The Green Investor: Choosing An Alternative Energy ETF

by: Mick Weinstein

It's as compelling an investment theme as you'll ever come across. With global energy demand rising sharply, oil prices at all time highs, climate change concerns growing, and new technologies enabling more efficient power extraction from natural resources, the case has never been better for investing in alternative energy companies that will help us overcome our oil and carbon-emission addictions.

But try to pick a winner from the dozens of 'green energy' stocks that have emerged in the past few years and you quickly find yourself slipping from confident investor to shaky speculator. Who's to say which of the upstart, publicly-traded solar energy companies, for example, will produce the efficiency breakthroughs that that field has anticipated for over 20 years?

For investors who are sold on the alternative energy theme but hesitant to stock pick, the recent profusion of exchange-traded funds (ETFs) couldn't have come at a better time. These low-fee funds offer diversification by holding a basket of stocks that follow a particular index, and may have tax advantages over traditional mutual funds.

There are currently six alternative energy ETFs to consider. Note the significant differences - in investment focus, international exposure, market cap and expenses - in each fund's holdings:

1. PowerShares WilderHill Clean Energy Portfolio (NYSE:PBW) Listed in March 2005, PBW was the first alternative energy ETF and tracks the WilderHill Clean Energy Index. The fund holds 40 U.S.-listed companies that produce green or renewable energy and related technologies. It's focused on small-caps (69% weighting) and is dominated by Information Technology companies (41% of holdings). The ETF charges a 0.60% annual fee that will weigh on gains. The relatively volatile PWB has returned 22.5% gain since its inception, but dropped just over 6% in the past year. See PBW's full holdings.

2. PowerShares WilderHill Progressive Energy Portfolio (NYSE:PUW) differs from PBW by focusing on companies providing “transitional energy bridge technologies” -- that is, technologies that improve the use of existing fossil fuels, rather than entire new approaches. PUW also has heavy small-cap exposure (49%) but offers relatively diversified sector exposure: the largest single sector, Industrials, constitutes just 28% of the fund. Since inception in October 2006, PUW has returned a strong 18.7%; it also charges a steep 0.60% yearly fee. Here's a useful discussion of PUW's full holdings.

3. PowerShares Cleantech Portfolio (NYSE:PZD) tracks the Cleantech Index™, which aims to capture the potential for companies that 'produce any knowledge-based product or service that improves operation, performance, productivity or efficiency, while reducing costs, inputs, energy consumption, waste or pollution.' PZD is heavily weighted toward Industrials (59%), with 63% of its holdings in small-caps; like the other PowerShares ETFs, it has a 0.6% expense ratio. See PZD's full holdings.

4. Claymore/LGA Green ETF (NYSEARCA:GRN), launched in December 2006, follows the Light Green Eco*Index™, which is comprised of about 200 stocks that are in some way active in alternative energy. Yet a quick look at GRN's holdings reveals the world of difference between this and the PowerShares ETFs. Top holdings of GRN read more like the S&P 500: Mobil, Citigroup and General Electric - mega-cap corporations that allocate a certain (no doubt, growing) portion of their investment or R&D in green technologies, but are hardly 'pure plays' on the alternative energy theme. GRN has a 0.6% yearly fee.

5. Van Eck Global Alternative Energy ETF (NYSEARCA:GEX), launched on May 9, 2007, tracks the Ardour Global Index (Extra Liquid), which is composed of stocks in 30 publicly traded companies that obtain at least half of their revenue from alternative energy activity. GEX is unique among its peers in two key ways: emphasizing large-cap exposure (31% of the fund's holdings; small-caps are only 26.9%), and international reach (European companies constitute 47.1% of the fund, China/Japan 11.1% and U.S. 41.8%). GEX charges 0.65% annually.

6. First Trust NASDAQ Clean Edge ETF (NASDAQ:QCLN), launched in February 2007, follows the NASDAQ Clean Edge U.S. Liquid Series Index, which captures five subsectors of the alternative energy industry: renewable power generation, renewable fuels, energy storage and conversion, energy intelligence, and advanced energy-related materials. The 44 stocks in this basket are almost entirely small-caps. QCLN charges a 0.68% annual fee.

Building A Portfolio and Choosing the Right Green ETFs

How should you fit these ETFs into your portfolio? One option is to build a "core portfolio" of broad index ETFs using this guide to building portfolios with ETFs and then add one or more of these narrower ETFs to "tilt" your portfolio to green investing.

For more in-depth discussion of the "green ETFs", check out Brett Steenbarger's Assessing The Clean Energy ETF, Richard Kang's PowerShares WilderHill Clean Energy ETF: Leverage Through Volatility, and Matt Hougan's Van Eck Launches Alternative Energy ETF: A Peer Comparison.