Eco ETFs Grow In Various Shades Of Green

The good news about “eco-investing” these days is that investors have more choices than ever. The bad news is that none of the choices is perfect. All this came into focus this week with Earth Day celebrations and a carbon-free fund that went into registration.

The proposed fund, the FFI U.S. Large Cap Fossil Free ETF, is an interesting and innovative idea, but has serious limitations. It’s worth looking at this fund and at this eco-investing realm, as the climate-change issue isn’t going away, meaning the focus on alternative energy is likely to persist.

Moreover, some countries—like China and those in northern Europe—are pushing forward with wind and solar energy because they consider the development of those sources of energy to have national security implications.

Let’s start by looking at a chart comparing returns in the past year of the index underlying the proposed fund with returns of the SPDR S&P 500 ETF (SPY | A-98) and those of the Energy SPDR Select Sector Fund (XLE | A-98), the latter serving as a proxy for the exposure this proposed fund plans to eliminate. XLE, deeply in the red, has bombed in the past year as oil prices have plunged.

Again, the proposed FFI U.S. Large Cap Fossil Free ETF is basically a “subtractive” approach to the climate change issue. It will serve up S&P 500 exposure—minus all the hydrocarbon sinners of the world, which it has categorized in a listing cleverly called the “Carbon Underground 200.” That’s the main reason SPY’s returns in the chart below trail those of the FFI Index. In other words, SPY is weighed down by its 8 percent weighting to energy stocks and its 3 percent weighting to utilities.

Chart Courtesy of Bloomberg: Returns of Fossil Free Index vs. SPY and XLE in past 12 months

Filling The Holes

That’s all well and good, except it’s not allocating any investment capital to energy. That’s a huge blind spot for an investor, especially considering that coal, oil and gas have been at the very center of the industrial revolution. The point is, not investing in energy is tantamount to not investing in the future.

So, a few “additive” ideas are necessary to fill the gaping energy hole created by the carbon-free approach to that served up in the FFI U.S. Large Cap Fossil Free ETF. Thankfully, and true to the rich and diverse world of ETFs, myriad options are available on the market that could accompany this fund once it goes live.

I’m talking about niche funds, such as the following:

• Market Vectors Global Alternative Energy ETF (GEX | B-19), a fund with $89 million in assets under management (AUM) that’s been around for almost eight years. It canvasses various pockets of what might be considered alternative energy, and includes household names like Tesla, Vestas Wind Systems and Solar City.
• Guggenheim Solar ETF (TAN | B-39), a more niche-y play that drills deeply into the world of solar energy companies, tilting heavily to U.S. and Chinese firms. It has $447 million in AUM, putting it in the company of some of the successful niche ETFs.
• First Trust ISE Global Wind Energy Fund (FAN | D-30), another niche-y play that drills into the world of wind-derived electricity generation. It has $40 million in AUM.
• Global X Uranium ETF (URA | D-100), the ultimate niche fund that’s chock full of uranium producers around the world. The inclusion of this fund is bound to anger hard-core environmentalists, but let’s call a spade a spade: Electronuclear energy is—Chernobyl and Fukushima radiological disasters notwithstanding—a carbon-neutral energy source.

The chart below, including SPY in fuchsia just trailing TAN in green, gives you an impression of how these ETFs have performed in the past year. URA, the uranium fund, is the loser.

Chart courtesy of StockCharts.com

There are a few takeaways in this chart—not least that solar energy seems to be becoming disconnected from oil prices. Oil has lost half its value in the past year, but solar energy remains very much in demand. Also, uranium is a “drench or drought” type of proposition. URA fell out of bed after Japan’s March 2011 nuclear disaster, but has come to life with even the slightest hint of renewed interest in nuclear energy.

Wind—while growing in popularity—is more closely tracing oil prices, while a diversified alternative energy fund like GEX (in black) seems to split the difference between solar and wind.

Finally, SPY is among the top performers, not least because a marketlike diversified slice of large-cap companies historically does relatively well compared to most other slivers of the market.

2 ‘Green’ Funds For Boring Grown-Ups

There are, however, two funds that are the ultimate pragmatic choices for investors intent on “doing the right thing” in terms of climate change while simultaneously not shooting themselves in the foot. Not shooting themselves in the foot means remembering to keep diversification and asset allocation in sharp focus.

Here are the two funds—both seeded by the United Nations—that are trying to “have their cake and eat it too,” according to ETF.com’s analysis:

• SPDR MSCI ACWI Low Carbon Target ETF (LOWC), $92 million AUM
• iShares MSCI ACWI Low Carbon Target EYF (CRBN), $150 million AUM

These two essentially identical funds are dead-serious, broad-as-you-can-get index funds. But they have gradualist twists that emphasize firms that have low-carbon footprints. Actually, it’s more accurate to say that they tilt slightly away from firms with bigger carbon footprints.

To those who notice “MSCI ACWI” in the names of the two “eco-ETFs,” that’s pretty much what these are. They own an optimized version of all the planet's investable equities—with the lower-carbon-footprint tilt, of course.

To be clear, these two funds could plausibly serve as a typical investor’s entire equities allocation, meaning these are green funds that indexing legends like John Bogle or Burton Malkiel might seriously get behind.

As you might expect, the returns of LOWC and CRBN since they both launched in November 2014 are basically indistinguishable from funds like the iShares MSCI ACWI ETF (ACWI | A-95). The differences in sector allocation focus on energy and utilities, though the differences are slight.

Chart courtesy of StockCharts.com

This gradualist approach to addressing the climate change issue might be annoying to stalwart environmentalists. But you certainly can’t fault these funds for lacking real-world underpinnings.

For now, the iShares fund ACWI allocates almost 7.75 percent to energy and 3 percent to utilities, while the two green ETFs have energy and utilities allocations of 6.4 percent and 2.3 percent, respectively. Over time, LOWC and CRBN might actually satisfy the most demanding environmentalists by looking quite like carbon-free or very carbon-light portfolios.

Aggressive investors looking for instant alpha in alternative energy are likely to find quicker gratification in places like the private equity universe for superconcentrated and high-beta bets. But my purpose here is to illustrate, as I often do, that the world of ETFs is almost always willing to oblige investors with a particular objective and a willingness to do a bit of homework.

At the time this article was written, the author held no positions in the securities mentioned. Contact Olly Ludwig at [email protected] or follow him on Twitter @OllyLudwig.