Going Green With Exchange-Traded Funds (ETFs)

What Are Green ETFs?

Today's investors have access to a growing number of green exchange-traded funds (ETFs), allowing them to incorporate environmentally friendly strategies into their investment decisions. ETFs are investment funds that trade on a stock exchange. Investors can choose from a wide variety of ETFs, from those that track a major market index to funds that track a basket of foreign currencies.

Another type of ETF is the green ETF, which focuses on companies that support or are directly involved with environmentally responsible technologies. For example, some ETFs may focus on companies that develop alternative energy or manufacture energy-saving equipment and devices.

Key Takeaways

  • Green ETFs invest in companies that promote socially and environmentally conscious policies and business practices.
  • These ETFs allow investors to gain access to a diversified portfolio of companies, making green investing easier.
  • Examples of environmentally supportive businesses found in green ETFs include those engaged in promoting green transportation, alternative energy, and sustainable agriculture.
  • Green ETFs may invest only in companies that focus on a specific technology, or they may have more broad criteria.
  • There is no single definition of what makes a company "green," so investors should consult a fund's prospectus to decide if the fund's values align with their own.

Understanding Green ETFs

Green investing, whether it pertains to ETFs, mutual funds, or individual stocks, refers to investment activity that focuses on companies whose business supports or promotes conservation efforts, alternative energy, clean air, and water projects, and other environmentally responsible business decisions.

The majority of green ETFs focus on companies involved directly or indirectly with the research, development, production, and provision of alternative energy. Companies may be distributors of alternative energy or manufacturers of parts and equipment needed to produce the energy, such as the photovoltaic cells necessary for creating solar panels. Each ETF has its own criteria for determining the eligibility requirements for assets.

Most brokers will provide an ETF screener, allowing investors to choose from a range of environmentally-focused funds.

Special Considerations

Many new businesses can go green from the start, but established companies may have to work extremely hard to develop environmentally friendly practices. Automobile manufacturers are a good example: the same company that makes gas-guzzling SUVs might also be at the forefront of developing hybrid and electric cars.

So what makes a company or an ETF green? Currently, there are no strict rules regarding which companies or investment instruments are officially green. Many of the considerations are a matter of opinion. For example, some people consider nuclear energy to be a clean and green energy choice while others argue that toxic waste precludes it from being environmentally responsible. In general, it is up to each investor to decide if a fund is green by their standards.

Some "clean" ETFs contain securities from oil and auto companies because these companies devote some of their research to alternative energy. Investors should research to determine if an ETF aligns with their values. This information should be found in the fund's prospectus.

Types of Green ETFs

Although each investor must decide if an investment is green, a growing number of ETFs are centered around companies that are actively engaged in the research and development of alternative energy sources—namely, broad clean energy, wind, solar, and nuclear.

Broad Clean Energy ETFs

Broad clean energy exchange-traded funds are involved in the alternative, renewable, and clean energy sectors. ETFs based on broad clean energy include:

  • The Invesco WilderHill Clean Energy ETF (PBW): This fund is based on the WilderHill Clean Energy Index. The fund selects companies focused on greener and renewable energy sources and technology that facilitates cleaner energy. The fund has a large focus on holding small-cap firms and implements a growth strategy investment approach.
  • The iShares Global Clean Energy Fund (ICLN): This fund allocates its holdings to alternative energy, including solar and wind, and companies involved in biomass, ethanol, and geothermal electricity production. Its top sector is semiconductors and semiconductor equipment with additional exposure to the utility sector.

Wind Power ETFs

Wind power converts wind energy into other forms of useful energy. Wind turbines are used to generate electricity, windmills create mechanical power, and giant sails can be used to provide thrust for ships. Energy production of wind power has increased, and as of 2021, 115 countries have some level of commercial wind power capacity. ETFs based on wind power include:

  • The First Trust Global Wind Energy ETF (FAN): This ETF is based on the ISE Global Wind Energy Index. A security component must be actively engaged in some aspects of the wind energy industry, such as the development of a wind farm, or the distribution of wind-generated electricity. Many of the holdings in this ETF are non-U.S. companies and, as a result, this ETF contains ADRs, GDRs, and EDRs.

Solar Power ETFs

Solar power harnesses the sun's energy and converts it into electricity, either directly using photovoltaic cells or indirectly using concentrated solar power (CSP). Germany, China, and Japan are among the world leaders in solar innovation. The price drivers for solar ETFs include oil prices (which are generally positively correlated), government subsidies and incentives, and technological developments. ETFs based on solar power include:

  • The Invesco Solar ETF (TAN): This ETF is based on an index (the MAC Global Solar Energy Index) that tracks companies involved in the production of solar power equipment, the production of fabrication products or services, and companies that supply the raw materials used by the solar power equipment producers.

Nuclear Energy ETFs

Nuclear power accounts for a rapidly growing percentage of global electricity. Despite historical setbacks, such as the Fukushima Daiichi (2011) and Chernobyl (1986) incidents, utilities and miners have begun to focus their resources on uranium and nuclear energy. ETFs based on nuclear energy include:

  • The Global X Uranium ETF (URA): This fund has a focus to replicate the performance, before fees and expenses, of the Solactive Global Uranium & Nuclear Components Total Return Index. The fund's focus is on uranium mining, with heavy weight on Canadian companies and capitalizing on the demand for nuclear material.

Why Do Green ETFs Have Higher Expense Ratios?

Some ETFs with a strong environmental focus might have a higher ratio than similar funds in the same category. This is likely due to the management costs of choosing investments: before investing in a security, the fund's managers must research the company to determine if it truly satisfies the fund's ESG criteria. In addition, because these companies tend to be smaller and more volatile, the fund will have to rebalance its portfolio more frequently.

What Is the Purpose of Investing in Green Technology?

In addition to the social benefits of supporting green technology, green investors also hope to profit from buying stock in companies with a bright future. For example, solar investors reaped high rewards in the mid-2000s, when solar companies made substantial gains.

How Do You Know If an ETF Is Green or Not?

There is no single definition for the word "green." Some "green" funds may invest in companies that research alternative energies, even if those companies also work with fossil fuels. Others may invest only in companies with a low carbon footprint. Since there is no objective definition, investors should decide themselves if a fund matches their environmental criteria.

The Bottom Line

This article highlights only some of the green ETFs that are available to today's investors. Interested investors can further research green ETFs by speaking with a qualified financial consultant.

Many green investments involve newer and smaller companies, which often equates to greater volatility and/or weak performance. That said, as these companies gain traction and the need for alternative energy is further realized and regulated, green investing will likely become an increasingly stable platform for investors.

Article Sources
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