This is based on exposures to various markets and is the classic definition of market risk.

Traditional alpha which they call “non-commoditized beta”. This is based on other risk factors not associated with market exposure.

Basically, the writers of this paper sum up things well in four points (bottom of page 4) provided here ad verbatim:

1. Any investment process which today generates return by taking exposures, which are not well known, will become obsolete progressively, as the exposure premium reduces or the exposure is commoditized.

2. As exposures become commoditized, the space to generate additional alpha return (from the residual) decreases, and the space for beta return increases.

3. There is practically no alpha based exposure, which cannot be commoditized.

4. The investment problem which originated in finding exposures to generate alpha will gravitate towards becoming the process of analyzing when to take a specific commoditized beta exposure.

They go on to say that the alpha versus beta debate is irrelevant. “The eventual investment problem is therefore not to now generate exposure combinations, which would generate alpha, but to be able to time the betas of the existing exposures. We therefore believe that active management will devolve to an exposure based allocation process, where the objective is largely to allocate to different forms of beta, and where alpha does not actually exist. Portfolio diversification is then just the diversification obtained by applying the forecasting process to more than one beta.” This is basically a rewording of point #4 above.

A key point from the above I believe is this: ” … where the objective is largely to allocate to different forms of beta.”

Remember, this was written by some portfolio managers who were at ABP, one of the world’s largest pension plans. They’re trained and compensated to care about the long term horizon, not the short term. But it seems like what they’re saying is that not only should one NOT stick to only investing in the plain vanilla betas (broad market index exposures … let’s just call that the very large, broad, market-cap weighted ETF behemoths which generally come with low management fees) but in fact must allow for the niche exposures personified by the newer and more controversial ETFs that have higher fees. I’m assuming that these niche ETFs provide the required “different forms of beta” mentioned above. The writers say that alpha does not actually exist in these areas (this could be sector or regional exposures). They even go so far as to say that the investment problem should focus on the timing of the beta exposures.

Let me be clear: The moment you talk about timing beta exposures, you’re talking about actively managing your ETF holdings. I’m not sure if this is what the original ETF pioneers were thinking about roughly 15 years ago but I don’t believe that this paper I was referring to was written by two dummies. I have great respect for this philosophical exercise in thinking about alpha and beta.

Why do I bring this up today? Well today, I spoke at the Hedge Funds World Canada conference here in Toronto. I led a session in the afternoon focusing on matters related to beta within an alpha centric world (it’s a hedge fund conference in case the event’s title wasn’t clear). The session following mine focused on alpha but since the two greek letters are very much related in portfolio theory, there was some overlap.

Aside: Interestingly enough, I found the term “beta” used just as much (if not more) than “alpha” in this first day of this conference. There was a session on 130/30 programs. These mandates are engineered to remain extremely constrained so as to continually have beta of 1.0. Again, at a hedge fund conference. Beta 1.0!!! Isn’t that an index fund?! Well not necessarily but it kind of blurs the line between hedge funds and mutual funds. At the least, it certainly makes me think what Jones, Soros, Robertson and other “old school” hedgies would think about a mandate with a target beta of 1.0 being discussed at a hedge fund conference. 130/30 programs also called a variety of other names including “Active extension strategies” and are commonly discussed in many other events both related to hedge funds, ETFs and well just about any investment related conference these days. Think of it, currently anyway, as the rock star of the institutional investment community. Well, I don’t know about rock star … why am I picturing a bunch of pension actuaries dressed up in leather like Kiss for their office Halloween party? Note to self: Too much coffee at the conference today.

Well, from one of the discussions today, I was reminded of the concept of alpha as simply un-commoditized beta. And when I got back home, I found an email from HSBC about a new set of indices:

HSBC has announced the launch of its Global Climate Change Benchmark Index, together with a family of four investable global climate change index products.

The HSBC Global Climate Change Benchmark Index, developed by CIBM’s Global Research team, is a global reference index which has been designed to reflect and track the stock market performance of key companies that are best placed to profit from the challenges presented by climate change. The performance of the benchmark has been tracked back to 2004 and has outperformed the MSCI World Index by around 70%.

From this benchmark, HSBC has established four investable climate change indices that can be used to create portfolios for a diverse range of investment needs such as long only funds, hedge funds, exchange traded funds, discretionary funds and structured products. The indices are:

• HSBC Climate Change Index

• HSBC Low Carbon Energy Production Index (including: solar, wind, biofuels, geothermal)

• HSBC Energy Efficiency & Energy Management Index (including: Fuel Efficiency Autos, Energy Efficient Solutions, fuelcells)

• HSBC Water, Waste & Pollution Control Index (including: water recycling, waste technologies, environmental pollution control)

In creating these indices, HSBC has responded to changing investor sentiment in global equity markets. The HSBC research team has looked at a wide range of stocks and identified approximately 300 companies that are well positioned to benefit from the challenges of climate change.

Group Chairman Stephen Green said: “HSBC has long recognized the importance of climate change and has shown real commitment to addressing the risks and opportunities it brings. In developing tailored climate change indices we are providing real investment solutions which enable our clients to incorporate climate change into their investment decisions.”

By the way, attached to the email was a 24-page report from HSBC’s Global Equity Quantitative Research group and the lead analyst’s name is Joaquim De Lima. Please don’t ask me for this report as I don’t even know how I suddenly got on their mailing list. I provide this bit of info so that you can go to HSBC and make your own inquiry. Now my thoughts.

What can I say … another set of new indices. Am I surprised that again we see something introduced to the market within the realm of climate change? Not really. The entry of alternative energy related ETFs has shown no signs of slowing down and I have discussed this area several times in the past. By the way, have you seen how PBW has been doing?

Up nearly 40% year-to-date and despite some ugliness in concert with the markets this summer, a strong rebound in recent weeks.

Getting back to main topic, what I find interesting is that this sector, or perhaps parts of this sector, should be (only my opinion, of course) the domain of hedge funds. Although not a significant part of the above release from HSBC, ask yourself if the related space of carbon emission credits is really an efficient market. Take any of the above HSBC indices and ask yourself if there is an army of CFA/MBA/PhDs as well as Average Joes at home looking into these markets in the same way as Citigroup or Microsoft. No way … it’s just too new.

[FYI and another aside: I know that carbon trading is a hot topic and I’ve just mentioned it in passing here. According to the HSBC report, the sector breakdown of the overall Global Climate Change Index shows only three stocks (0.29% weighting in the index) to financials of which two (0.22% weight of index) positions are further classified as carbon trading. So basically, don’t think of this index or sub-indices as a strong play for the emissions trading market.]

Despite the fact that these new markets are relatively new, underdeveloped and lacking in the kind of information flow similar to most global large cap equities, I find it interesting that the commoditizing of what should be alpha-centric markets is happening with greater speed. This does not take away, of course, from the fact that within these markets there will certainly be traders, some of whom will be winners and likely many more who will be losers. Some will be alpha providers (losers) and some will be alpha takers (winners).

Thus, with new markets (relatively speaking when I use the term “new”), there will be opportunities for those with a beta point of view (assuming something like an ETF is quickly produced to commoditize that market) as well as those who are alpha-focused. This is not unique and goes simply back to the active versus passive debate which one must consider when investing in any asset class. My comment here, and what I find unique, is simply the observation that the commoditizing of alpha can be faster than one might imagine simply due to the evolution of the ETF industry away from broad market exposures and towards niche markets.

But coming back to the guys formerly at ABP: According to them, the beta point of view is actually a rather active set of decisions (timing beta) and thus leads to much less differentiation from the pure active point of view which is the hedge fund.

Confused? Then the newer niche ETFs likely have little meaning for you and a disciplined buy-hold strategy with a longer focus on the “hold” applies. Not so confused? Then maybe I’ll see you next week in Scottsdale Arizona for the “World Series of Exchange Traded Funds -West” conference where I hope to explore this topic and others in greater detail. Furthermore, for those in the Far East, keep your eyes on this blog as I’m hoping to get a spot in an indexing conference in Hong Kong as well as a fund conference in Seoul both in late November.

Hey, just thought of something. I just said that the speed of bringing an area of the capital markets to beta (that is, commoditized to beta in what would seem to be a healthy space for alpha oriented investors) has significantly increased. If that’s true then why is it that we’re only seeing the first international fixed income ETF coming to market now? Well, the shape of yield curves globally didn’t help as well as a nearly five year bull market whose growth rate looks steeper than what we saw in the 90’s (not including Nasdaq in the years before the top). So the commoditizing of alpha into beta is a concept which can not be gauged solely by monitoring the ETF marketplace. But it certainly does give a strong argument for the value and purpose of the many new entrants (and soon to be entrants) within the ETF community.

Thoughtful and significant exposures that have a real purpose within a portfolio construction process. If this is what new entrants in the ETF industry provide with their new product offerings, then I think it’s a good thing. As usual, the market will decide this.

Interesting finding in the Globe and Mail’s Streetwise blog where Andrew Willis provides news of an upcoming IPO for GHG Emission Credit Participation Corp. on the Toronto Stock Exchange. Willis mentions that this is a pure play into the carbon emissions market similar to other funds on the TSX that provide pure play exposure to gold, molybdenum and uranium. I’ve mentioned Uranium Participation Corp. (U) as a unique and easy means to uranium price exposure however there are now futures for this commodity as well.

This press release give a bit more on the IPO.

Technically neither of these “Participation Corp.” (uranium and now emission) instruments are ETFs but they are traded on an exchange like a stock and for the vast majority of investors do the job of providing indirect commodity exposure as GLD and SLV do for gold and silver respectively.

I’ve discussed carbon markets in the past and some googling will provide more background information … more than you need, of course. I find Wikipedia may not be the most reliable source of information for a particular subject, but it usually provides a decent set of links and this is true when you look here and here.

Not surprisingly, there’s also news of problems in this new space. Fertile ground for active managers.

Another interesting angle is to explore getting a piece of the infrastructure by purchasing shares in Climate Exchange PLC (CLE) which is covered in the topmost link as well as in this National Post article.

For the large institutional investors, I’d speculate that they would gain exposure to emission markets through hedge funds. Frankly, I would be surprised if internal managers in even the largest pension funds included direct carbon instrument exposures within their GTAA programs. For most investors, this market is still in its infancy and therefore getting in quick and easy may be the best approach simply for practical reasons. Alternative energy will be hot for a long while and emissions may be the next uranium. Perhaps exposure to the market itself through GHG Emission Credit Participation Corp. as well as to the exchanges through Climate Exchange PLC should provide more than enough of an allocation replacement should uranium investors decide to take their profits and move on.

Many observers of the ETF industry have commented on the thinner slices to sector exposures provided by fund manufacturers in recent years. My take is different. Although there are some “sectors” that are indeed quite narrow, many new fund offerings are more “thematic” in nature. These include water, alternative energy and infrastructure and are more broad that they are, in my opinion to be considered asset classes themselves. Of course, some would consider this issue semantics but that’s for the final user to decide within their own investment process. Certainly, many institutional investors look at infrastructure as an asset class. I don’t know if I would consider water to be an asset class … actually, I don’t … but it certainly is broader than a sector and can be considered thematic in nature.

At the end of the day, I am interested in finding things (call it a sector, call it a theme, I really don’t care) that help in the overall risk-adjusted return potential for any given portfolio. I think Van Eck is a firm that thinks the same way. Steel company exposures (through their Steel ETF, SLX) may not be a diversifier for many, but I could see it as one for many unique types of investors. The same could be said for their Environmental Services ETF (EVX), their Gold Miners ETF (GDX), their Global Alternative Energy ETF (GEX) and their new Russia ETF (RSX).

To take RSX as another example, for an investor with a need for emerging market exposure outside of what they likely already hold (China, India, EEM) and with a strong commodity bias, this fund makes sense. For someone like a Canadian or Australian, it likely doesn’t make so much sense.

But now I’m getting word of some new ETF product development in the Van Eck pipe as seen from this recent SEC filing.

What have we here? (Think Lando when he first met Leia for all the fellow Star Wars geeks out there.) Here are some of the more interesting excerpts:

Market Vectors—Global Agribusiness ETF and Market Vectors—Global Nuclear Energy ETF (the “Funds”) are distributed by Van Eck Securities Corporation and seek to track the DAXglobal^® Agribusiness Index and DAXglobal^® Nuclear Energy Index, respectively, each of which is published by Deutsche Börse AG (“Deutsche Börse”).

More specifically on the Agribusiness ETF:

MARKET VECTORS-GLOBAL AGRIBUSINESS ETF

Principal Investment Objective and Strategies

Investment Objective. The Fund’s investment objective is to replicate as closely as possible, before fees and expenses, the price and yield performance of the DAXglobal^®® Agribusiness Index.” Agribusiness Index (the “Agribusiness Index”). For a further description of the Agribusiness Index, see “The DAXglobal^® Agribusiness Index.”

Principal Investment Policy. The Fund will normally invest at least 80% of its total assets in equity securities of U.S. and foreign companies primarily engaged in the business of agriculture. Companies primarily engaged in the agriculture business include those engaged in agriproduct operations, livestock operations, agricultural chemicals, providing or transporting agricultural equipment, and providing or transporting ethanol/biodiesel, and which derive at least 50% of their total revenues from such activities. This 80% investment policy is non-fundamental and requires 60 days’ prior written notice to shareholders before it can be changed.

Indexing Investment Approach. The Fund is not managed according to traditional methods of “active” investment management, which involve the buying and selling of securities based upon economic, financial and market analysis and investment judgment. Instead, the Fund, utilizing a “passive” or indexing investment approach, attempts to approximate the investment performance of the Agribusiness Index by investing in a portfolio of securities that generally replicate the Agribusiness Index.

The Adviser anticipates that, generally, the Fund will hold all of the securities which comprise the Agribusiness Index in proportion to their weightings in the Agribusiness Index. However, under various circumstances, it may not be possible or practicable to purchase all of those securities in these weightings. In these circumstances, the Fund may purchase a sample of securities in the Agribusiness Index. There also may be instances in which the Adviser may choose to overweight another security in the Agribusiness Index, purchase securities not in the Agribusiness Index which the Adviser believes are appropriate to substitute for certain securities in the Agribusiness Index or utilize various combinations of other available investment techniques in seeking to replicate as closely as possible, before fees and expenses, the price and yield performance of the Agribusiness Index. The Fund may sell securities that are represented in the Agribusiness Index in anticipation of their removal from the Agribusiness Index or purchase securities not represented in the Agribusiness Index in anticipation of their addition to the Agribusiness Index. The Adviser expects that, over time, the correlation between the Fund’s performance and that of the Agribusiness Index before fees and expenses will be 95% or better. A figure of 100% would indicate perfect correlation.

The Fund will normally invest at least 95% of its total assets in securities that comprise the Agribusiness Index. A lesser percentage may be so invested to the extent that the Adviser needs additional flexibility to comply with the requirements of the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”), and other regulatory requirements.

Because of the passive investment management approach of the Fund, the portfolio turnover rate is expected to be under 30%, generally a lower turnover rate than for many other investment companies. Sales as a result of Agribusiness Index changes could result in the realization of short or long-term capital gains in the Fund resulting in tax liability for shareholders subject to U.S. federal income tax. See “Shareholder Information—Tax Matters.”

Market Capitalization>. The Agribusiness Index is comprised of companies with market capitalizations greater than $150 million that have a worldwide average daily trading volume of at least $1 million and have maintained a monthly trading volume of 250,000 shares over the past six months. The total market capitalization of the Agribusiness Index as of [ • ], 2007 was in excess of $[ • ] billion.

So we now have a competitor to the up to the PowerShares-Deutsche Bank agriculture ETF (DBA). A quick review from its website gives us this description:

The PowerShares DB Agriculture Fund is based on the Deutsche Bank Liquid Commodity Index – Optimum Yield Agriculture Excess Return™ and managed by DB Commodity Services LLC. The Index is a rules-based index composed of futures contracts on some of the most liquid and widely traded agricultural commodities – corn, wheat, soy beans and sugar. The index is intended to reflect the performance of the agricultural sector.

With all the focus on metals and energy, diversifying into agriculture is a reasonable move for investors with the size to spread their allocations out even further. Those who lean more towards a Jim Rogers philosophy will look to DBA and/or this new Van Eck offering as more of a strategic (I would say tactical) bet.

And like applying a GLD/GDX combo for exposures to both the gold bullion price and gold miners, a similar DBA/new Van Eck combo makes sense here. For those implementing a position to a specific commodity, I think this dual positioning is ideal and the tilting between the two positions can be a significant source of alpha in the long-term (in my opinion). If only this were also available to the commodity I’ve been commenting on recently and for quite some time: uranium.

More specific to the upcoming Nuclear Energy ETF from Van Eck:

MARKET VECTORS-GLOBAL NUCLEAR ENERGY ETF

Principal Investment Objective and Strategies

Investment Objective. The Fund’s investment objective is to replicate as closely as possible, before fees and expenses, the price and yield performance of the DAXglobal^®® Nuclear Energy Index.” Nuclear Energy Index (the “Nuclear Energy Index”). For a further description of the Nuclear Energy Index, see “The DAXglobal

Principal Investment Policy. The Fund will normally invest at least 80% of its total assets in equity securities of U.S. and foreign companies primarily engaged in various aspects of the nuclear energy business. Companies primarily engaged in the nuclear business include those engaged in uranium mining, uranium enrichment, uranium storage, providing equipment for use in the provision of nuclear energy, nuclear plant infrastructure, nuclear fuel transportation and nuclear energy generation, and which derive at least 50% of their total revenues from such activities. This 80% investment policy is non-fundamental and requires 60 days’ prior written notice to shareholders before it can be changed.

Indexing Investment Approach. The Fund is not managed according to traditional methods of “active” investment management, which involve the buying and selling of securities based upon economic, financial and market analysis and investment judgment. Instead, the Fund, utilizing a “passive” or indexing investment approach, attempts to approximate the investment performance of the Nuclear Energy Index by investing in a portfolio of securities that generally replicate the Nuclear Energy Index.

The Adviser anticipates that, generally, the Fund will hold all of the securities which comprise the Nuclear Energy Index in proportion to their weightings in the Nuclear Energy Index. However, under various circumstances, it may not be possible or practicable to purchase all of those securities in these weightings. In these circumstances, the Fund may purchase a sample of securities in the Nuclear Energy Index. There also may be instances in which the Adviser may choose to overweight another security in the Nuclear Energy Index, purchase securities not in the Nuclear Energy Index which the Adviser believes are appropriate to substitute for certain securities in the Nuclear Energy Index or utilize various combinations of other available investment techniques in seeking to replicate as closely as possible, before fees and expenses, the price and yield performance of the Nuclear Energy Index. The Fund may sell securities that are represented in the Nuclear Energy Index in anticipation of their removal from the Nuclear Energy Index or purchase securities not represented in the Nuclear Energy Index in anticipation of their addition to the Nuclear Energy Index. The Adviser expects that, over time, the correlation between the Fund’s performance and that of the Nuclear Energy Index before fees and expenses will be 95% or better. A figure of 100% would indicate perfect correlation.

The Fund will normally invest at least 95% of its total assets in securities that comprise the Nuclear Energy Index. A lesser percentage may be so invested to the extent that the Adviser needs additional flexibility to comply with the requirements of the Internal Revenue Code and other regulatory requirements.

Because of the passive investment management approach of the Fund, the portfolio turnover rate is expected to be under 30%, generally a lower turnover rate than for many other investment companies. Sales as a result of Nuclear Energy Index changes could result in the realization of short or long-term capital gains in the Fund resulting in tax liability for shareholders subject to U.S. federal income tax. See “Shareholder Information—Tax Matters.”

Market Capitalization. The Nuclear Energy Index is comprised of companies with market capitalizations greater than $150 million that have a worldwide average daily trading volume of at least $1 million and have maintained a monthly trading volume of 250,000 shares over the past six months. The total market capitalization of the Nuclear Energy Index as of [ • ], 2007 was in excess of $[ • ] billion.

Perhaps the whole green ETF thing has gone a bit far in the past year but, a bit surprisingly, this would be the first pure play on the nuclear energy story. I have commented recently on uranium as have so many other industry watchers in recent months after having seen the commodity double in price in the past four calendar years … it’s up roughly 70% so far this year according to the chart found here.

I just said “pure play”, but it’s important for prospective investors to consider the 50% and 80% values quoted in the above descriptions. That’s 50% of the revenue of an underlying holding must fit the required parameters and 80% of the fund’s assets is to be invested in companies whose primary business operations are in the field of agriculture or nuclear energy respectively.

I don’t want to comment too much on this nuclear energy ETF as I don’t have enough information at this time. But here’s the problem I foresee: There’s just not an even spread of companies involved in the nuclear energy business. Let’s take uranium mining for example. It’s Cameco (CCJ), a very small number of competitors who are close in terms of size and a large number of small cap, if not micro cap, producers. Having an ETF based just on uranium miners would be a logistical nightmare and investors would have to accept a few stocks dominating the fund. An equal weighted ETF for this sector would make sense except for the fact that the thinly traded smallcaps/microcaps would provide an interesting (to say the least) situation for the market makers of the fund. I could see hedge funds getting into that game on the other side. We can only hope that there is a more robust mix in other related businesses mentioned in the prospectus namely uranium enrichment, uranium storage, providing equipment for use in the provision of nuclear energy, nuclear plant infrastructure, nuclear fuel transportation and nuclear energy generation.

In the past I’ve mentioned both Cameco and Uranium Participation Corp (U) as appropriate uranium plays. This new nuclear energy ETF would be an even more appropriate holding in the place of Cameco and with recent uranium derivatives on the market, exposure to the price of uranium itself allows for more complete exposure (and inverse through shorting) than in the past.

No word yet on fees as well as other details on these upcoming Van Eck ETFs.

I’d say that of all the ETF providers, it’s the news out of Van Eck that gets me the most interested and I always look forward to finding out what’s next from them.  Nothing too fancy … just new exposures, but I like it!

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 (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 (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 (PUW).

In a recent article I’ve also covered the Market Vectors Environmental Services ETF (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:

There’s an interesting new development in the alternative energy space that may soon apply to ETFs. The following is from Hedgeworld.com:

UBS today [Nov. 2] announced the launch of the first index to track emissions allowances. The UBS World Emissions Index will initially track two of the European Emissions Trading Scheme platforms and will potentially expand to include other emissions programs. The EU-ETS is the largest carbon dioxide trading scheme, and covers about 46% of European carbon dioxide emissions. The new index will be published in U.S. dollars, euro and Swiss francs.

This is an interesting play on what looks to be the big issue of this century: global warming. Further from this press release:

The timing for the launch of the new index couldn’t have been much better. Carbon dioxide emissions are seen as one of the main factors in climate change and global warming, and the index has been presented in the same week that Sir Nicholas Stern, head of the Government Economics Service [United Kingdom] and adviser to the U.K. government on the economics of climate change and development, presented his influential report, The Stern Review on the Economics of Climate Change.

Here is a short executive summary on this report (.pdf). And here’s the main page for further information.

Lastly, this section from the same press release gives an indication of current product development efforts as well as constraints:

UBS has already structured products on the new index, available in the index’s three denominations. “Open End PERLES on UBS World Emissions Excess Return Index” products were launched today, and the subscription period will remain open until Nov. 24, which will be the pricing date. The pre-announced bid-offer spreads—1.75% when markets are open and 3% when markets are closed under normal market conditions—are an indication of the currently limited liquidity in the underlying markets.

We could potentially see some form of fund structure providing exposure to this important new market in the not too distant future. Certainly, this would be a good compliment to PBW and uranium related holdings as diversifiers to long energy holdings.

PowerShares has finally launched the ETFs that take choices for alternative energy beyond PBW in this space.The following 3 funds began trading yesterday on the Amex:

PowerShares Cleantech Portfolio (PZD)

PowerShares Progressive Energy Portfolio (PUW)

PowerShares Listed Private Equity Portfolio (PSP)

I’ve commented on all three of these ETFs in the past here:

A Look at the New Private Equity ETF

PowerShares WilderHill Clean Energy ETF: Leverage Through Volatility

97 New ETFs Planned for U.S. Market — Powershares Leads the Way

For this entry, I will not comment on the private equity fund.

For investors in PBW, the new cleantech fund and the progressive energy fund may be a bit of overkill in terms of holding all three. First let’s review PBW:

PBW peaked at just under 24 in early May ending a 50% rise since the beginning of 2006. Wow. However, like all of the energy complex it fell hard this summer. PBW had a drawdown of roughly 30% hitting lows around 16.30 in late September. In fact, since September 22nd, PBW has risen about 13% to October 16th. A pull back in the past week and a half to just under 18 at the time of writing makes this look like a good point to get in. Recent action can’t be considered evidence of the beginning of a longer term uptrend but we’re still in a much better valuation than we were in early May.

PBW holds a diverse portfolio of 42 stocks with the largest sector weightings in IT (37%) and industrials (29%). Although it holds a small number of relatively “clean” utility companies, I consider this fund as a Nasdaq play on stocks with an alternative investment bent. I see alternative energy as a new technological wave commonly seen in major Nasdaq uptrends. Tech waves in the past have come in different forms but are clearly based on new innovations such as the biotech/pharmaceutical wave and the telecommunications/internet wave. On the positive side for alternative energy, we’re nowhere near the speculative state of the dot com bubble. But with 42 stocks and a small cap growth bias, this fund is significantly more volatile than the Nasdaq which is a volatile index itself! Based on this kind of volatility, PBW shouldn’t comprise any more than 5% of a portfolio.

Taking this argument of a high-tech fund to the extreme leads to the new cleantech fund. This is simply one to watch. Here’s the site for this ETF:

According to the site, “A company is considered to be part of the cleantech industry if it produces any knowledge-based product or service that improves operation, performance, productivity or efficiency, while reducing costs, inputs, energy consumption, waste or pollution.”(emphasis in this quote is mine)

Also from the website, I find that this fund has sector weights very similar to PBW. In the case of PZD, it’s 27% in IT and 43% in industrials. Again, roughly two-thirds of the fund is dominated by these two sectors. Also similarly, both funds have roughly three-quarters in small cap holdings. Although PZD does not hold utilities like PBW (roughly 9% weighting), there is still a significant amount of common holdings between these two ETFs. Refer to the PowerShares site to find the holdings in both to do the usual comparison shopping.

I’m eager to see the initial price action of PZD but my expectation is a slightly more volatile chart compared to PBW.

In the case of PUW, the fund is based on the WilderHill Progressive Energy Index. “The Index is comprised U.S.-listed companies that are significantly involved in transitional energy bridge technologies, with an emphasis on improving the use of fossil fuels. The modified equal-weighted portfolio is rebalanced and reconstituted quarterly.”

Again, I find it interesting to find another ETF moving away from market cap weighted indexation. This continues the trend started with RSP (Rydex S&P Equal Weighted Fund) and furthered today by firms like PowerShares, Claymore and WisdomTree. Although not an ETF manufacturer, I always try not to forget Dimensional Fund Advisors, the pioneer in the space of non-market cap weighted passive funds.

Looking at the stats on this ETF (sector weights, underlying holdings dispersion by market cap, etc.) I find it to be the most unique, or at least significantly different in its composition compared to PBW and PZD. I would guess that this would be the least volatile of the three. Despite this assumption, again I have to state clearly it would still be significantly more volatile then the Nasdaq. Here’s a historical chart picked off the PowerShares site:

I still believe that these funds will have strong correlations with the commodity indices, especially with the strong bias in these for energy. Like energy, these will be volatile so I can’t think of holding any combination of these in a sum of more than 5% in a portfolio. There are also other “alternative energy” parts missing with these three funds. For example, what about exposure to uranium? Considering how many nuclear plants exist today and are either being built or are in the planning stages, perhaps it is no longer an “alternative” energy source. Still, it’s another area I like.

I received the latest press release form Van Eck Global. Earlier this year, they entered into the ETF market with their first offering – a gold producer ETF (ticker: GDX). As of September 30, 2006 it has over $250 million in assets and averages over 500,000 shares traded per day. It’s even option eligible. We maintain gold exposure through XGD, an iShare ETF domiciled in Canada giving exposure to stocks in the TSX Gold Subindex. Basically, this would be Canada’s counterpart to GDX. This is complemented with GLD. We’re holding no more than 5% in these gold related positions right now and don’t plan on touching these.Some news on two new ETFs from Van Eck Global from today’s press release:

Today, we are launching two new unique ETFs, one on Environmental Services and another on Steel shares. Both are based on indices developed and calculated by the American Stock Exchange.

Market Vectors Environmental Services ETF (ticker: EVX) is the only way we know of for investors to gain exposure through an ETF or mutual fund to the fast-growing environmental services industry. This ETF seeks to track, before fees and expenses, the performance and yield of the Amex Environmental Services Index [AXENV].

Market Vectors Steel ETF (ticker: SLX) gives investors a unique and important way to focus on steel, an industry that is fundamental to consumer durables, capital spending and construction and one undergoing significant change. SLX is the only ETF or mutual fund that we know of that investors can use to gain exposure to the steel industry. This ETF seeks to track, before fees and expenses, the performance and yield of the Amex Steel Index [STEEL].

More information on Van Eck and their “Market Vector” family of ETFs can be found at on their website.

With regard to EVX, I think about how it might play along with our clients’ positions in PBW (PowerShares WilderHill Alternative Energy ETF) which I have discussed in the past here and here. PBW casts a fairly wide net. It has utility companies that are relatively clean in terms of using hydroelectric power versus the burning of fossil fuels as one example. It also has significant “high tech” type exposure with companies in the clean energy industry. In fact, according to the PowerShares website, IT has the largest sector weight in PBW with 37.26%. For anyone interested in doing some “comparison shopping”, here’s the list of constituents in the Amex Environmental Services Index [AXENV) picked right off the AMEX website:

Amex Environmental Services Index [AXENV]

“Constituents as of September 29, 2006″

Ticker Component Name Shares

(ARS) Aleris International Inc. ” 112,920 ”

(AW) Allied Waste Industries Inc. ” 523,358 ”

(CCC) Calgon Carbon Corp. ” 801,254 ”

(CLHB) Clean Harbors Inc. ” 133,699 ”

(CVA) Covanta Holding Corp. ” 271,936 ”

(CWST) Casella Waste Systems Inc. ” 312,291 ”

(DAR) Darling International Inc. ” 1,411,638 ”

(ECOL) American Ecology Corp. ” 298,630 ”

(FTEK) Fuel-Tech N.V. ” 237,863 ”

(LAYN) Layne Christensen Co. ” 196,169 ”

(MTLM) Metal Management Inc. ” 212,749 ”

(NLC) Nalco Holding Co. ” 304,219 ”

(NR) Newpark Resources Inc. ” 1,069,342 ”

(RSG) Republic Services Inc. ” 433,275 ”

(RTK) Rentech Inc. ” 1,205,275 ”

(SGR) Shaw Group Inc. ” 234,497 ”

(SRCL) Stericycle Inc. ” 83,439 ”

(SYGR) Synagro Technologies Inc. ” 842,800 ”

(SZE) SUEZ France ” 383,091 ”

(TTEK) Tetra Tech Inc. ” 330,558 ”

(VE) Veolia Environnement ” 286,354 ”

(WCN) Waste Connections Inc. ” 149,905 ”

(WMI) Waste Management Inc. ” 475,926 ”

(WSII) Waste Services Inc. ” 370,612 “

Just below this list on the same page, AMEX gives daily price data going back to March 30, 2001 for all you backtesters.

For those of you more interested in the Steel ETF, here’s the low down on the Amex Steel Index (STEEL) from the same source:

Amex Steel Index [STEEL]

“Constituents as of September 29, 2006″

Ticker Component Name Shares

(AKS) AK Steel Holding Corp. ” 176,054,206 ”

(ATI) Allegheny Technologies Inc. ” 161,006,988 ”

(CAS) A.M. Castle & Co. ” 26,503,386 ”

(CGA) Corus Group PLC ” 797,929,419 ”

(CHAP) Chaparral Steel Co. ” 74,220,357 ”

(CLF) Cleveland-Cliffs Inc. ” 67,012,665 ”

(CMC) Commercial Metals Co. ” 193,332,833 ”

(CRS) Carpenter Technology Corp. ” 40,811,599 ”

(FSTR) L.B. Foster Co. ” 16,795,555 ”

(GGB) Gerdau S.A. ” 690,673,048 ”

(GNA) Gerdau AmeriSteel Corp. ” 488,139,610 ”

(IPS) IPSCO Inc. ” 75,477,624 ”

(LSS) Lone Star Technologies Inc. ” 49,212,576 ”

(MSB) Mesabi Trust ” 20,986,446 ”

(MT) Mittal Steel Co. N.V. ” 580,505,687 ”

(MTL) Mechel AOA ” 221,952,459 ”

(MTLM) Metal Management Inc. ” 43,028,612 ”

(NSS) NS Group Inc. ” 36,217,615 ”

(NUE) NuCor Corp. ” 258,252,205 ”

(NX) Quanex Corp. ” 59,128,351 ”

(OS) Oregon Steel Mills Inc. ” 57,282,440 ”

(PKX) POSCO ” 264,141,742 ”

(RIO) Companhia Vale do Rio Doce ” 1,905,989,847 ”

(ROCK) Gibraltar Industries Inc. ” 47,643,391 ”

(RS) Reliance Steel & Aluminum Co. ” 120,668,864 ”

(RTP) Rio Tinto PLC ” 213,201,208 ”

(RYI) Ryerson Inc. ” 42,017,680 ”

(SCHN) Schnitzer Steel Industries Inc. ” 49,162,989 ”

(SID) Companhia Siderurgica Nacional ” 416,449,219 ”

(SIM) Grupo Simec S.A. de C.V. ” 224,588,561 ”

(STLD) Steel Dynamics Inc. ” 80,868,198 ”

(STTX) Steel Technologies Inc. ” 20,871,276 ”

(TKR) Timken Co. ” 150,337,812 ”

(TX) TERNIUM S.A. ” 320,673,531 ”

(USAP) Universal Stainless & Alloy Products Inc. ” 10,298,075 ”

(WOR) Worthington Industries Inc. ” 141,868,054 ”

(WPSC) Wheeling-Pittsburgh Corp. ” 23,529,773 ”

(X) United States Steel Corp. ” 199,724,908 ”

(ZEUS) Olympic Steel Inc. ” 16,680,385 “

I see the Steel ETF as a potential building block for an infrastructure sub-portfolio. Thus far, I have focused on closed end funds from Macquarie (MIC, MFD, MGU, etc.) all traded on the NYSE. Stock selection makes sense here as well with positions such as CEMEX (CX) and Caterpillar (CAT). It’s amazing how this commodity plays into so many other asset classes. Another case aside from infrastructure would be alternative energy. I’ve heard from wind farm developers that one of their biggest costs is the price of steel. Another correlation play tying the commodity complex with alternative energy.

If you’re looking for the link that leads you to the above data, here it is.

Some further interesting notes about the composition of the two underlying indices from AMEX. This is from an October 3rd press release from AMEX found on PRNewsire:

The Amex Steel Index is a modified market capitalization-weighted index comprised of publicly traded companies involved primarily in the production of steel products or mining and processing of iron ore. The Amex Environmental Services Index is a modified equal-dollar-weighted index comprised of publicly traded companies that are engaged primarily in consumer waste disposal, removal and storage of industrial by-products and the management of associated resources.

If you read closely you’ll see that the Steel Index is market cap weighted. The Environmental Services index is equal dollar weighted. I would very much be interested to hear what Rob Arnott would have to say about this. He’s the first person I heard discussing the benefits of non-market cap weighted exposure with first the concept of equal weighting and then the concept of fundamental indexation.

From the same press release, the next paragraph states:

The Amex Steel Index includes common stocks or American Depositary Receipts (ADRs) of selected companies with market capitalizations greater than $100 million that have an average daily volume of at least $1 million over the past three months. The Amex Environmental Services Index includes common stocks or ADRs of selected companies with market capitalizations greater than $100 million, three-month trading price greater than $3.00, and three-month daily average traded value greater than $1 million.

It’s fairly clear that there are not a lot of steel companies that can be put into the Amex Steel Index. However, the environmental services is certainly an area for decent long term growth. I would expect to see hundreds if not thousands of potential stocks that could be in this index now and in the not too distant future. Keeping a $3.00 minimum average price makes sense if not simply to keep the cost of running this ETF reasonable.

I love these new ETFs breaking into new asset classes. Keep ‘em coming.

Back on June 12th I discussed PowerShares WilderHill Clean Energy ETF (PBW), and how it behaved relative to traditional energy exposures like iShares Goldman Sachs Natural Resource ETF (IGE), iShares S&P Global Energy Sector ETF (IXC), iShares Dow Jones US Energy Sector ETF (IYE), Vanguard Consumer Staples ETF (VDC) and Energy Select Sector SPDR ETF (XLE). I tried to make a case for buying PBW. The drop since then has proven me wrong, but I still think it’s an important holding, and my clients have held it throughout the year (we haven’t touched it), as it’s only about 3-5% of the total portfolio depending on the client.Well, it hit a low of around 16.50 on August 14th. It popped up about 10.5% thereafter, but had a 4% drop yesterday. This thing’s volatile.

As discussed on June 12th, what interests me about PBW is its correlation to the traditional energy ETFs. Take a look at this chart below comparing PBW and XLE over the past 12 months. I use XLE, but any of the other energy ETFs mentioned above could be used as well, since they are very similar in nature and performance. I care more about the trend when looking at these charts for this particular bit of analysis.

Note the relatively strong correlation prior to June 2006. The key difference prior to June 2006 was PBW’s stronger climb relative to XLE during the first half of 2006.

Again from my earlier piece, it’s important to note how important IT is in terms of PBW’s sector allocations. With a 30% IT weighting, it’s fairly significant. Energy has less than a 3% weighting in PBW. So why does PBW not have a chart more similar to the Nasdaq than to XLE?

There are some months with great similarity (November and December 2005), and they generally both decline, as did most markets this summer. But you don’t have the same strong similarity like you have between PBW and XLE prior to June 2006.

Although too simplistic in its discounting of underlying fundamentals for the component positions, PBW seems to be a vehicle traded as an energy proxy. The important question now is: What’s going on post June ‘06 that has lead to what seems like an “out of sync” relationship between PBW and XLE? Is it simply that traditional energy rose in July and August due to the war in Israel/Lebanon? That’s fairly obvious. But clearly we see a divergence after the first week of June 2006. This is the same chart as the first but only showing the past six months:

By eyeballing the lines closely, you see that the general weekly trends remain intact between the two ETFs in July and August. The only difference is the strong drive up by XLE in the latter half of June due to geopolitical concerns in the Middle East. But otherwise, we still see the same week-to-week trend matching.

PBW still seems to be an energy play, but acts as a more volatile proxy to oil producers. Sometimes we invest to diversify, sometimes it’s for the story, whether it’s macroeconomic or otherwise. PBW can be considered a “high volatility” energy play. I think similarly of Canada and emerging markets. Buying iShares MSCI Emerging Markets Index ETF (EEM) for a Canadian investor provides no diversification, but is more like having a levered position.

iShares MSCI Emerging Markets Indx ETF (EEM) vs. iShares MSCI Canada Index ETF (EWC) 2-yr Daily Chart

Lastly, I compare PBW and oil itself over the past three months, which is the period I initially commented as one of divergence. It seems more clear here:

Now for the first time we see true divergence, and very little week-to-week trend-matching. My feeling is that this is not the moment many have been waiting for. That is, the moment where alternative energy and traditional energy completely de-couple as oil drops down to $30 or less and the massive acceptance of alternative energy pushes something like PBW up astronomically. New oil find in the Gulf of not, I still think we’re many years away from that “paradigm shift.” But I still hold 3-5% in PowerShares WilderHill Clean Energy ETF (PBW) because it behaves like traditional energy, and you just never know. A 9/11 type plan except aimed at several mideast refineries could do it. I think the limited resources of what’s left of El-Qaeda would likely aim for a western target, perhaps American energy infrastructure.

Moving from speculation back to investing and focusing again on diversification (especially for Canadian investors with heavy energy exposure), I’m still waiting to find out more on the new PowerShares ETFs, specifically the PowerShares Cleantech Portfolio and the PowerShares WilderHill Progressive Energy Portfolio. I wonder how they will behave compared to PBW and other energy ETFs.

There are alot of energy based ETFs out there to select from, many of them covered well on Seeking Alpha’s ETF site. We have been holding all our energy related positions despite them being down roughly 12% from their peak in early May. Relatively high cash balances and some broad market put options have helped ease the pain. We still feel strongly about our long-term view on the commodity complex, especially energy, as well as certain other areas like emerging markets.For those that have built some cash, this is a follow up to my previous “shopping list” discussion but with a greater focus on energy. Now that we’re well into June, there will certainly be increasing talk of upcoming tropical storms and speculation of their potential growth to hurricane status. With ongoing events in Iraq and Iran, volatility in this area will certainly remain high which should be good for the numerous energy related funds I see popping up.

Below is a 1-year chart for five fairly broad energy related funds, although IGE tracks a broader natural resources index. I include it because according to the iShares website, it has a roughly 78% weight in oil/oil services plus 4% in gas. Not an insignificant divergence among these energy ETF choices, especially during the volatile period of the past three months.

Energy ETF 1-yr chart:

What interests me and what has been a great performer in our portfolios has been alternative energy, specifically the PowerShares WilderHill Clean Energy ETF (PBW). Taking the two “middle of the group” performers from the above chart and including PBW, we have the following 1-year chart:

PBW 1-yr chart:

I note two things from this second chart:

1. There is a fairly high correlation between all the funds which is of little surprise.

2. PBW’s relative outperformance of other broad energy ETFs.

With regard to the correlation, we can see from this chart that from early June 2005 to early January 2006, the lines overlap fairly well. The only sizeable divergence was during late August/early September (prime hurricane season).

But what about the sizeable divergence for most of 2006? The stocks shown above have similar up and down blips, but PBW seems to have become a “high beta” version of the energy plays. Proof is in the recent declines. PBW is down nearly 18% since its peak on May 9th. VDE and XLE’s declines are 13% and 12% respectively.

This really isn’t that surprising if you go to the PowerShares website and look at the holdings of PBW. The roughly 40 positions are certainly not all big names. Big sector weights in info tech (30%) and industrials (35%). Energy is shown as having only a 2.4% weighting. Average market cap of PBW is somewhere between that of PowerShares’ small and mid-cap ETFs. So the volatility is not that surprising.

Analysis of the 4 largest holdings (IMCO, QTWW, MGPI, ZOLT) as well as the largest positions thereafter show a general common uptrend from the beginning of the year. All of these positions have a story that is quite separate from the broad energy story. Thus, it might seem that during times of higher energy focus in the financial markets (like hurricane season), PBW behaves more like an energy fund as investors play the alternative angle. At other times, the fundamentals of its underlying holdings play a more distinctive and significant role.

If this hurricane season is anything even close to last year, you really have to wonder if alternative energy will be perceived as a place for significant asset allocation. I’m still not sold on alternative energy’s potential to replace traditional energy to keep the manufacturing process moving. I just can’t imagine how alternative energy could even come close to addressing global energy needs all if oil, coal and nuclear were suddenly wiped off the planet today. We’ve got a long way to go which is all the more reason to see the potential upside on something like PBW.

Finally, I was recently at an environmental finance conference sponsored by the University of Toronto. The main subject of the conference was actually “cleantech.” Interesting that there was a big absence of investors (institutional or retail) at the event. Through a contact from the event, I learned of a potential cleantech ETF. This was confirmed Wednesday of last week with the new of PowerShares’ SEC filing of 31 (wow!) new ETFs including the PowerShares Cleantech Portfolio ETF. Something to watch for.

Again, what we’re looking for here is something that can behave like an energy play during energy sensitive periods (with price action on the upside) and with potential greater upside during times of less dramatic energy sensitivity in the markets and general public persona.

Just remember that PBW is volatile. The current 18% drop is not the first time this has happened in PBW’s short 15 and a half month life. It had about the exact same percentage drop in its first two months (March/April 2005) and again in the fall of 2005 (basically after Katrina). Strong stomach required.

PBW 1-yr chart: