Going Green With Mutual Funds

by Mark Veverka, March 2, 2010

Investing in companies that embrace leading-edge environmental practices and technologies can bring healthy returns. The green industry is a new frontier encompassing not only construction, conservation and energy, but nearly every human endeavor, and it could balloon into a $6 trillion market. That's "an order of magnitude of the Internet market," says John Segrich, co-portfolio manager of the Gabelli SRI Green mutual fund.

Unlike the Internet, however, the green economy isn't consumer-driven, or even business-driven. It has been propelled and shaped largely by government policies, standards, subsidies and regulation. "Those polices can change rapidly and have a dramatic effect on the markets," says Segrich, whose $11.6 million fund, launched in mid-2007, was the best-performing green mutual fund in 2009, with a total return of nearly 68%.

It may be most prudent, at this early stage, to invest in green companies through actively managed mutual funds, especially because keeping track of public policy, in the U.S. and elsewhere, requires extensive homework.

Green index and exchange-traded funds offer another alternative to individual stocks and actively managed funds, although these funds are only as good as the components of the underlying indexes. Companies with widely divergent characteristics can be lumped together in such vehicles.

A growing number of ETFs have been created to track small slices of the green market, such as wind, water or biofuels. But Michael Herbst, associate director of fund analysis for Morningstar, warns that "the narrower the swath, the greater the risk [that] an investor will use the ETF ineffectively."

Single-sector funds tend to be volatile, much like the industries they track. "It is fairly common to see investors steer money into hot sectors, such as tech in the late 1990s and energy and commodities heading into 2008 -- after the big gains have been made -- only to take their money out after the inevitable decline, quite possibly missing out on a rebound," Herbst says.

Picking a green mutual fund isn't as easy as it seems. For one thing, fund-research firms have yet to create a "green investing" category.

As a group -- and back then, it was a tiny group -- green funds rallied for several years leading up to 2008, buoyed by investor enthusiasm for solar and wind energy. But the financial crisis and bear market decimated most of these funds, and even after last year's gains, many have yet to retrace all their losses. Only 16 of the funds have three-year returns; those range from an annualized loss of 1.2% for the PFW Water ETF to a much steeper decline of 22.5% for Guinness Atkinson Alternative Energy.

"Waves of enthusiasm and pessimism are likely to affect the group in the future," says Herbst. "Investors may be looking for a direct tie between increased government-stimulus spending in these areas and investment success. We haven't yet seen that direct connection for green funds as a group."

That's why well-managed, diversified funds might hold the greatest appeal, notwithstanding their generally higher costs, especially when it comes to following the bouncing regulatory ball. Gabelli's Segrich is focused on the light-emitting diode (LED) market, which benefits from demand by consumers as much as government policy. Many governments have mandated that incandescent lights be replaced by LEDs, which gives the industry visible growth.

In addition, the consumer-electronics industry continues to roll out LED televisions and other appliances that are more energy-efficient than older gadgets. "The LED industry is sustainable on its own, but governments are behind it, making it all the more attractive," says Segrich.

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