Green Funds and ETFs Reduce Your Risk

Alternative-energy choices are growing, from solar to wind power.

Alternative-energy stocks have offered investors a bumpy ride.

Investors looking to power up their portfolios with alternative energy have a small but growing menu of options. Yet navigating the alternative-energy industry today isn't unlike picking Internet stocks in the late 1990s: There are bound to be some big winners, along with a fair share of duds. Publicly traded companies in the green sector range from established players like Suntech Power Holdings to early-stage biofuel companies, which are still "lottery tickets," says Kirk Kim, lead manager of the Transamerica Science & Technology fund.

For the bold (and those with time to do research), individual stocks are an obvious choice, but "investors must go in with the mind-set that they're not going to sell in three months," says Jeff Siegel, managing editor of Green Chip Stocks, an investment advisory service.

A safer way to invest in alternative energy is to spread your bets around with a mutual fund or exchange-traded fund that holds dozens of stocks. The sector hosts more than a dozen funds and ETFs, most of which invest in a mixed bag of renewable-energy technologies. While diversification reduces investors' overall risk if one or two companies in a fund go belly up, alternative energy remains a risky business. "This is a very dynamic, fast-moving sector that's maturing quickly but unevenly, so performance can be very volatile," says Rafael Coven, managing director of Cleantech Indices, which tracks publicly traded renewable-energy firms.

Downdrafts. Consider the performance of the New Alternatives fund, a category veteran that was launched in 1982. Run by father-and-son team Maurice and David Schoenwald, the Melville, N.Y., fund has gained a respectable 8 percent annualized return over the past decade. But not without turbulence: It rose 52 percent in 2000, fell 12 percent in 2001, and lost 30 percent in 2002. New Alternatives soared 34 percent in both 2006 and 2007; so far this year, it's down 16 percent. The $296 million fund, which levies a sales charge, invests beyond renewable energy in recycling, water, and natural foods companies with good social and environmental track records.

A few other funds have entered the category, including the no-load funds Guinness Atkinson Alternative Energy and Firsthand Alternative Energy and a load fund, Calvert Global Alternative Energy. Foreign stocks make up a sizable chunk of each fund: "This is really a global industry, so you don't want to limit your investments to U.S.-based stocks," says Richard Asplund, author of Profiting From Clean Energy: A Complete Guide to Trading Green in Solar, Wind, Ethanol, Fuel Cell, Carbon Credit Industries, and More.

Mutual funds certainly aren't the cheapest way to get access to this sector (three of the previous four funds charge more than 1.5 percent in annual fees). A no-frills route is through ETFs, which mimic indexes and, like stocks, trade on exchanges. At $1.6 billion in assets, the largest is the PowerShares WilderHill Clean Energy Portfolio, which invests in 54 mostly small up-and-comers, including top holdings FuelCell Energy, First Solar, and Ormat Technologies. Its annual fees are 0.70 percent. Other broad-based ETFs that focus on alternative energy include Market Vectors Global Alternative Energy and First Trust NASDAQ Clean Edge U.S. Liquid Series, which levy expenses of 0.65 percent and 0.60 percent, respectively.

A more aggressive strategy for ETF investors is to bet on a particular renewable-energy technology. The Van Eck Solar Energy and Claymore/MAC Global Solar Energy funds—with playful ticker symbols KWT and TAN—each invest in about two dozen solar companies. Both funds launched in April and charge 0.65 percent annually. Their portfolios are similar, although Van Eck includes more pure solar plays. "Solar is a riskier investment, but it also accounts for most of the industry's best performance over the past few years," Asplund says. (The Ardour Solar Energy Index is up 44 percent over the past year.)

In June, wind energy gained two ETFs: the First Trust ISE Global Wind Energy Index fund, which includes 67 companies and charges 0.60 percent in annual expenses, and the PowerShares Global Wind Energy ETF, which invests in 32 stocks and charges 0.75 percent. As the alternative industry matures, more technology-specific ETFs are bound to pop up. Biofuel fund, anyone?