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 ETFis thegreen 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 provisionof 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 2022, 115 countries have some level of commercial wind power capacity. ETFs based on wind power include:
One example of a wind power ETF is 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). China, United States, 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.
One example of a solar power ETF includes 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 f*ckushima Daiichi (2011) and Chernobyl (1986) incidents, utilities and miners have begun to focus their resources on uranium and nuclear energy.
An example of an ETF based on nuclear energy is 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.
Evaluating Green ETFs
Investors are in the market to make money. However, green ETFs add an interesting component where the entire goal may not be to maximize profits. For this reason, there may be complicated considerations when evaluating what a successful green ETF means. Consider the following potential evaluation measurements:
- Financial Performance Metrics: Let's state the obvious one first: success is measured by the ETF's ability to deliver competitive total returns compared to its benchmark index. If the ETF doesn't turn a profit, it just can't be considered a successful investment (even if it's doing great for the planet).
- Environmental Impact Metrics: Green ETFs have a few options here. Green ETFs may evaluate the carbon intensity of their holdings, measuring the amount of carbon emissions produced per unit of revenue generated by portfolio companies. Green ETFs may also measure its renewable energy capacity. Success can be measured by the percentage of a company's energy portfolio derived from renewable sources. These two examples demonstrate that it's not always about the dollars.
- Community Engagement Initiatives: Successful green ETFs may assess portfolio companies based on their community engagement initiatives. These initiatives may include things such as philanthropy, local development projects, and support for underserved communities.
- Sustainability Ratings: Green ETFs may reference MSCI ESG ratings which evaluate companies based on environmental, social, and governance criteria. Higher MSCI ESG Ratings indicate better sustainability performance.
- Innovation and Technology: Successful green ETFs may prioritize companies investing in and developing clean technologies, such as advanced energy storage, efficient solar technologies, or innovative waste management solutions. Though the companies may not yet be directly contributing to bettering the world, their solutions and the research going into them may help evaluate them as a future positive company to consider investing in.
Green ETFs and Regulation
One really important thing to consider when thinking about investing in green ETFs is prevailing regulation. Because these ETFs are niche, the government may protect investors by ensuring the ETF complies with what it proposes it is invested in.
The main regulatory agency involved here is the Securities and Exchange Commission (SEC). The SEC has proposed rules to make sure investment companies provide enhanced disclosures about environmental or ESG practices. The SEC has also modernized a regulatory framework to ensure certain conditions are met as part of the ETF's operations.
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.
