UPDATE 3/4/2011: An up-to-date article on selecting green mutual funds and ETFs can be found here.
A Choice of Alternatives
There are now 6 mutual funds focused on what I usually refer to as "Clean Energy." I use this designation because "Renewable Energy" does not include Energy Efficiency, which is the most cost effective and scalable way of cleaning up the economy, while "Alternative Energy" usually is taken to include such technologies as nuclear and coal-to-liquids.
Nuclear may have low carbon emissions, but security concerns, waste disposal, and cost all lead many investors who wish to green up their portfolios reluctant to invest. Coal-to-Liquids companies such as Rentech (RTK), in contrast, emit as much or more carbon than would be emitted by the use of the same amount of conventional petroleum products. As a strategy to cope with peak oil, coal to liquids only makes sense if you ignore the climate impact, and hence these companies cannot be considered clean, even if they are alternative.
The six mutual funds which mostly focus on such clean energy technologies (as opposed to the broader categories of Cleantech or Socially Responsible/SRI) are the American Trust Energy Alternatives Fund (ATEAX), the Calvert Global Alternative Energy Fund (CGAEX), Firsthand Alternative Energy (ALTEX), Guinness Atkinson Alternative Energy Fund (GAAEX), New Alternatives Fund (NALFX), and Winslow Green Growth Fund (WGGFX). In general, all of these have relatively high expense ratios, even for actively managed mutual funds, but if you are uncomfortable trading the Clean Energy ETFs or individual stocks, these are your choices.
A Renewable Mutual Fund in Your 401(k) Plan?
Another reason to use a mutual fund rather than an Exchange Traded Fund (ETF) is if you’re investing through a 401(k) plan. Although most 401(k) plans do not offer a Renewable Energy Fund as an option, there is a movement to encourage companies to add them with a Federal tax credit. There’s also a how-to guide both for individuals trying to encourage their companies to add such funds, and for companies which want to include such funds in their plan.
If your company is planning to add such a fund, it makes sense to add the one which will bring the best diversification at the lowest cost, and that’s what this article is about.
Many fund advisors will say that their expense ratios are high because the funds are still small. In some part, that is true, but the fees are also high because there simply is not enough competition, and most people investing in one of these funds spend more time thinking about the environment than about what they’re paying to protect it. In my view, it’s important to protect the environment, and worth spending a great deal of money on, but that money should be spent wisely, in order that it be used to greatest effect.
There are two types of fees you will encounter: Front-end loads and ongoing expenses.
A Front-end load is the percentage of your money which you pay to get into the fund, under the rationale that this allows the fund to charge lower ongoing expenses. If you are only considering mutual funds, and are confident that you will leave your money in the fund for many years, then a load fund may make financial sense.
The funds with Front-end loads are the Calvert Global Alternative Energy Fund (class A), and the New Alternatives Fund. Both have front- end loads of up to 4.75%, after which the Calvert fund’s expense ratio is 1.85%, and the New Alternatives fund’s expense ratio is 0.95%, making New Alternatives the far better choice of the two. Most of these funds also have fee for early withdrawal, or back end load, but only if money is not kept in the fund for a minimum period, usually 6 months or a year.
Front-end loads do fall with the amount invested, and are often waived for institutional investors, such as 401(k) plans. Calvert offers class A shares with no sales load to 401(k) and similar retirement plans, but New Alternatives does not seem to.
No-load funds recoup their expenses over time, and this cost is expressed in the expense ratio, which is the percent of assets every year which go to the fund manager for expenses and the manager’s profit. For the no-load funds, here are the expense ratios:
|Fund Name||Expense Ratio Investor/Institutional||Minimum initial investment (Standard/IRA)|
|Firsthand Alternative Energy Fund||2.10%/-||$2000/$2000|
|American Trust Energy Alternatives Fund||1.89%/-||$5000/$2500|
|Calvert Global Alternative Energy Fund, Class C/ Institutional A||2.85%/1.85%||$2000/$2000|
|Guinness Atkinson Alternative Energy Fund||1.64%/-||$5000/$1000|
|Winslow Green Growth Fund||1.31%/1.06%||$2500/$2000|
Investor shares are those offered to the public, but a 401(k) plan would qualify for the lower expenses available to institutional investors.
In this fee comparison, the Winslow Green Growth Fund wins out, since it not only has one of the lower minimum investments, but also has the lowest expense ratio. The Winslow fund also compares favorably to the New Alternatives fund, since it would take about 9 years for the lower expense ration of the New Alternatives fund to pay back the cost of the front- end load.
The other factors to consider are the funds’ holdings. Do they invest globally? Are they overly concentrated on particular sectors, such as solar? How much of their
money is invested in clean energy?
Unlike some of the ETFs, all of these funds invest globally. However, reading the fund descriptions, you will find that the Winslow fund is focused on "environmentally responsible" companies, while New Alternatives "It usually invests at least 25% of assets in common shares of companies which have an interest in alternative energy." In contrast, the other funds are all at least 80% committed to alternative energy.
Those are just the investment guidelines, however. More important is how the funds are actually invested. I looked at the top ten holdings of each, and here is my categorization of their holdings, and here is the breakdown over major clean energy categories. I combined technologies such as wave power, batteries, and geothermal into the "Other clean energy" category because of the small amounts held. With diversified renewable energy companies, I split the ownership between the various categories based on my judgment of how much of the company was involved in each business.
Top ten holdings can change any time, but this should at least be an indication of the general thrust of each fund’s strategy.
On the assumption that investors are not buying these funds because they want a fund that is very much focused on clean energy, a fund’s investments in the "Utility" and "Non-energy" categories are mostly wasted. The utility companies in these funds are the greener electric and gas utilities, but they still derive the majority of their energy from fossil fuels. Additionally, I currently expect regulated utilities to underperform for the next year or two.
In contrast, I think that clean energy investors should strive to emphasize energy efficiency companies in their portfolios. This is for the same reason that we do energy efficiency first before installing renewable energy systems on our house. Energy efficiency measures are much more cost effective. Most energy efficiency measures pay for themselves in just a few years, and that is why energy efficiency features so prominently in the stimulus plan: the economy will get a short term boost from the spending, but there will also be larger long term gains from the energy savings over time.
Also because of economics, I prefer investments in Wind companies to Solar companies, so despite the large investment of the Winslow fund in two medical companies and an internet company, I still think it has the best portfolio of the six, followed closely by the American Trust Energy Alternatives Fund.
My Top Pick
If you can, you are better off buying one of the clean energy ETFs, or even a portfolio of individual clean energy stocks (here are 10 clean energy picks for 2009.) However, it you want a mutual fund for the ease of investment, or you are looking to add one to a retirement plan, the Winslow Green Growth Fund comes out on top with its emphasis on energy efficiency stocks (including these two Geothermal Heat Pump stocks), and its lower expenses.
Tom Konrad, Ph.D.
DISCLOSURE: The Guinness Atkinson Alternative Energy Fund is an advertiser on the author’s website, AltEnergyStocks.com.
DISCLAIMER: The information and trades provided here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.