The Price of Green

Specialized funds invest in alternative energy and avoid polluters. But a narrow scope can mean big risk.
By ANNA PRIOR
You have a hybrid automobile in your driveway, and you faithfully recycle. Is it time to go "green" with your money, too, by investing in eco-sensitive funds?
There are roughly three dozen dedicated green portfolios from which to choose, according to research firm Morningstar Inc. They include both mutual funds and exchange-traded funds. Most focus on companies involved in environment-related industries—such as alternative energy or water treatment and distribution—though a few take it a step further by including a broader mix of companies with low carbon footprints, regardless of the sector in which they operate. Beyond these dedicated green portfolios, there are funds that screen holdings for certain environmental factors as part of a broader commitment to socially responsible investing.
Some financial planners and green-investing professionals say the near future bodes well for companies involved in green industries because of what many see as an eco-friendly White House, economic-stimulus money earmarked for alternative-energy technology, and proposed legislation in Congress that seeks to cut greenhouse-gas emissions and establish standards for energy efficiency.
The "policy and regulatory environment is going to be a boon for green investing, as companies across industries scramble to realign their carbon intensity and how they perform energy-efficiency-wise," says Bennett Freeman, the senior vice president for sustainability research and policy at Calvert Asset Management Co., a longtime participant in socially responsible investing and the manager of the Calvert Global Alternative Energy fund.
But investors tempted by green investing need to choose funds carefully and understand that some of these sectors can be very volatile, as illustrated by the bankruptcy of multiple ethanol and biofuel producers, as well as struggles among small solar-power companies, amid a drop in oil prices over the past year. It is also important to recognize that buying into green businesses and shunning those that are harder on the Earth's resources won't benefit the environment directly.
The thought that "if you are buying stock [in] an oil company, you are somehow giving money to the oil company" is just not true, says Brian Pon, a financial planner with Financial Connections Group Inc. in the San Francisco Bay area. Whether you're investing in a traditional energy company or an alternative-energy player, you are typically buying shares from another investor and not pumping cash into the firm. Further, he says, "an individual doesn't really have the money to affect investment markets. You're buying a hundred shares when hundreds of thousands of shares trade daily."
Green investing has "a less direct impact" on the environment than personally polluting less and recycling, concurs Steve Schueth, president of First Affirmative Financial Network LLC, an independent investment adviser specializing in socially responsible investing. But it is a way for one's investments to reflect one's values, he says.
In many ways, green investing is a subset of socially responsible investing, where fund managers and other investors typically use a set of screens to weed out the stocks of companies that don't meet certain criteria, usually relating to environmental, social and corporate-governance issues.
A wide range of fund strategies fall under the green label, says Morningstar analyst Michael Herbst. The narrowest funds and ETFs are dedicated to specific sectors, such as solar power or water treatment. Others hold a mix of such stocks and "because they are a little more broadly diversified, their performance tends to be less volatile over time," he says. Less common are funds that consider green factors in their stock selection but also include a broad enough range of stocks to serve as a core holding in an investment portfolio. Most green mutual funds and ETFs are on the smaller side, with all but a few having less than $300 million in assets; a couple of the narrow sector ETFs are among the largest portfolios.
Green Sector Bets
Among the narrow and volatile green portfolios are two ETFs that focus on solar energy: Claymore/MAC Global Solar Energy Index and Market Vectors Solar Energy. They are both down 45% over the past 12 months, while the Standard & Poor's 500-stock index declined 6.9%.
"Any time you make a sector bet, you are making a very narrow bet that has lots of opportunities to go wildly wrong," says Milo Benningfield, founder of Benningfield Financial Advisors in San Francisco. Just make sure you are "comfortable with that and have the capacity to take on that risk."
A drop in the price of oil, which made alternative energy sources less viable economically and less attractive to investors, weighed heavily on the solar sector and other alternative-energy areas in the past year. But Claymore Securities Inc. President Christian Magoon says that if the U.S. passes legislation favorable to alternative energy, solar-energy stocks could get a big pop. "There's a lot of volatility in solar stocks," he says.
PowerShares WilderHill Clean Energy, a somewhat broader alternative-energy portfolio, has also taken investors for a bumpy ride. The ETF gives investors exposure to areas including ethanol, solar and wind power, and energy efficiency. Over the past year, the fund—one of the larger green portfolios, with a recent $783 million in assets—returned a negative 27%. Over the past three years, it has declined an average 13.5% a year, trailing the S&P 500 by more than eight percentage points.
One of the largest green portfolios, with a recent $1.4 billion in assets, is PowerShares Water Resources, up an average 0.14% a year over the past three years. This fund invests in companies that generally derive 50% or more of their revenue from water-related businesses, including water utilities, water-treatment companies and firms that are involved in the infrastructure and distribution of water.
A Broader Mix
The next group of green funds are those that branch into broader sectors of the economy but that Morningstar's Mr. Herbst says still aren't diversified enough to be attractive as core holdings.
New Alternatives, launched in 1982, has one of the longest track records among green funds. It invests in various areas of alternative energy, including wind, solar and hydropower, as well as in companies focused on energy efficiency and pollution reduction. Recently, two-thirds of its assets were in utilities and industrial-materials firms, according to Morningstar. Like a traditional socially responsible investment fund, New Alternatives steers clear of certain sectors, including nuclear power, coal and oil, and incorporates screens for other social issues.
Over the past decade, New Alternatives ranks in the top 15% of Morningstar's World Stock category, with an average annual return of 6.47%.
Winslow Green Growth and Winslow Green Solutions also fall into this broader group. These mutual funds focus on companies that provide solutions to environmental concerns and those that have environmentally sustainable operations. For example, both funds have holdings in Chipotle Mexican Grill Inc., a fast-food burrito chain. Chipotle has made an effort to be greener by using recycled materials and energy-efficient lighting in some of its restaurants, while also working to source food locally and use natural and organic ingredients, says fund co-manager Matthew Patsky. Both Winslow Green Growth and Winslow Green Solutions have outperformed the S&P 500 this year, with gains of 39% and 26%, respectively.
Pax World Global Green, meanwhile, invests primarily in companies that provide environmental services in the areas of water, energy and waste. It is up 32% this year.
Possible Core Holdings
Several green funds are considered broad and diversified enough to be used as core holdings in an investment portfolio.
The 10-year-old Portfolio 21 is one of Morningstar's favorites in this group because of its established track record and broad exposure to various sectors, issues and locations. This fund ranks in the top 30% of Morningstar's World Stock category for past five years and top 40% for the past decade. Assets are just under $300 million.
Portfolio 21's holdings range from lesser-known companies such as energy-efficient ball-bearing manufacturer SKF AB in Sweden to Internet giant Google Inc. and pharmaceutical company Novartis AG.
Google's business success along with the company's attention to energy efficiency—including installing solar panels at company headquarters—caught Portfolio 21's attention, says Tony Tursich, one of the fund's portfolio managers. Novartis, meanwhile, has taken a leadership role in trying to reduce waste from drugs, which ends up in water supplies, he says.
The fund has some exposure to sectors that wouldn't be considered green by most. It doesn't own traditional mining companies, "but we do have exposure to the metals sector through Johnson Matthey PLC, a metals recycler and refiner," says Mr. Tursich. Portfolio 21 also has investments in several auto-parts suppliers, including one that develops hybrid-auto technologies, though it is avoiding auto companies themselves.
"Toyota and Honda are way ahead of the curve in [building] fuel-efficient cars, but they are still jumping in and making big SUVs and trucks," says Leslie Christian, chief executive of Portfolio 21 Investments.
Other funds that Morningstar analysts say could be considered for core holdings are Green Century Balanced, Green Century Equity, Northern Global Sustainability Index and Alger Green.