Welcome back! The last week has gone by so fast researching more green investment options. Since this is such an organic process, I have made another change to my plan. After searching tirelessly for traditional index funds that would meet my criteria, I have decided to abandon these (for now) and change course just ever-so-slightly. This week I’ll offer some clarity about the pros and cons of achieving your sustainable investing goals through a passively managed ETF (Exchange Traded Fund).
What is it and why should I care?
An ETF is similar to and behaves like an index fund in that it is (usually) passively managed, allowing for a low expense ratio and tracks a chosen market index. The main difference between the two is that an ETF is traded on a stock exchange and can be purchased through a broker at any time of day that the market is open. Index and mutual funds require a separate account with the investment companies that provide them and can only be traded at the end of the day. So, if you have an online account with one of the many brokers out there like Zecco, Etrade, or TradeKing, you can simply log on and start trading. For a more in-depth explanation of the differences between an ETF and an index fund, take a peak at this article I found over at Investopedia.
Let’s compare some of the basic advantages to an ETF over a traditional mutual fund:
They’re passively managed – A sentient being rarely gets involved with the day to day management of an ETF. A fund is set up to track a specific index and does not attempt to beat it. That means that Sally, the trusty ETF computer, can handle all the day to day tasks of making sure the fund stays on track while we humans hang out by the pool knowing that our money is in good, binary hands. And this lack of active management keeps the fees down! Humans require paychecks, but Sally will work for free with minimal maintenance. If you remember from last week, the mutual funds I was researching all had expense ratios of 1.25% or greater. The green ETFs that I’ll tell you about below are all under 0.75%. You may think 0.5% is too little a difference to worry about. I did at first, too, but for the long term investor, 0.5% could equal some astronomical losses in potential gains. Compound interest is a force to be reckoned with.
They’re tax efficient – Since the way that shares are traded in an ETF are different from a traditional fund, there’s much less turnover, meaning that the fund manager does not have to buy and sell large amounts of holdings in order to let new investors in or old investors out. When a fund sells shares, it is required to pay a capital gains tax to the government. Obviously, the more often your fund is able to avoid this scenario, the better the overall performance will be and the more money you’ll keep in your pocket.
There’s no minimum purchase – One of the great barriers to entry into a mutual or index fund for younger, less-endowed (financially!) folks like me is the minimum amount required just to open an account. Oftentimes, the minimum is at least $1000 and can be as staggeringly high as $50,000! When you buy into an ETF, you can purchase just one, single share of it if you like. Now, I wouldn’t recommend this strategy seeing as the per trade fee from your broker would decimate your future earnings if you bought one share at a time, but having the option to get in for less up front can really help out the beginning investor who sees that account minimum as a giant hurdle.
On the otherhand, you’d be wise to consider the possible downsides to investing in an exchange traded fund:
They’re passively managed – Looks like this going to be another one of those double edged swords! If the stock market takes a turn for the absolute worst, an actively managed fund will abandon ship and shelter your money in temporary defensive investments. Most ETFs will do this as well, but when it comes to abandoning ship, Jane, the mutual fund manager who is paying attention to the market every day will probably be better prepared than Joe, the guy who has to turn off Sally the ETF computer and figure out what to do with his pot of money.
They’re easy to trade – If you’re like me and trying to set yourself up for a smooth, long-term investment, having the option to simply log on to your brokerage account and move money around may prove devastating to this plan if you do so. You’ll incur brokerage fees at each trade that could quickly wipe out the savings you thought you were getting from the low expense ratio! Let me repeat myself:
You’ll pay a brokerage fee for each trade – This is one area where traditional index and mutual funds can beat the pants off of an ETF. Unless your fund has a front-end fee ( a percentage removed from every deposit you make) most traditional mutual and index funds will allow you to add to your investment for no additional cost. Dollar cost averaging is a very useful investment tool that you will pay more to utilize for an ETF than for a traditional fund. If you’re going to dollar cost average into your ETF, I suggest finding the cheapest broker around and making sure that each trade you make is big enough to be worth the cost.
I can’t really say that there is anything terribly ugly about ETFs, but here’s the dirt that seems to be getting kicked around lately – over the last several years ETFs have experienced, overall, greater “tracking error.” This means that the funds have not matched the return of the index that they track as well as they “should have.” This could mean that they don’t perform as well, but it could also mean that they accidentally beat the return of the index! One explanation for this is that the ETF has gained a great deal of popularity lately. New funds are sprouting up all over the place to track new indexes that are appearing. New indexes and, subsequently, new funds are not perfect and are difficult to get right. This is definitely something to consider when deciding to enter the world of green investing. Most of the options out there are relatively new. While the explosion in popularity of socially responsible investing is exciting, all of these new funds to choose from could make for a bit of a bumpy road as the industry grows and matures. Personally, I am happy to know that I’ll be getting in near the beginning, exposed to all the potential growth. This likely won’t come without some rocky patches, but I’m willing to ride them out because I’m in this for the long-haul.
So on that note, I’d like to introduce you to the ETFs that I decided to research this week. There are six of them – all are based on clean energy indexes, three focused domestically and three focused globally.
Powershares Clean Energy (PBW) – PBW tracks the WilderHill Clean Energy Index (54 stocks of all market capitalizations, but mostly small) and has an expense ratio of 0.67%.
Powershares Progressive Energy (PUW) -Similar to the Clean Energy Portfolio but focuses on transitional energy – companies working to improve the cleanliness and efficiency of existing energy sources. The Progressive Energy ETF also covers all market caps and carries a slightly higher expense ratio of 0.73%.
Nasdaq Clean Edge US Liquid Series (QCLN) -This is another domestic fund that focuses on emerging clean energy solutions like solar power, biofuels, and advanced battery technology. QCLN uses a weighting methodology to give larger companies more weight in the portfolio but maintain a balance of all market caps.
iShares S&P Global Clean Energy (ICLN) – ICLN is a global fund that tracks the S&P clean energy index of 30 holdings across a fairly diversified field of clean energy companies. It also has the lowest expense ratio of all that I picked at 0.48%. Attractive.
Powershares Global Clean Energy (PBD) – This fund holds 80 different companies across a broad array of clean and alternative energy markets. While it has exposure to all market capitalizations, it is weighted heavily towards mid caps. PBD seems well diversified comparively speaking, but it boasts a pretty high expense ratio as well, 0.75%.
Van Eck Global Alternative Energy (GRN) – With an expense ratio of 0.62%, GRN tracks the Ardour Global Index with 30 holdings practically split between large and mid cap stocks. It should also be mentioned that Van Eck offers an Agribusiness ETF with the stock ticker symbol “MOO.” That’s funny.
As you might remember, back in Part One I laid out the criteria that I would use to guide my selection. After evaluating these ETFs based on those principles, my profile as an investor, and taking into account the reltive “newness” of all these funds, I feel my personal winner is the iShares S&P Global Clean Energy Fund. It has the lowest expense ratio of the funds I selected and the index that it tracks was created by Standard & Poors who’ve been around the block. I think they’re the best qualified to manage a successful index. Two of the larger companies in this index also have major operations in Oregon. Living in Portland, supporting them with my investment dollars feel good.
I feel good about this. I could analyze every option to death, but I feel I’ve done a fair amount of research on funds that fit my profile and I now have two funds remaining to compare side by side and select. Only one week remains until a final decision is made and I am on my way to bettering the world and my portfolio with a green investment.
Maybe you’ve found yourself interested in green ETFs. I hope you have. I would highly encourage you to take a deeper look at the funds that I outlined above, but don’t stop there! Those ETFs that I picked were hand selected for my own situation and there are many options out there to fit your particular needs. If you haven’t yet, please go back and read Part One to make sure that you fully understand your own situation before selecting an investment vehicle. Create your own investor profile and go from there.
Note: This is part three of a four part series on entering the world of green investments. The four parts are as follows:
- Part One: The Analyzation Stage
- Part Two: Researching Mutual Funds
- Part Three: Researching Green ETFs
- Part Four: The Final Decision