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How to Profit from the Energy Efficiency Boom

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"Companies in this segment could be key components in a time of high energy prices, helping to stretch supplies in all forms of energy."

With a modestly improving economic environment, it appears as though businesses are slowly starting to hire while consumers are once again opening up their pocketbooks. While this trend has led to some optimism across the economy, one downside to this increased demand from a variety of sectors looks to be in the commodity world.

A number of products have seen rising prices so far this year with some of the biggest gains coming in the energy world. Oil prices are now firmly above $100/bbl. while coal, heating oil, and RBOB have all seen price increases in the first part of the year as well.

If these positive economic trends continue, high prices in this segment could be in the beginning of a bull market, if not at the very least poised to stay at elevated levels for the time being.

This development could boost demand for those engaged in the exploration and production of new fossil fuel areas as higher prices make fields that were once off limits profitable again. Another end result of this trend could be renewed interest in alternative fuels such as wind and solar power.

These energy forms tend to be much more competitive with their ‘traditional’ cousins when prices are high in the hydrocarbon world, spurring some to make the switch to clean energy. Yet, while exploration for new deposits and the broad clean energy sector look to be winners, investors could also see huge gains in stocks that promote energy efficiency as well.

Companies in this segment could be key components in a time of high energy prices, helping to stretch supplies in all forms of energy. By utilizing these techniques offered by some firms in this corner of the market, companies can cut down on costs and possibly become more profitable in the process. Seemingly, a commitment to energy efficiency by power intensive businesses could be a competitive advantage in times of high prices.

As a result, it could be ideal for some investors to consider making a play on this space for investment. While it is true that a move into broad clean energy or oil firms could be another way to play high prices, both of these sectors look to be among the first places that investors target with their capital in times of rising energy prices, suggesting that energy efficiency firms may be overlooked in comparison.

Thanks to this, valuations in this corner of the market may be more tolerable at this time than most other plays on the growing trend. Furthermore, the sector looks to be less volatile, and more profitable, than many in the alternative energy space while also offering more growth than many oil firms, implying that it could be the best of both worlds if energy prices remain elevated.

For investors intrigued by these trends, any of the following three ETFs could make for intriguing selections that could possibly benefit from a boom in demand for energy efficient technologies and processes:

PowerShares Cleantech ETF (PZD)

For investors who are unsure of which segment of the sector is going to perform the best, an ETF targeting the entire space could be the best bet. In order to do this and make a play on emerging technologies that could be useful to those looking to increase energy efficiency, PZD is hard to beat.

The product tracks the Cleantech index which focuses in on firms that primarily engaged and involved in electric grid, electric meters and devices, networks, energy storage and management, and enabling software used by the smart grid infrastructure sector. With this focus, the fund should be a solid barometer for the health of the industry at large.

PZD holds just under 70 securities in total, putting a heavy weight in industrials (54%) and technology (30%) companies. From a market cap perspective, the product is pretty well spread out, allocating about 38% to small and micro cap securities, 37% to mid caps, and the rest in large-cap stocks.

Top individual securities include European firm Schneider Electric, Autodesk (ADSK), and Borg Warner (BWA), all of which make up around 3.1% of the total holdings profile. This fund was down significantly in 2011, but as the economy has rebounded and energy efficiency has come into focus, the product has produced strong gains, adding nearly 12% so far in 2012.

First Trust NASDAQ Clean Edge Smart Grid Infrastructure Fund (GRID)

According to recent research, more than half of all energy produced in the U.S. is wasted thanks to inefficiency in the power system. Given that the U.S. produces over 4,300 TWh of power per year, this is clearly a huge area of improvement for those seeking to increase the use of energy efficient technologies.

For investors seeking to hone in on this potentially high growth segment the aptly named fund GRID could be an intriguing choice.

The product tracks stocks that are in the grid and electric energy infrastructure sectors, holding 36 securities in total. GRID focuses in on companies primarily engaged and involved in electric grid, electric meters and devices, networks, energy storage and management, and enabling software used by the smart grid infrastructure sector.

The ETF also tilts holdings, 80/20, towards pure play companies, ensuring that more diversified companies are represented but do not dominate the index. Top individual holdings include NGK Insulators, ABB Ltd. (ABB) and Schneider Electric, each of which make up about 8% of the total. Much like the other ETFs on this list, the fund had a rough 2011 but has seen a rebound in 2012 gaining close to 14.8% since the start of the year.

Global X Lithium ETF (LIT)

Some investors may be scratching their heads wondering what a basic materials play like LIT is doing in an article about energy efficiency, but lithium is an increasingly important story in the space as well. That is because lithium is a key component in many electric batteries which are vital to electric cars, consumer electronics, and industrial applications. As alternative energy takes off, efficient and clean ways to store this power will be needed, and lithium looks to easily take over this role.

In terms of holdings, LIT has 22 securities in total, giving heavy weights to Chilean firm Sociedad Quimica y Minera de Chile (SQM) and FMC Corp (FMC). For sectors, metal and mining takes up about 26% while agricultural chemical firms 19% and electrical equipment 19% companies round out the top three sectors.

Investors should also note that the fund has a focus on mid cap securities, which is unlike many basic materials focused funds which seem to have a definite large-cap tilt. In part thanks to this, the fund has had a weak 2011 but it has roared higher in 2012, gaining about 16.6% so far this year.

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Author is long LIT.

Eric Dutram, Zacks Investment Research

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