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Despite the ethanol IPOs, there's still no alternative in energy funds

Market has a taste for ethanol, but energy fund managers aren't buying -- yet.

Imagine this: The year is 2021. A new popular form of individual transportation known as hovercars get 500 kilometres a litre (horizontally and vertically) thanks to a new fuel discovered back in 2008 when crude oil hit $100 (U.S.) a barrel.

A small company developed and marketed the fuel when motorists finally had enough of high gasoline prices. Soon competitors found cheaper and cheaper ways to produce more and more fuel, and the hovercar sector flourished.

Problem is, you can't afford a hovercar because the energy fund you invested in was chained to the oil and gas sector.

That's the kind of future alternative energy boosters dream about. For ethanol producer VeraSun Energy Corp. it came a tiny step closer to reality yesterday when its stock jumped as high as 34 per cent in its market debut.

Other ethanol-related initial public offerings set to come to the market include Hawkeye Holdings Inc. and Aventine Renewable Energy Holdings Inc.

Ethanol is mostly derived from corn or sugar cane and mixed with gasoline to produce a slower, cleaner-burning fuel. Its merit as a cheaper and more efficient substitute for gasoline is hotly debated. Ethanol proponents say a great deal of research and development is still needed to make it commercially viable but a day will come when traditional gasoline will be an additive, and not the other way around.

Canadian energy fund managers who have been watching oil and gas stocks plunge from record highs over the past week aren't buying it just yet -- literally. "It's an expensive alternative, subsidized by taxes in the United States," says Glenn MacNeill, vice-president of investments with Sentry Select Capital Corp.

Mr. MacNeill manages the Sentry Canadian Energy Growth Fund -- packed full of Canadian oil patch stalwarts like Talisman Energy Inc., Shell Canada Ltd. and Penn West Energy Trust. Up to June 1, the fund's value increased nearly 40 per cent over a one-year period.

But since June 1 the fund has dropped more than 11 per cent following a decline in crude oil prices from a high of $74.61 (U.S.) a barrel to $69.14 yesterday. Mr. MacNeill is keeping the faith, saying oil will hit a floor of $50 before heading back up to "who knows."

That's not to say Sentry Select sees no future for alternative energy. The fund has small positions in companies that dabble in wind power and hybrid electric vehicle systems.

Mr. MacNeill also holds a large position in Suncor Energy Inc., which in addition to being a major oil sands player has a division devoted entirely to wind power.

As far as ethanol goes he says Archer-Daniels-Midland Co., the largest producer in the United States, is on his radar screen but is too expensive right now. "Clearly there's a point in time when ethanol becomes more viable. . . . At some time in the future it might make sense," he says.

You can't blame Mr. MacNeill if the subject of alternative energy hits a raw nerve.

Sentry launched an alternative energy fund a few years ago and it attracted so little investor attention it had to be rolled into another fund.

There are 10 mutual fund companies with open-ended energy funds that invest directly in energy stocks. Oil and gas stocks dominate in every case with little more alternative energy than a mention in the prospectus. Four have Suncor Energy as a top holding but mostly for its operations in the oil sands.

In addition to oil and gas stocks, the Sprott Energy Fund has Arch Coal Inc. as a top holding and mentions uranium under the fund's objectives. The TD Energy Fund mentions coal and nuclear energy in its investment objectives, and CI Global Energy Corporate Class mentions coal, hydroelectricity, geothermal, solar and wind.

The only energy fund to mention alternative energy specifically is the Front Street Energy GW Fund. It's a government-subsidized, labour-sponsored fund that invests in venture startups.

A statement for the fund's objectives includes industries involved in fuel cell, power generation and wind power projects, but oil and gas companies dominate. "Wind and solar power are making their way but the economics aren't all that appealing yet," says Front Street managing director Norman Lamarche.

A booming oil and gas sector has managed to bring the Front Street Energy GW Fund an average annual return of 19.5 per cent over the past three years while the average labour-sponsored fund has lost money. Roughly 25 per cent of the fund's $90-million assets are cash, which puts Mr. Lamarche in the position to capitalize on any non-oil and gas-related opportunities. However, he says traditional energy sources like oil, natural gas and coal are still catching his eye. "We need to be looking closer at what we have already," he says.

Oddly enough, energy funds are the best place for mutual fund investors to be for a possible alternative energy boom.

The fact that energy funds are lumped in with natural resource funds as an asset class is testimony to our reliance on fossil fuels. On the other hand, it's no coincidence that fund companies like Sentry Select Capital Corp., Altamira Investment Services Inc., CI Investments Inc., CIBC Securities Inc., RBC Asset Management Inc. and TD Asset Management Inc. have separate energy and natural resources funds in that same asset class.

Energy funds may not hold very many alternative energy stocks now, but at least they're in a position to make a change if managers feel they can produce returns.

Dale Jackson is a producer at Report on Business Television.

© 2007 The Globe and Mail. All rights reserved.

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