I was surprised to notice that the last articles about alternative energy ETFs date from 2007. There have been good articles on selected funds more recently, but when it comes to an overview of available choices nothing has been published since the excellent Seeking Alpha articles “The Green Investor: Choosing An Alternative Energy ETF” and “Green and Alternative Energy ETFs”, both published in May 2007. A lot happened since then, some new funds have been added, and so I decided to contribute this review of the available choices.
I love building my own green portfolio with handpicked stocks, but for many investors venturing into this exciting market sector for the first time, it makes a lot of sense to establish an initial stake with index exchange traded funds (ETFs).
For investors not very familiar with the advantages of ETFs, we find that they are diversified, transparent, liquid and affordable investment vehicles. They have been all the rage for the last 10 years. From about 30 funds holding some $1 billion in 1999, there are now well over 800 ETFs with combined assets of over $500 billion. The reason they have grown so popular is because they present the individual and institutional investor some compelling advantages.
Convenience and cost
For our money, ETFs are the most practical and economical investment vehicles for buying baskets of stocks, and they are extremely convenient and easy to use. ETFs are index funds listed on a stock exchange. Like some index-based mutual funds, they hold shares in the spectrum of companies or commodities constituting the index. But, unlike mutual funds which are typically priced once per day at the close, ETFs can be bought or sold at any time during the trading day just like any other stock. And for those who like trading this way, ETFs can use the identical techniques used with stocks, such as limit and stop orders, short sales, margin trading, and even options for some. They are not subject to the "frequent trading restrictions" that brokers increasingly enforce on mutual funds and their expense ratios tend to be about half those of mutual funds.
Just for clarification of terms, the ETFs listed in this article are by definition non-diversified from an industry sector standpoint, as they narrowly focus on the alternative or clean energy sectors. Some are even more targeted, like the solar and wind categories. The ones we label "diversified" cover the main green market sub-segments including biomass, geothermal, hydroelectric, solar and wind. The global ones are geographically diversified and all invest in a range of company types and sizes, from small caps to large caps. Most important, they are diversified by representing an entire basket of stocks, with any one company only representing a small fraction of the fund's assets (typically less than 3%).
Transparency and predictability
By definition, with an index ETF, there is no question as to what it invests in or what performance to expect in relation to the index, unlike actively-managed closed-end funds and mutual funds which follow the whim of the fund manager. ETFs are highly regulated and scrutinized, so they're less prone to all the illegal practices and fraud that have plagued the mutual fund industry. The market risk of an ETF -- or how much you can lose -- is identical to the index it tracks and the type of underlying assets. Next to commodity ETFs, stock sector funds like the ones we track here are of the more risky category. A note of caution, the stock market as a whole and the energy sectors in particular can be highly volatile.
Contrary to popular belief, since ETF shares can be created and unwound in real time, the liquidity of an ETF is not related to its daily trading volume but rather to the liquidity of the stocks comprised in the index. In addition, ETFs typically have small spreads (generally less than 1%) because market makers, specialists and arbitrageurs all interact and compete to effectively flatten the premiums and discounts to fair market value.
One of the challenging realities of the green sector is that many leading companies happen to be foreign and exclusively traded on foreign stock exchanges (and thus difficult to trade for individual US investors). Until the advent of global ETFs that is. Fund managers are able to trade on foreign exchanges and give us access to companies otherwise unreachable, all in one compact portfolio. While we are not currency speculators, fundamentals and long-term technical analysis both point to a continuation of the U.S. dollar secular bear market. This means that, all things being equal, an investment in a company traded in a stronger currency, relative to the U.S. dollar, will have compounded gains of the share price gain times the currency appreciation.
For your convenience we have listed all green ETFs in Table 1 below. The ETFs include "Diversified green ETFs", and specialized sector ETFs (environmental services, solar and wind) which we include for completeness.
Table 1: Green ETFs at a glance
Focus Date (millions)
Note that we have intentionally omitted the so-called carbon trading ETFs/ETNs, such as ASO and GRN because they are entirely different animals which do not belong on this list of stock funds. Similarly, we also exclude NLR, PKN and PUW for not fitting our definition of a green ETF, which is to be clean and renewable. And we exclude GWO because it is technically an ETN (exchange traded note) which presents substantially more risks than an ETF, and the fact that it is highly illiquid.
Disclosure: Long PBD and TAN