Strategies for Investing In CleanTech Companies

Presentation to the Minneapolis CFA Society

March 15th, 2012

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The Typical Clean-Energy Analyst’s Day…

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Agenda

• About The Leuthold Group • Overview of the Clean Technology sector• Skeptical Approach to CleanTech Investing

– Oil Correlation Study– It’s Not Easy Being Clean– Understand What People Are Selling

• Understanding Wall Street’s Motivations• Thinking Skeptically

– Renewables, Biofuels

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About The Leuthold Group• Research Group

– Leuthold Weeden Institutional Research

– Founded in 1981— Institutional investment research firm started by Steve Leuthold; conducted by a staff of 9 analysts

– Proprietary research includes:

• Technical & quantitative analysis

• Broad sector and industry group analysis

• Earnings momentum

• Supply/demand dynamics

• Valuation studies

• Capital Management– Leuthold Weeden Capital

Management (LWCM), based in Minneapolis, MN, has managed assets since 1987.

– AUM of $3.2B across 8 mutual funds & hundreds of separate accounts

– Strategies include:

• Tactical Asset Allocation (“TAA”)

• Long-only, short-only, and long-short funds & accounts

• Clean Technologies

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About The Leuthold Group (cont.)• Research Group • Capital Management

All performance presented reflects past performance. Past performance is no guarantee of future results. Investment returns and principal will fluctuate so that investor's shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than performance quoted. For performance data current to the most recent month end, call Leuthold Shareholders Services, toll-free, 1-800-273-6886.

Investors should consider the investment objectives, risks, charges and expenses of the investment company carefully before investing. The Prospectus contains this and other information about the Funds. For current Prospectus, call toll-free, 1-800-273-6886, or download from our web site: www.LeutholdFunds.com. Please read the Prospectus carefully before you invest

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Defining Clean Technology (“CleanTech”)• Any technology or service that reduces

humans’ impact on the environment

• Most people think of Alternative Energy, but…– CleanTech is very diverse– Encompasses part of many existing industrial

sectors, including transportation, energy transmission & storage, water treatment, pollution control, advanced materials, recycling, and many others

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It’s tough to make money in CleanTech…

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About The Leuthold Group (cont.)Why Develop A Long/Short Strategy? Because there will be winners and losers

• Motivations to take CleanTech companies public aren’t always based upon wise business decisions– CleanTech companies have significant capital

requirements• Public venture capital • V.C. exit mechanism• Bankers seeking underwriting fees

• Investors get emotional when considering CleanTech– Excellent source of euphoria & despair; volatility of

CleanTech stocks = Opportunities– Potential entry / exit points for patient investors

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About The Leuthold Group (cont.)Why Develop A Long/Short Strategy?

Opportunity to generate uncorrelated returns and alpha with a low standard deviation

PERFORMANCE RESULTS, GROSS Return Since CorrellationInception to CT Oppt. Standard

(as of Feb. 29, 2012) (Oct. 17, 2011) Portfolio Deviation Alpha BetaCleanTech Opportunity Port. 8.08% 1.00 1.78% 0.08% (0.05) Ardour Composite Index 0.00% (0.16) 5.92% NMF 1.00 S&P 500 Index 13.73% (0.04) 4.18% NMF 0.56

Data Points 93Risk-Free Rate (10-yr Bond) 2.0%

"Gross" performance results reflect the deduction of all transaction costs, but do not include custodial, investment advisory fees or other expenses. "Net" performance results reflect the deduction of all fees and expenses, including investment management fees paid by any account employing the Clean Tech Opportunity strategy.Performance quoted represents past performance.  Past performance should not be considered predictive of future performance. As with any investment, there can be no assurance that LWCM’s investment objective will be achieved or that an investor will not lose a portion or all of its investment. 

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About The Leuthold Group (cont.)Why Develop A Long/Short Strategy? CleanTech shares some of the same risks as other

technology sectors

• A long-only strategy misses half the investment opportunities– Technology companies are exposed to high risk of

obsolescence– Benefit from impatient capital seeking quick returns

• Some CleanTech strategies represent solutions looking for a problem– Investors often view Clean Technologies in a vacuum– Incumbent technologies often can be “cleaner” for less money

and faster rates of adoption

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Guilt is not the only market driver at play…

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There Are Numerous Market Drivers• The basic laws of economics (drive for productivity & efficiency)• Political motivation (multi-governmental; Obama)• Consumer demand (is green the new “luxury” for the developed

world?)• Corporate agendas (green-colored glasses & “green washing”)• Technological advancement (demand for energy; cost reductions)• Social stimuli (rising living standards)• Global climate change (socio-political consciousness; self-

preservation)– Water shortages– Population growth– Higher fossil fuel prices

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Strategies For CleanTech Investing

Be Skeptical• Don’t be in it to be green, be in it to make green

• Invest in common stocks, but watch the private companies

• Use sector & asset allocation strategies– There may be a component of sub-sector rotation

• Be open to shorting stocks (humility pays dividends…)– Most CleanTech companies will fail– Public venture capital

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We are “CleanTech Skeptics”• Technologies that are dependent upon incentives

– Some technologies are, but it’s more complicated than that– Most industries are dependent upon some form of government assistance, tax incentives,

regulatory support, etc.

• Perpetually 5 to 10 years from commercialization– Don’t focus on “solutions looking for a problem”

• Money-losing technologies– Don’t invest in money-losing technologies

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Correlation to Oil Prices? We’re Skeptical…• The overall correlation between oil prices & CleanTech

stocks is weak

• But we found something interesting…

Correlation R-SquaredPrice of Oil vs. CleanTech Universe1 0.388 0.150 Price of Oil vs. Alt. Energy Stocks2 0.091 0.008

© 2011 Leuthold Group Footnotes1 In 2000, there were ~280 publicly traded CleanTech stocks in our universe; in 2010, there were between 470 and 510 stocks (excludes "diversified" CleanTech stocks).

2 Includes just the alternative energy segment of CleanTech; in 2000, there were ~135 publicly traded CleanTech stocks in our universe; by 2010, there were over 270 stocks.

Oil's Relationship to Clean Technology Stocks: 2000-2010

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Correlation to Oil Prices? (cont.)

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WTI Petroleum, Price per Barrel (Right-Hand Scale)

Correlation of Oil to Alternative Energy (Left-Hand Scale)

A steady climb in oil prices, followed by a rapid increase

Little-to-no correlation to oil prices…and then BOOM!

© 2011 Leuthold Group

Correlation steadily increased from 2007 to mid-2008, peaking as the price of oil peaked, as a barrel of oil rose by 130%, from $61 to $140.

Conclusions: 1) Investor psychology (“sentiment”) is at work, not economics;

2) The mere belief of a relationship can have a powerful (albeit limited) role in determining the correlation between these investments.

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What are Wall Street’s motivations?

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Understanding Wall Street’s MotivationsTesla, the electric car company, makes a very nice car…

Source; Tesla Motors

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Understanding…Motivations (cont.)In fact, last year Morgan Stanley called Tesla “America’s

Fourth Automaker” and gave the stock a $70 target price

Source; Morgan Stanley reports

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Understanding…Motivations (cont.)To generate a $70 valuation required some fancy financial

modeling…and a lot of disclaimers!

Source; Morgan Stanley reports

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Understanding…Motivations (cont.)What could be the motivation for a huge target price based

upon such far-reaching projections???

Using the 6% rule of thumb, this could be worth up to $9 million in underwriting fees for the banks involved

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How To Be A Skeptic (“Contrarian”)Don’t believe everything you read…particularly if it comes

from investment bankers…

Source: http://www.zimbio.com/member/malikharis/articles/734928/Funny+UK+Signboard

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Thinking Skeptically: Renewables

• Renewables will continue to have a tough time– Pricing is going against them, margins are coming

down– Incentives are on the cutting block:

• Conservatives are questioning the integrity of incentives and loan guarantees (think: Solyndra)

– “Austerity” & “Deficit Reduction” are the new catchphrases

– Single-digit multiples are likely to become the norm (except during periods of euphoria)

• How much would you pay for a 10-20% revenue grower with flat or falling earnings?

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Thinking Skeptically: Biofuels

• Risks facing biofuel investors: “Non-correlation” Risk– Ethanol producers understand this very well– Particularly prevalent when the input, such as corn, has other

uses and/or is subject to supply constraints that have little or nothing in common with the demand for the output, such as fuel ethanol

• ~39% of corn will be converted into fuel ethanol or exported to other nations (largely Brazil)– Our single largest use of corn– Animal feed/residual uses: ~37% – The rest is consumed, planted in future years or exported

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Thinking Skeptically: Biofuels (cont.)

• The ethanol producers’ quandary– Corn represents 75% to 85% of the cost of ethanol– Corn price is subject supply, which is subject to numerous

market dynamics that have nothing to do with the price of ethanol

• Adverse weather patterns (heat waves, hurricanes, tornadoes, etc.)

• Export demand

• Availability and cost of fertilizers

• Economic cycle

• The difference between razor-thin margins or losing money

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Thinking Skeptically: Biofuels (cont.)

• Risks facing biofuel investors: “Radius” Risk– Biomass lacks density, so supply usually must be secured within

a 40- or 50-mile radius• Sourcing biomass a very local, highly logistical effort, one that can

lead to increasingly intense competition and rising feedstock prices

– Advanced biofuel producers generally argue that their feedstock protects their business models from “Radius” risk

• Suggest that biomass feedstock prices are stable and characterized by long-term availability

• We’re skeptical: demand for industrial quantities of feedstock can dominate a local market

• Biodiesel: razor-thin margins, government incentives might expire = biodiesel is quite a gamble

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Thinking Skeptically: Biofuels (cont.)

• Risks facing biofuel investors: “Technology” Risk– Pre-commercial technologies

• Not aware of a cellulosic, biomass, or algae technology that is cost effective without government subsidies, incentives, or mandates

• Not aware of an operating and profitable industrial-scale facility in the western world

– So why where there some many biofuel IPOs recently?• Timing was right for venture capitalists to seek their initial exits

• Their good timing isn’t necessarily our good timing

• VC’s interests are not aligned with that of the public company investor

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Thinking Skeptically: Biofuels (cont.)

• Risks facing biofuel investors: “Technology” Risk (cont.)– Most will require substantial additional capital, probably dilutive

equity – Many of the technologies have only been operated at “pilot-

scale” facilities • It’s a science fair project on steroids

– Substantial R&D still required to achieve cost-effective production….if they reach cost-effective production at all

• They probably wouldn’t even win the science fair contest

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Thanks.

Q&A (difficult questions please)

David Kurzman

dkurzman@lwcm.com

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DisclaimersInvesting in foreign securities presents risks that may be greater than

U.S. securities. These risks include, but are not limited to, currency rate fluctuations, regulatory differences, accounting standards, higher trading costs, and political risks.

Investors should consider the investment objectives, risks, charges and expenses of the investment company carefully before investing. The Prospectus contains this and other information about the Funds.

For current Prospectus, call toll-free 1-800-273-6886, or go to www.LeutholdFunds.com. Please read the Prospectus carefully before you invest.

Not FDIC Insured ~ No Bank Guarantee ~ May Lose ValueDistributor: Rafferty Capital Markets, LLC, Garden City, NY 11530