Green Investing: ETFs vs. Individual Stocks

By Wayne Pinsent | November 13, 2007 AAA

Green investing has gained momentum as people become more aware of the environment and our impact on it. There are two easy ways investors can add some green to their portfolio:

1) Buy individual shares of companies that are eco-friendly, or
2) Invest in green exchange traded funds (ETFs) that give exposure to many such companies at the same time.

As with everything, there are pros and cons of both strategies. Let's investigate further.

Green S&P
The main advantage to investing in any ETF is that investors receive instant diversification. For people who don't have enough capital to properly diversify, ETFs provide an important edge, and with a wide variety of strategies that still provide choice. (To learn the basics of ETFs, check out Introduction To Exchange-Traded Funds and Advantages Of Exchange-Traded Funds.)

The iShares KLD Select Social Index (NYSE:KLD) and the iShares KLD 400 Social Index (NYSE:DSI) both give exposure to the broad market.
• KLD selects green companies from the Russell 1000 and the S&P 500.
• DSI mostly invests in an underlying index called Domini 400 SocialSM index.

Both track the S&P 500 quite closely and provide the peace of mind that the companies being supported are ones that have implemented plans to limit environmental impact. Companies included in these funds are American Express (NYSE:AXP), IBM (NYSE:IBM) and Procter & Gamble (NYSE:PG).

Super Green
For those who want more exposure to companies who explicitly target improving the environment, there are ETFs for that as well. The PowerShares WilderHill Clean Energy (AMEX:PBW) launched in 2005 and invests in companies that produce renewable, cleaner alternative energies. The fund is up more than 30% year to date (YTD). Another great ETF is the Powershares Cleantech fund (AMEX:PZD) which invests in companies that develop technologies to help other companies reduce waste and use energy more efficiently. This fund has also performed admirably, up around 25% YTD, currently trading in the $32 range.

Both of these funds invest in smaller companies, and I like the prospects. This is where investors need the diversification of ETFs, since smaller companies are typically riskier than larger businesses. As demand increases for renewable fuels and for companies to be more eco-friendly, small companies who provide these services will benefit. These ETFs provide the exposure, without the risk of having the bulk of your portfolio tied up in one losing green stock like Pacific Ethanol (Nasdaq:PEIX); the ethanol producer is down more than 50% YTD.

The Disadvantages of ETFs
When it comes to ETFs, investors pay management fees in the same fashion as in a mutual fund. So, for investors who have enough capital to properly diversify, maybe the ETFs mentioned aren't the best options. Remember the portfolio will track the index, but won't likely outperform because the fees still need to come out. For investors who can accept the risk, the right move could be picking some individual stocks like the ones above that may be undervalued compared to the market, and also have reputations for being green. Other great companies that fit this bill include Goldman Sachs (NYSE:GS) and Apple (Nasdaq:AAPL). (To learn more about ETF fees and other hazards see, see Five ETF Flaws You Shouldn't Overlook.)

However, when it comes to the smaller companies that make concentrated efforts in environmental practices or alternative energy, I think ETFs are the best route for the average investor to take. For instance, there are many different types of alternative fuels being developed. One type will likely eventually emerge as the best and the companies that produce it will reap most of the economic benefits. An investor who buys one stock in another small alternative energy company can lose big time.

The Bottom Line
Profits from green investing aren't leaving soon, everyone has the ability to get a piece of the action, whether through ETFs or individual stocks. It is all relative to risk tolerance and investment knowledge. However, for investors with enough money, who want market exposure to companies who limit their impact on the earth, I believe a little research can go a long way. An investor doesn't need to just track the S&P 500 (or a green version of it), they can beat it with a more concentrated portfolio of undervalued green companies.

Is it possible to be environmentally friendly and still make money? Our Green Investing Feature examines both sides of the issue.

Looking to cook up a market-stomping stock portfolio? Check out our FREE report "7 Ingredients to Market Beating Stocks" and get started right now!

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