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Green Investing The Gold Rush


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Green investing is growing up. Previously the province of a small number of investors who chased an even smaller number of companies, the market for environmental technology has expanded dramatically in recent years. And it has captured investors’ wallet share along the way. Inflows into green funds totaled $766 million for the year ending May 31, according to Morningstar, compared with $37 million in net outflows from religious funds over same time period. (Morningstar tracks these two subcategories under the umbrella of socially responsible investing, or SRI, funds). “The interest has turned from ‘maybe I'll dabble in this’ to ‘this is an asset class I should include in my portfolio, '" says Jerry Moskowitz, president of FTSE Americas.

Surging fuel prices have helped make green technology one of the biggest equity growth areas in the U. S. , says John Quealy, a green tech analyst at Canaccord Adams, an independent financial services firm in Boston. New products are keeping pace. Mutual funds represent the largest share of socially and environmentally screened funds, with $171.7 billion in total net assets invested across 173 different funds, according to the Social Investment Forum's 2007 Report on Socially Responsible Investing Trends in the United States. Exchange-traded funds accounted for only 1% of the total assets of all socially and environmentally screened funds at the beginning of 2007, but their ranks are growing daily.

The source of investors’ fascination is, of course, the need to find alternatives to oil and other fossil fuels in today's environment of scarcity and climate change. We've reached a point where environmental technologies have moved way beyond good wishes for Mother Earth, and are starting to make economic sense. Alternative energy has finally captured businesses’ and investors’ imaginations and the gold rush is on-and so are nascent fears of a bubble.

Oil prices of $140 or more per barrel highlight the scarcity-or at least, the fears of scarcity-of this hot commodity. Global demand for oil will only increase over the short term, even if record gas prices finally cause Americans to curb their consumption.

China and India are expected to more than double their energy use by 2030, according to the International Energy Agency. Increasing demand for fossil fuels pushes their prices up, which in turn spurs technological advances across all alternative energies. The world will continue developing better ways to power cars (the next iteration of the Toyota Prius, the ragingly popular gas sipper, will come with solar cells that help run its air conditioning), as well as alternatives to coal and other greenhouse gas emitters. Industry experts say that oil would have to drop back down to $50 per barrel for alternatives like solar, wind and geothermal energies to lose their economic viability.

Here's a closer a look at the opportunities, and some potential risks, in green investing.

Clean and Green

Investors considering environmental tech should start by defining their terms. For example, some use “clean tech" and “green tech" interchangeably, while others make a clear distinction. Jack Robinson falls into the latter group. The manager of the $410 million Winslow Green Growth Fund-whose three-, five- and 10-year performance has bested the Russell 2000 Growth Index-defines green companies as those involved in a bona fide, sustainable solution to global warming or other environmental ills; clean companies, in his parlance, are environmentally neutral. One clean company that Winslow holds in Green Growth is Bankrate, a North Palm Beach, Fla. -based online consumer banking and personal finance network. A green company he owns is Green Mountain Coffee Roasters, a Waterbury, Vt. -based purveyor of fair trade organic coffee that is carbon-neutral and donates 5% of its earnings to earth-friendly causes.

Investors must also decide for themselves what constitutes a green company. Quealy identifies four subcategories within the green sector: energy and power technology, which includes fuel cells; water technology; recycling technology; and bioresource technology, which includes ethanol. However, many so-called green companies don't draw 100% of their revenues from green activities. Purely returns-driven investors may not care to know the full scope of a company's endeavors, but those who see themselves as socially responsible will. “If you're large enough, you're going to be doing things some people don't like, " says Peter Kinder, president of KLD Research & Analytics, a Boston-based social research and index firm.

Robinson won't hold companies that are at all “dirty. " For example, he won't own BP, even though the British oil company is also developing alternative energies. Don Rogers, executive director of Virginia United Methodist Pensions, won't invest in conglomerates with more than 10% of their income from any combination of alcohol, firearms and gambling. Green investors also line up on different sides of the nuclear power divide, with some embracing the technology as an attractive alternative to fossil fuels and others shunning it as expensive, a cause of toxic waste and prone to accidents or terrorist attacks.

The growth of green tech investment vehicles mirrors the increase in individual companies in the space. When Robinson first began investing in the category 15 years ago, he had only a handful of stocks to choose from. These days, he says, “the universe has expanded dramatically and a lot of the small caps have become mid-caps or even large caps. " One stock that graduated from small cap to mid-cap on Robinson's watch is Itron, a Liberty Lake, Wash. -based company that produces electricity, gas, water and heat meters. When Robinson first invested in the company in early 2006, its market cap was under $1 billion, and today it's about $3 billion.

The Al Gore Effect

Many credit Al Gore and his 2006 Oscar-winning movie, An Inconvenient Truth, for the uptick in consumers’ desire to go green. “He's had a major impact on educating the public, " Robinson says. And today, more consumers are gaining access to green mutual funds through their 401(k) plans, he notes.

Christopher Manning, a financial advisor in Houston who focuses on SRI, says alternative energy investments are the most popular SRI category among his new clients this year. He uses Green Century mutual funds with his clients, as well as two PowerShares ETFs, Global Water and WilderHill Clean Energy.

Before he launched his own SRI-focused firm in 2005, Manning worried about how it would play deep in oil country. While he hasn't encountered any outright hostility toward his mission, he says, he has found plenty of educational opportunities among potential clients. He's also found himself quite a niche. “In this area, I'm the only game in town" for clients interested in SRI, Manning says.

Justin Harris, a financial advisor in Seattle, says few of his clients come in with specific requests about green investing. Most request a general negative screen that weeds out tobacco, gambling and alcohol stocks. While many advisors adopt SRI vehicles at their clients’ request, Harris went the opposite route: About seven years ago he set a mandate that all assets his clients invested with him would be in socially responsible investments. “I saw I wasn't gaining anything by divorcing my money from my values, " he says. Harris didn't lose any clients as a result of the mandate, and clients embraced the cause. “I find that people really want to be fully engaged, " he says. “They want to walk their talk. "

Policy Watch

As with so many issues in this election year, market watchers wonder how the new occupant of the White House will affect green technology next year and beyond. Both the presumptive Republican and Democratic nominees, John McCain and Barack Obama, respectively, support a cap-and-trade system for carbon emissions, so it's likely this initiative will move forward regardless of the election's outcome. A system adopted by the European Union several years ago, a cap-and-trade system creates market incentives for reducing carbon emissions. Companies are allotted a certain number of permits to release carbon gases, and if they can figure out a way to reduce their emissions, they can sell their excess permits for cash.

When investing in individual securities, investors can analyze how well companies are preparing themselves for these coming regulations, says Todd Larsen, spokesman for the Social Investment Forum, a trade association of the U. S. social investment industry. Companies will incur greater costs as a result of cap-and-trade regulations, and they will pass these costs along to their customers. For example, a one-cent increase in the cap-and-trade cost per ton of carbon translates into a 33% increase in the end consumer's electricity costs, Robinson says. Investors interested in carbon as a commodity also have expanding options: In June, Barclays launched the first exchange-traded note offering investors pure exposure to the global price of carbon.

Many assume that a Democratic administration will be friendlier toward SRI principles. For example, conventional wisdom holds that Obama would be more likely than McCain to increase incentives for environmentally friendly corporate behavior. But in some ways, among individual investors the opposite may hold true. “SRI is demand-driven, and there's nothing like a Republican president to drive demand, " says one prominent industry participant who requested anonymity for fear of being perceived as cynical. Indeed, frustration at President George W. Bush's dismal environmental record has contributed to the popularity of alternative energy investments in recent years.

Investors or Believers

While the next occupant of the White House may affect certain environmental policies, SRI and green investing has enough momentum that it should make progress no matter who wins this November. “There has been a sea change at work, " says Calvert CEO Barbara Krumsiek. Corporations have embraced positive change on environment, social and governance issues (also known as “ESG"), she notes. Large institutions like public pension funds have taken up SRI investing, including shareholder advocacy, and investors are expressing unprecedented interest in SRI, Krumsiek continues.

Calvert doesn't track how many of its investors are purely returns driven, as opposed to those who invest according their beliefs, but Krumsiek believes that both groups are well represented among her shareholders. The venerable SRI fund family ventured into the green tech space last year with the launch of the Calvert Global Alternative Energy Fund. The fund was down 12.1 % as of June 30, negative 0.2 points below Standard & Poor's 500 results for the same period, according to Morningstar. Calvert plans to launch a Global Water Fund in the third quarter.

Bill Crager, president of Envestnet, a Chicago-based provider of investment management products and services, envisions a day when information on companies’ environmental, social and governance track records will become more readily available. One day, he predicts, clients might receive, along with their quarterly returns statement, a statement of their holdings’ sustainability efforts. This could take the form of a report on individual companies and how they help or hurt the planet during that time frame, by opening up a water filtration plant, say, or by polluting a local river, Crager says. Envestnet's products include Veris Sustainable Strategies, mutual fund portfolios for socially conscious investors.

Potential SRI investors will invariably ask whether investing with their hearts-and their attention on ESG reports rather than earnings reports-will damage their wallets in the form of lower returns. “My experience is all investors are returns driven, " says Dan Porter, founder and vice president of marketing for IW Financial, a Portland, Maine-based provider of environmental, social and governance research, consulting and portfolio management solutions. “When I want to incorporate my values, the question is, can I do that at an acceptable level of cost?" The answer will vary from client to client.

Ready to Boil?

Only a handful of green mutual funds and ETFs tracked by Morningstar have even a five-year track record. “The jury is still out about performance of SRI funds in general, " says Stephen Horan, head of private wealth and investor education at the CFA Institute. “Both sides can cite studies to support their case. " Not surprisingly, of those that do, some have underperformed and others have outperformed the broader market. Those in the latter category include Winslow Green Growth, with 11.2% five-year returns as of June 26, compared with 7.4% for the Standard & Poor's 500; and the New Alternatives Fund, which invests in alternative energy and boasts an 18.1% five-year return as of June 26, according to Morningstar.

Outsize returns like those may prompt the question of whether alternative energy is entering bubble territory. It's never an easy question to answer. “If it pops, we'll know, " says Johann Klaassen, vice president of managed account programs for First Affirmative Financial Network, an independent investment advisory firm in Colorado Springs, Colo. , that designs green investment portfolios. That said, Klaassen believes alternative energy is still in “the opportunity phase. "

Robinson says solar companies got “priced to perfection" recently but have since receded from their highs. It would be wrong to avoid the category altogether, he says: “Long-term, solar is a part of the solution. " Oil prices will not likely make a big retreat, he believes, and demand for alternative energy sources will only grow.

After all, it's not as if the world will stop using energy. FTSE's Moskowitz says green tech companies are reporting solid earnings that are reflected in FTSE's environmental indexes, the FTSE ET50 and the FTSE Environmental Opportunities All-Share Index. “They don't look wild, " Moskowitz says of his indexes’ components.

Even so, green tech investors must have a strong stomach to weather the sector's volatility. Some of that volatility comes from the fact that most green tech stocks are small-cap growth companies, which are among the most mercurial. In addition, Quealy says, “We live in an unbelievable bull market for commodities, where geopolitical discussions swing the price of oil two to three bucks daily. " This adds another layer of volatility to green tech stocks that other sectors don't share, he notes.

Quealy still thinks green tech companies rank among the best secular growth opportunities for the next five to 10 years. Stock pickers would do well to study the management, market and marketable technology of the companies they're considering, instead of blindly investing in the sector as a hot growth prospect, he advises. “The passive investment approach is likely to be a risky one as Wall Street decides who the winners and the losers are, " Quealy says.

Jan Bryan, a planner specializing in SRI out of Prescott, Ariz. , reports that while her clients expect competitive returns from their investments, these long-term investors also understand and accept cycles of underperformance. For example, when defense and big oil are doing particularly well, portfolios that eschew them will miss out on those gains. Her clients have found other kinds of rewards in SRI and green investing. “Clients absolutely love it when you ask them their views on social issues, " she says. “They feel respected and heard, and these are the most loyal clients. " Klaassen also notes the phenomenon of “sticky clients" in the space: “They get invested in us, as well as with us. " First Affirmative does get some returns-driven investors, but they generally don't stick around for long. “Hot money flows in and flows out, " Klaassen notes.

Elizabeth O'Brien is an author with Financial Planning magazine. For more information, please visit


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