Everyone knows green is good. But will buying a green-focused mutual fund mean more green in your wallet?
A lot depends on your investing time horizon and the type of funds you pick.
Michael Herbst, a mutual fund analyst with Morningstar, says that while the green group as a whole sold off pretty hard in 2008, the sector is likely to benefit from the Obama administration's energy and environmental policies, starting with the stimulus package and the green jobs initiative.
“There is validity to the idea that investors in these industries are starting to connect dollar signs to environmental efficiency or inefficiency. The real question is: Over what time horizon are people expecting to realize these benefits?”
According to Herbst, the rewards of increased environmental efficiency are likely to continue to grow and be realized anywhere from five to 20 years out. The issue, though, is “that time horizon may be much longer than many investors have.”
If you are looking to capture environmental benefits over a short period—say one to three years—says Herpst, there is a chance you will be disappointed.
Another factor is the kinds of green funds in your portfolio.
The 30-plus green funds that Morningstar currently tracks can generally be divided into two buckets—those that invest in companies directly related to pro-environmental initiatives, such as solar, wind and alternative energy; and those that use a ‘best of breed’ approach that looks for the most environmentally-friendly companies in various sectors.
Given that, the risk/reward profiles can differ dramatically.
According to Herbst, companies directly related to the environment tend to be smaller and earlier stage companies. “Generally speaking [these funds] are going to be more risky than the broad market.”
On the other hand, “funds that use a best-in-breed approach tend to be more broadly diversified in terms of market cap and the types of companies they invest in,” he says.
Those risks have largely determined how the funds have performed over the past year, with “some of the more broadly diversified best-of-breed funds have suffered more or less in step with the market as those that focus on smaller caps or earlier stage companies have fared worse."
Matt Patsky, co-portfolio manager of the Winslow Green funds, agrees, and acknowledges that over the last year the performance of his funds—which invest primarily in companies that have a direct positive impact on the environment through their business, has been terrible.
“We’ve been investing in higher growth, higher beta stocks, which have been hurt,” he says, adding that the funds also invest in companies that offer oil alternatives, which have traded down in sympathy with oil stocks.
For 2008, the composite Winslow Green Growth Fund was down a dramatic 60 percent, compared with its benchmark, the Russell 2000 growth index, which shed about 39 percent.
Patsky, however, is quick to add that such a performance is atypical. “Over time, the performance [of the fund, which has been around for roughly 25 years] has been better than the overall market”.
As recently as 2007, the fund was up 24.5 percent, compared with 7.1 percent for the Russell 2000 Growth index; in 2006, returns of the fund and index were in-line at around 13 percent and in 2005 the fund returned 9.5 percent, compared with 4.2 percent for the index.
Patsky expects a strong future performance, partly because the economic stimulus package, which includes “the largest dollar amount to stimulate demand for renewable energy.”
In addition, Patsky says there are “major secular trends that are causing these types of industries to grow faster than the overall market, regardless of the stimulus package.”
For instance, he says that “while fossil fuel prices have trended up, the cost of producing energy from renewable sources has declined and continues to decline. This is particularly true in the solar sector where you are seeing dramatic strides in reducing costs.”
Some stocks that Patsky expects to thrive are: Nalco Holding , which is a play on water infrastructure, supplying equipment and chemicals for water systems; LSB Industries ,which is a leader in geothermal energy, Itron, which supplies globally automatic meter reading equipment to enable smart grid technology; and Vestas Wind Systems , which trades on the Danish exchange and is the largest maker of wind turbines in the world.
Another green fund that employs a best-of-breed approach to green investing is Portfolio 21, which invests in companies that are taking steps to deal with ecological issues.
“We are essentially looking at companies that are becoming more energy efficient and lean in terms of manufacturing operations,” says Tony Tursich, a manager of the fund, adding that the fund also invests a small amount of its money in direct plays on renewable energy companies.
While the performance of the fund has been largely negative over the past several years, it has outperformed its benchmark, the MSCI World Index, over the long term.
Since its inception in 1999, the fund has posted average annual returns of 0.46 percent, compared with -2.33 percent for the MSCI World index. Over the 12-month period ended March 31, the fund is down 37.7 percent, vs. 42.2 percent for the index.
On a three-year, annual-return basis, the fund is down 10.1 percent, compared with a 13.3 loss for the index; over five years, the fund is off 1.19 percent, compared with a negative return of 3 percent for the index.
Going forward, Tursich says there will be government regulations that will increase awareness in the environment, and as people become more aware of ecological challenges and resource consumption, “we believe we are very well positioned going forward.”
One company that Tursich likes is ABB, a Swiss engineering firm focused on power and automation technologies. He also favors Novozymes, a producer of enzymes that help companies conserve energy, which trades on the Copenhagen exchange.
Another example of a green fund that is even more broadly diversified is the Green Century Balanced Fund, which invests 60 percent in stocks and 40 percent in bonds.
Eric Becker, vice president of Trillium Asset Management, which sub-advises the fund says it uses a stringent set of environmental screens to weed out companies with poor environmental records and actively seek companies with pro-environmental footprints.
This fund is broadly diversified among sectors and is designed to be “an all-weather fund for average retail investors,” he says. Becker adds it is also “a fossil-fuel free fund, with no oil or gas companies and no utilities that use fossil fuels to generate electricity”.
“We believe that companies that are better managing their environmental profiles are going to be companies that are better managed and more likely to succeed against peers that may be ignoring environmental impacts," he says.
“The companies we invest in tend to have higher margins and lower debt because we look for companies with above average growth and higher quality companies with strong track records in terms of earnings and margins,” Becker said.
On a short-term basis, the fund has underperformed its benchmark, the Lipper Balanced Index. Over a three-year period, the fund is down 8.5 percent, compared with a 7.3 percent loss for the index; over five years, the fund is down 3.9 percent versus 1.5 percent for the Lipper index. On a ten-year basis, however, the fund is up an average 4.2 percent, compared to the index, which is up just 0.8 percent.
Looking ahead, Becker also agrees that these stocks will continue to benefit, particularly as energy conservation becomes a bigger issue.
“You’re going to start getting real price signals as we put a cap on carbon emissions…it's going to force companies to either reduce their energy intensity or use cleaner fuels or have to pay a price to buy the right to pollute. Companies that embrace more energy efficiency will see better margins," he says.
Solar Stands Out
Some of the stocks that Becker likes are solar ones, which he says are experiencing a difficult period now but going into 2010 and beyond will likely see very strong growth. One such company is Sun Power , which provides the highest efficiency solar cells. He also favors First Solar , which is the leading company in thin film solar panels.
Like Patsky, Becker also likes Itron because it is a play on smart grid technology and it allows utilities to better manage electricity that is being produced.
Some indirect green plays that he likes because of their strong environmental profiles include Chipotle Mexican Grill , which has a large focus on souring local and organic ingredients, as well as healthcare company Baxter International , which has made major strides in becoming environmentally responsible and communicating the resulting cost savings.
While it is important to understand your time horizon as well as the various options available when considering a green fund, Morningstar’s Herbst says it is also important that “investors are realistic about their motivation.”
“If you are looking purely for investment return, that is one motivation, but if you are looking for something more in line with your environmental principles that is another consideration.”