Hoping to profit by going green

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Interest in green investing has blossomed, thanks largely to Al Gore's 2006 documentary, "An Inconvenient Truth," and soaring oil prices, which have fueled a sharp rise in alternative-energy stocks.Many green funds are full of solar, wind and water energy companies. But you'll also find companies such as Google, Apple, IBM and Johnson & Johnson. Morningstar analyst Michael Herbst says funds take two basic approaches to green investing.The first group takes what I'll call the direct approach. They invest in companies that produce goods or services aimed at solving environmental problems. They typically invest in alternative energy, conservation, recycling, organic foods and pollution control. Some invest in nuclear power, some won't.The second is a "best-in-breed approach, where managers are looking at various sectors or industries and trying to find the greenest retail store or auto manufacturer," Herbst says. Such a fund might own an oil company if it is deemed the cleanest oil firm.Some green funds blend these two strategies but most lean more heavily in one direction or the other. It's pretty easy to figure out which way a fund tilts by reading its Web site and prospectus and looking at its portfolio. If its top holdings are companies such as First Solar, Whole Foods or Vestas Wind, it's probably taking the direct approach. New Alternatives, PowerShares Wilder Hill Clean Energy Portfolio, Guinness Atkinson Energy and Winslow Green Solutions are in this camp.If the fund owns companies such as Microsoft and Procter & Gamble, it's probably taking the best-in-breed approach. Portfolio 21, Green Century Balanced, Green Century Equity and Spectra Green fall into this category.Which is the better shade of green depends on your environmental philosophy, but investors should be mindful of the risks inherent in the two approaches.The best-in-breed funds tend to be more diversified across economic sectors and generally invest in bigger companies. They might be less volatile and more appropriate as a core holding.Funds taking the direct approach are less diversified and often invest in smaller companies, which makes them riskier and more volatile over the short run. Many of these companies are also subject to shifting political and regulatory landscapes, which add another layer of risk. Funds that focus exclusively on alternative energy are even more narrowly focused and influenced by oil prices.Many of these funds did quite well in 2006 and 2007 when energy prices were soaring and investors were willing to shoulder a lot of risk, but have struggled in 2008."They are sector funds in essence," says Morningstar analyst Bill Rocco. "Any kind of green energy fund is narrow and should be used in small doses."Robert Cohen, a financial adviser in Berkeley, Calif., agrees. "As a stand-alone, get-rich concept, it probably doesn't make sense," he says. "The time to invest (in these funds) was before Al Gore made a movie."However, Cohen says a green energy fund could make sense for investors who have most of their money in socially responsible funds. These are broad-based funds that take a wide variety of social factors, not just the environment, into account. These funds tend to be light on energy stocks and many have been lagging the broader market as a result.Lloyd Kurtz, a principal with Nelson Capital Management in Palo Alto, Calif., says buying an alternative-energy fund today is like buying an Internet fund in the late 1990s."We don't even know which technology is going to win -- natural gas, solar, wind," he says. Plus, a lot of the most promising companies are still private."If you owned an Internet fund in 1999, you did not own Google," Kurtz says.Investors should take note of a fund's overseas exposure. Many green funds have a large percentage of their assets abroad, mainly because Europe has been quicker to commercialize alternative energy than the United States has.In the past few years, owning foreign stocks generally helped a fund's returns. Overseas markets have mostly outperformed the U.S. market and the falling dollar produced currency gains when a fund repatriated its foreign profits. If the dollar started climbing against foreign currencies, funds with foreign holdings could realize currency losses that would detract from their returns.Investors also should decide if they want a traditional fund or an exchange-traded fund. Most of the traditional green funds are actively managed, which means they have people researching and trading stocks based on their green credentials and profit potential. Traditional funds can be purchased directly from the fund company or through a broker and are priced once a day when the market closes. E-mail Kathleen Pender at kpender(at)sfchronicle.com. For more stories visit scrippsnews.com