Understanding Green ETFs

In 2009, investors didn’t have to be great stock pickers to see their stocks rise, but some sectors (and stocks) performed much better than others.

Although clean energy stocks rose about 40%, that only reversed about a third of the losses from 2008. Energy efficiency, grid and energy storage stocks were the place to be, pre-empting more "traditional" clean energy solar and wind stocks.

2009 winners had spectacular share price performance, including:

LED Lighting: Cree (255%) and Dialight (100%)
Smart Grid: EnerNOC (308%); Comverge (128.6%)
Energy Efficiency: Johnson Controls (64.64%); Baldor Electric (57%)
Energy Storage: BYD Company (439%); Maxwell Technologies (252%).
Geothermal Heat Pumps: LSB Industries (69.9%); WaterFurnace (60.22%)

Let’s look at the green stock landscape through some of the leading green Exchange Traded Funds (ETFs).

When we look at the performance of green ETFs in 2009, most rose 30-40%, easily beating the S&P at 28.8%, but underperforming the Nasdaq at 43.9% and a multitude of individual stocks. Still, ETFs are a great, inexpensive place to invest for those hesitant to pick stocks.

For investors not very familiar with the advantages of ETFs, they have the compelling advantages of being convenient, low cost, diversified, transparent and liquid investment vehicles. Over the past 10 years ETFs have grown from 30 funds with $1 billion in assets to well over 800 funds with over $500 billion in assets.

Convenience, Cost, Diversification: When you buy an ETF, you’re buying a basket of stocks that fit a theme (an index) – pretty much any theme you can imagine is available, but in the green world themes include large cap world leaders, clean energy, cleantech, or smaller niches – solar, wind or water.

The theme gives you diversification within the specific area the ETF focuses on. ETFs contain many of the stocks in a given sector, so some stocks will outperform and others will underperform. If you’re a good stock picker, you’ll usually do better buying individual stocks.

But if you’re not a stock picker, ETFs have advantages over buying mutual funds: they cost about half and you can buy or sell them just like stocks – trade anytime, use limits and stop orders, shorts etc. ETFs are not managed actively however, so well-managed mutual funds may have an advantage in terms of performance if they pick great stocks. The average stock in an ETF represents a small fraction of the fund’s assets, typically 3-4%.

Transparency, liquidity: since ETFs track indexes, you’ll never wonder what an ETF invests in, because all the constituents are transparent, unlike mutual funds, which follow the whims of portfolio managers. The liquidity of an ETF is related to that of the stocks in the index, rather than its daily trading volume, and ETFs usually have small spreads (generally under 1%) because market makers, specialists and arbitrageurs compete to effectively flatten the premiums and discounts to fair market value.

International reach: one of the challenges in green investing is the international nature of the space – there are important companies in China, Europe and much of the world now, many of which only trade on their home exchanges. Global ETFs make it easy to invest in companies around the world all in one portfolio.

This article is reprinted from our green investing newsletter, Progressive Investor.

PowerShares WilderHill Clean Energy ETF (PBW)
PowerShares Global Clean Energy Portfolio (PBD)

The WilderHill Clean Energy ETF (PBW) was the first clean energy ETF – as the first mover, it’s the most well known and widely invested in ETF, but its share price rose only 30% in 2009.

PBW invests across the spectrum of clean energy companies that trade on US exchanges, while its sister ETF – Powershares Global Clean Energy Portfolio (PBD) – invests globally. PBD rose 39% in 2009. Both ETFs reached record highs in 2007 and then dropped about 60% in the 2008 crash.

And both ETFs fell prey to shifting investor preferences in 2009. During the 2008 crash, clean energy stocks suffered as nervous investors shied away from young, high-growth stocks in capital-hungry sectors. Confidence recovered in 2009, but investors steered clear of many solar stocks because of concerns about over-supply and the steep drop in prices. Wind stocks did somewhat better, but also lagged because of their exposure to the credit crunch.

In 2009, the outperforming clean energy subsectors were energy storage (batteries, electric cars) and smart grid, which were new areas for significant government support. In a year when government stimulus programs were the backbone of the economy, that’s where the investors were.

Thus, the clean energy sector as a whole – unlike previous years – didn’t move as one unit. The industry’s subsectors are becoming substantial and deep, and we expect greater variability between them going forward.

Taking PBD as an example, Energy Storage stocks were the stars, rising 120% on average in 2009. BYD Company (a Warren Buffet investment on the Hong Kong exchange), which makes batteries and electric cars, soared 439%, and ultracapacitor manufacturer Maxwell Technologies advanced 252%.

Energy efficiency/smart grid stocks rose 48%, led by Taiwan-based Epistar with a 315% gain, and US companies EnerNOC and Cree, which rose 308% and 255% respectively.

Solar stocks gained 30% on average even though the group contained the index’s five worst performers: US-based Energy Conversion Devices fell 58.1% and Germany’s Q-Cells fell 54.3%. Wind stocks gained 36% on average.

Thus, PBD lost out on investors’ shift toward energy storage and efficiency stocks because the index is heavily weighted toward solar and wind: it contains 9 energy storage stocks, 17 energy efficiency stocks, 25 solar stocks and 18 wind stocks.

Four stocks were added in the quarterly index reshuffle, including newly listed energy storage firm A123 Systems and wind project developer China Longyuan Power. Among the five stocks that were dropped were Evergreen Solar and troubled wind developer Theolia.

Don’t count these ETFs out going forward however – 2010 could be a banner year for clean energy companies in general, including solar and wind. The top 10 holdings are quite different between PBW and PBD, but both include compelling companies across all the clean energies – American Superconductor, Cree, Trina Solar, Ormat, Itron – all stocks on our "short list" and poised for strong performance in 2010.

Major economies pledged about $200 billion in clean energy stimulus funds, much of which will hit company coffers in 2010 and 2011. Those that gain the most will drive share price performance in the months ahead.

http://www.wildershares.com/

PowerShares WilderHill Progressive Energy (PUW)

The lesser known PUW has actually been the best performer of the WilderHill indexes. The ETF, which gained 61% in 2009, consists of transitional technologies that improve the use of the dominant conventional sources we use today (coal, oil, natural gas). The companies in the index help de-carbonize polluting energy sources by cleaning them up, reducing emissions and making them more efficient.

Although renewable energy stocks have the most sex appeal, PUW gives investors exposure to more nitty gritty companies that are making materials lighter, recycling batteries, building the smart grid, efficient lighting – in other words, everything except renewable energy.

www.whprogressive.com

PowerShares Global Progressive Transportation Portfolio (PTRP)

September 2008 was a tough time to launch a new ETF, just preceding the market crash! But in a year when the US made its first serious commitment to upgrading the nation’s rail system, PTRP rose 52%.

The index invests in innovative, energy efficient transportation – businesses that stand to benefit substantially from a societal transition towards cleaner, improved means of moving goods and people. It emphasizes solutions that make both ecological and economic sense and includes stocks around the world.

You’ll find a combination of modern high-speed rail technologies and old-line railroads and many of the exciting newcomers in alternative vehicle technologies, from bicycles to advanced batteries and electric car-makers.

http://greentransportation.com/

Solar ETFs

Claymore/MAC Global Solar Energy (TAN)
Market Vectors Solar Energy ETF (KWT)

Tan rose 27.7% in 2009, reflecting the difficult year for solar (the S&P rose 28%), but 2010 could be a great year for solar. Of the two solar ETFs, we like TAN better than KWT, which gained 18.6%.

Although both ETFs have similar top 10 holdings and cost the same 0.65%, TAN has a wider diversity of stocks, which helped its performance this year. TAN is a much larger fund with $207 million in assets compared to KWT’s $34 million. Neither fund compares in size to PowerShares Clean Energy PBW, which has $770 million in assets.

After lagging in 2009, solar stocks have already started moving up the first week of January, pushing the solar ETFs up 10% in the first week. Buy on dips!

Wind ETFs

First Trust ISE Global Wind Energy (FAN)
PowerShares Global Wind Energy ETF (PWND)

As with the solar ETFs, there are two wind ETFs, which also have subtle differences in holdings, accounting for the discrepancy in returns. PWND gained 31% in 2009 ($43 million in assets), while FAN rose 24% ($97 million in assets).

Their top 10 holdings are near identical making it difficult for many investors to distinguish between them. PWND outperformed in 2009 because of its higher weighting in China, benefiting from the country’s stimulus package, which invested heavily in infrastructure upgrades. China High Speed Transmission Equipment Group rose 95% and was 4.73% of PWND’s assets, while only 0.99% of FAN’s, for example. Clipper Wind is in FAN’s top holdings, which had a tough year.

Conclusion

If you’re very familiar with the individual companies in the field, look carefully at the ETFs’ holdings to choose between them. Look at the mix of large and small companies in the fund – does the fund emphasize large or small caps? Smaller companies are more volatile, but have the potential for higher returns. Pick funds that match your comfort level.

And look at the weightings of individuals stocks – more concentrated funds – which contain fewer, heavily weighted stocks – outperform only if those top stocks happen to be winners.

Also consider sector weightings – is the fund heavily weighted toward solar, when you expect batteries and smart grid to outperform?

If you’re not very familiar with the companies/sectors, hedge your bets by buying small amounts of several funds including more general (eg. clean energy) and more specific funds (eg. solar). As with mutual funds, review the long term performance, not just one year. You might want to stick with funds that have been around longer and have more assets – there’s a reason why some ETFs are more popular than others.

All the funds we talked about will give you strong exposure and good diversification within their sectors, and most beat the S&P for the year.

Even though a fund outperforms one year, that doesn’t mean it will outperform the next. For example, since most well-established clean energy players aren’t in the US, domestic-only funds contain a greater percentage of more volatile stocks. That means US funds tend to outperform in good years, and under-perform in bad. While PBW underperformed nearly all the global funds in 2008, it outperformed the three global funds in 2007.

Green ETFs

Name	Ticker	Inception Date	Focus	Cost	Assets	2009 Performance
iShares KLD 400 Social Index Fund	DSI	11/06	Social Leaders Large Cap	0.50%	$96M	33%
KLD Global Climate Index	KLD	1/05	Global Climate Large Cap Leaders	0.50%	$122M	32.2%
Market Vectors Alternative Energy ETF	GEX	5/07	Global Clean Energy	0.62%	$213M	10.5%
PowerShares WilderHill Clean Energy ETF	PBW	3/05	US – Clean Energy	0.69%	$772M	30%
PowerShares Global Clean Energy Portfolio	PBD	6/07	Global Clean Energy	0.75%	$203M	39%
PowerShares WilderHill Progressive Energy	PUW	10/06	Technologies that clean up conventional energy	0.70%	$58M	61%
PowerShares Cleantech Portfolio	PZD	10/06	Global Cleantech	0.67%	$145M	38%
First Trust NASDAQ Clean Edge ETF	QCLN	2/07	US Clean Energy-Related	0.60%	$43M	39%
Claymore/MAC Global Solar Energy	TAN	4/08	Global Solar	0.70%	$208M	27.7%
Market Vectors Solar Energy	KWT	4/08	Global Solar	0.65%	$34M	18.6%
First Trust Global Wind ETF	FAN	6/08	Global Wind	0.60%	$97M	24%
PowerShares Global Wind Energy	PWND	6/08	Global Wind	0.60%	$43M	31%
PowerShares Global Progressive Transportation Portfolio	PTRP	9/08	Global Efficient Transport	0.75%	$4M	52%
Claymore S&P Global Water	CGW	5/07	Global Water	0.70%	$260M	31.2%
PowerShares Global Water	PIO	6/07	Global Water	0.75%	$325M	42.2%
PowerShares Water Resources Portfolio	PHO	12/05	US – Water	0.64%	$1.33B	22.9%

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This article first appeared in our green investing newsletter, Progressive Investor.