Energy and Utility funds show spark

High energy prices and major changes in the utility industry made those sectors shining lights in a very tough quarter.

The top-performing fund – Galaxy II Utility Index Fund in Boston – was up 32.7 percent for the quarter and 45.4 percent for the year.

The fund seeks to match the performance of the Standard & Poor's utility index by investing most of its money in the stocks of companies included in the S&P utilities index.

Utility stocks have benefited from several factors, said G. Jay Evans, Galaxy II fund manager, including:

•Lower interest rates

Lower rates make utility stocks more attractive because of their high yields, he said.

"These companies tend to have yields that may be twice the market yield," Mr. Evans said.

Lower rates also save utilities money in interest on the loans they take out to build power plants, he said.

"They represent enormous capital investments in construction of power plants or massive investments in pipelines themselves," Mr. Evans said.

"They're financed, so their exposure to interest rates is enormous."

•Deregulation

"Power generation is being deregulated," he said. "Several larger companies will now sell electric power, while others narrow their focus to regulated transmission and distribution.

"Change is also under way in telecommunications, as it moves toward deregulation and into new areas, such as data transmission, cellular and the Internet."

•Strong demand for electricity

Demand for power has been outstripping supply in several areas, he said.

"You have this economy that just can't use enough energy," Mr. Evans said. "All of the computers that are serving the Internet are gobbling up power."

At the same time, the sources of that power aren't being replenished.

"We haven't been building power plants, so that increases margins of the power companies," Mr. Evans said.

"Power deregulation will eventually come to the rescue with new construction, but until that occurs, generation margins will expand."

•Industry mergers

"Utility stocks have also benefited from the excitement of several mergers," he said.

"They remain sensitive to interest rates and over the next 12 months may continue to perform well as the economy slows."

Alternative energy

The high price of power also lit the way for investors who took a different path to invest in energy.

The second best-performing fund in the quarter was the New Alternatives Fund in Melville, N.Y., a socially responsible fund that puts its money in alternative energy sources, such as hydroelectric power, solar cells, wind energy and fuel cells.The fund, which has about $60 million in assets under management, soared 32.04 percent in the quarter and 75.2 percent for the year.

It was the price of oil that was mostly responsible for its performance.

"Where it's invested happens to be in favor right now," said Michael Gaul, natural resources fund analyst at Morningstar in Chicago, a fund research firm.

"With the price of oil being up, some of these companies are going through the roof."

Oil prices have tripled in the last 21 months to more than $30 a barrel. Natural gas prices have more than doubled this year.

New Alternatives' top holding is FuelCell Energy Inc. in Danbury, Conn., which develops and commercializes fuel cell power plants for electric power generation.

The stock of FuelCell has soared more than 600 percent for the year through last Friday.

"A lot of that is the oil scare," Mr. Gaul said. "Investors were looking at ways to play that area."

New techniques

New Alternatives' strong performance isn't so much due to rising energy prices as it is to the emerging importance of finding other ways to obtain energy, said Maurice Schoenwald, the fund's chairman.

"Alternative energy is becoming more cost efficient, and instead of depending on government subsidies and the support of environmentalists, it is now less dependent or possibly not dependent at all on those former sources of its growth," he said.

"Some of these techniques are equal to or surpass the cost efficiency of conventional electric utilities."

Investors are realizing that the United States must find other ways to feed its energy needs if it's to wean itself from dependence on foreign oil, Mr. Schoenwald said.

"People like me believe there's a limited amount of oil in the world and it would be very nice if we could use hydrocarbons and we wouldn't be dependent on OPEC for the life of our country," he said.

"Oil prices will continue to rise because it will become scarcer and scarcer."

On the other hand, the price of alternative energy sources will fall "because price goes down as production becomes more efficient, and the technology has gotten better at securing that form of energy," Mr. Schoenwald said.

Screening process

The fund screens out companies using animal testing for cosmetic purposes; tobacco, alcohol and major weapons manufacturers, companies that practice discrimination against "any group and companies that engage in unfair treatment of labor."

"Alternative energy, as we use the term, excludes atomic energy and petroleum," the fund said on an information sheet printed on recycled paper.

"We find atomic energy to be unsafe and expensive. Petroleum in its present form is not clean and makes us dependent upon foreign resources and politics."

Also excluded are investments in coal resources.

"There may be future technologies for the transformation of coal to a clean source of energy," the fund said.

Mr. Schoenwald is somewhat uneasy about his fund's muscular performance.

But he's pleased with the results.

"I dislike the suddenness of our growth in late 1999," he said.

"Our average performance has been 11, 12 percent a year. Now we're flying."

The fund was up 31.8 percent in the first half of the year, compared with 3.65 percent for the average mutual fund, officials said.

"We do not think that our fund can continue to proceed upward at this rate," they told shareholders in the second-quarter report. "We would prefer a less volatile market."

"You lose credibility with shocking jumps like this, but this is the way it is," Mr. Schoenwald said.

"It should grow naturally, but it doesn't."