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Dipping Into Green Investing

If you’re looking for ways to apply your environmental passion to your investment portfolio, there’s more than one way to get your green on.

Mark Lennihan

Those with the right stomach for risk can bet on individual stocks of companies at the cutting edge of solar, wind and biofuel research, putting all their eco-friendly eggs into one basket.

Those looking for more stability, on the other hand, can opt instead for funds that focus on clean energy stocks, letting professional managers chose the front-runners for them.

Green exchange traded funds, ETFs, and mutual funds, for example, provide average investors an easy entrée into the nascent and sometimes volatile world of carbon
conscious investing.

In many ways, eco-friendly ETFs and mutual funds are similar—both contain a specialized basket of investments from companies engaged in alternative energy research, those that promote environmental stewardship, or those that stand to benefit from the growing demand for clean fuel.

Yet, such funds also have some important differences that investors should be aware of. Here's a quick primer.

Exchange Traded Funds

ETFs, which debuted in 1993, are a lot like an index mutual fund and trade on a stock exchange throughout the day.

ETFs are also prized for their lower fees. Alternative energy ETFs, for example, have fees of around 75 basis points a year, while the expense ratio for many mutual funds can exceed
1.5 percent.

There are several varieties of green ETFs from which to choose but are generally categorized as either alternative energy, solar or wind.

The five alternative energy ETFs available invest in companies and products that use renewable sources of energy (unlike fossil fuels), such as wind and solar power, along with fringe technologies in the early stages of development, like tides, geothermal heat and biofuels.

They are: First Trust NASDAQ Clean Edge Green Energy , iShares S&P Global Clean Energy Index, Market Vectors Glb Alternative Energy ETF , PowerShares Global Clean Energy and PowerShares WilderHill Clean Energy .

The two solar ETFs, Claymore/MAC Global Solar Energy and Market Vectors Solar Energy ETF, and the two wind ETFs, First Trust Global Wind Energy and PowerShares Global Wind Energy , meanwhile, are more narrowly focused. As their name implies, they invest exclusively in companies that produce, market or utilize those sources of power.

Because they reflect a targeted approach to investing, green ETFs—like commodity ETFs and other thematic funds—are less diversified and more volatile than an ETF that tracks the broader market. That goes double for highly specialized solar and wind ETFs, which can experience daily price swings of 10 percent or more.

“I would say [green ETFs] are more volatile than theS&P 500, but less so than single stocks,” says Paul Justice, ETF strategist for Morningstar.

Unless “you feel strongly” about the potential for wind or solar technology, he adds, average investors should stick with alternative energy ETFs, which are generally less turbulent.

“Right now, if you plan to go into the space, go with a broader fund, like PowerShares WilderHill Clean Energy, a more liquid fund with about $700 million in assets,” he says.

The fund is down nearly 4 percent over the last 12 months ending Nov. 9, and an unsettling 40 percent for the last three years, according to Morningstar. The S&P 500, by comparison, was up 7 percent for the last 12 months through Oct. 31 and down almost 25 percent over the last three years.

“Green ETFs have had a pretty bad run here over the last few years since it’s highly correlated with energy overall,” says Justice, noting it’ll take years before the winners rise to the top, despite government stimulus spending earmarked for alternative fuel research.

“if you have strong conviction around the green energy idea it’s a reasonable long-term investment,” says Justice.

Mutual Funds

The 20 odd green mutual funds available offer a variety of investment options as well.

According to Morningstar, some focus on “best-in-breed” stocks, in which the portfolio manager invests in companies with industry-leading environmental track records.

Others invest in “environmentally proactive” firms, it notes, or companies that produce goods or services linked to green initiatives like alternative energy, energy efficiency, emissions reduction, water distribution and earth friendly agriculture.

A few, such as Alger Green and Portfolio 21 , blend elements of both.

Like ETFs, there are several green mutual funds that are more narrow and potentially more volatile, like the Calvert Global Alternative Energy fund, which invests in companies directly engaged in the production of alternative energy, like wind or solar power.

As its name implies, Alliance RCM Global Water Fund invests in water-related companies worldwide in a range of industries, while climate change funds, including DWS Climate Change and Neuberger Berman Climate Change , invest in equities that are positioned to benefit from efforts and regulations to effect climate change.

Most green mutual funds, however, are more general, investing in all things eco-friendly, from companies that seek to reduce their carbon footprint to those producing clean products and energy.

Red Flags

The Winslow Green Growth ,Alger Green and Portfolio 21 funds are all good picks in this broader based group, says David Kathman, a mutual fund analyst for Morningstar, with solid track records and strong management.

“These broader funds are better for average investors who want some green exposure,” he says.

Kathman notes, however, that Winslow Green Growth can be particularly volatile, so it’s best geared “for those who can tolerate a lot of risk,” while the Alger fund family often takes an aggressive approach.

“They’ve had some really good returns and because their top holdings include companies like Apple , Microsoft and First Solar , the Alger Green fund is more of a core-like fund,” he says.

The Alger Green Growth fund is up nearly 32 percent through Nov. 6, with a 5-year annualized return of 5.8 percent, putting it in the top 4 percent of funds in the large-cap growth category.

Caution Ahead

Generally speaking, green ETFs and mutual funds are more volatile than their broad-based counterparts because they tend to invest in early stage firms that carry the risks associated with all small-cap growth stocks.

Government regulations, both domestic and international, can also impact green companies significantly, making it critical that funds have a deep research bench to stay ahead of them.

Such funds, says Justice, are best suited as a specialty holding rather than a core investment.

If you’re in it for the long-haul, he notes, green mutual funds make a nice addition to a well-diversified portfolio. Just practice moderation.

“I wouldn’t put more than 5 percent of assets” into these funds,” says Justice, noting those who own energy funds may already have adequate exposure.

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