Funds: The two best ways to play clean energy

Alternative energy stocks were all the rage before the credit crunch. During 2006 and 2007, many companies saw their share prices double, or even triple. Prices crashed in 2008, as you might have expected. But even since the rally began last March clean-energy stocks have been notable for underperforming the broad energy indices.

What's the problem? The market for renewable energy is healthy enough. Global clean energy investment jumped by 25% this year and is set to rise again in 2011. Instead, the weak performance of the sector partly reflects unrealistic expectations built in during the boom times of 2006/2007. Another issue is that, while the 150% rebound in the oil price since early last year has boosted prospects for renewables, it is actually gas prices, which have risen by far less, that set electricity tariffs in the American market. As a result, renewable sources, such as wind, are still quite a bit more expensive by comparison.

But rapid technological development, combined with the bullish long-term prospects from emerging-market infrastructure spending, suggest the sector is a good theme for the long term. It's difficult to pick winners in such a relatively young industry, so the best bet is to use an exchange-traded fund (ETF) or investment trust to buy a wide range of companies.

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Three ETFs with London listings stand out. The iShares S&P Global Clean Energy ETF (LSE: INRG), the sector's largest fund, tracks an index of 30 firms, both energy producers and technology providers. The Powershares Global Clean Energy Fund (LSE: PSBW) tracks a more diversified index, Wilderhill New Energy, with 87 constituents. ETF Exchange's DaxGlobal Alternative Energy Fund (LSE: ALTE) tracks 15 firms specialising in natural gas, solar, wind, ethanol and geothermal energy. We'd favour INRG due to its size and lower dealing costs (in the form of the bid-to-offer spread).

But don't ignore alternatives to ETFs. The actively managed BlackRock New Energyinvestment trust (LSE: BRNE) is trading at a 14% discount to its underlying asset value. That gives you cheap access to the sector's stocks in exchange for a slightly higher annual fee than an ETF.

Paul Amery edits www.indexuniverse.eu .