Best Investments: Alternative energy and climate change investment funds, part I

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Alternative Energy and Climate Change Mutual Funds, Part I | Alternative Energy Stocks

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Alternative Energy and Climate Change Mutual Funds, Part I Tom Konrad CFA

Understanding the costs of greenenergy mutual funds.

It's been a bit over a year since I last looked at themutual funds in the Clean Energy sector. Each year, I combthrough their portfolios for new ideas on where to invest my ownfunds and those of my green-minded clients, with the added bonus ofbeing able to help readers make better decisions about which fund, ifany, is right for them.

This year, I looked at the eight mutual funds from AltEnergyStocks' greenmutualfundlist. Inorderoffundsize, they are:
WinslowGreenGrowthFund(WGGFX), with $276 million in assets undermanagement.NewAlternativesFund(NALFX), with $240 million in assets undermanagement.CalvertGlobalAlternativeEnergyFund (CGACX and CGAEX),at$188M.AllianzGlobalEcoTrends Fund (AECOX), at $72M.GuinnessAtkinsonAlternativeEnergy Fund (GAAEX), at $45M.
DWSClimate Change Fund (WRMAX and WRMSX),at$41M.GabelliSRIGreenFund (SRIGX and SRICX),at $12M.FirsthandAlternativeEnergyFund (ALTEX), at $5.4M.These are not the only "Green" or "Ecological" funds available. Instead, they are the funds that I feel are the best match to my ownfocus on clean energy, although each manager has a slightly differentslant to how they approach green investing. There may be a fewthat should be here but aren't: I added the Gabelli fund to the listwhen a reader brought it to my attention.

Fund Costs

Far too many investors put their money in a mutual fund withoutproperly considering the costs. I think this is especially truefor green minded investors, who may be more concerned about doing theright thing for the planet tahn doing the right thing for theirfinances.

The chart below displays some of the costs of investing in thesefunds. The dark blue "Max Load" are for mutual funds that have anup-front charge when you first invest. Small investments pay thispercentage (between 4.75% and 5.75% of the total investment) for theright to invest, after which they pay a somewhat reduced annual expenseratio every year. (The annual expense ratio for load funds ranges from1.02% for the New Alternatives Fund to 2.01% of the Gabelli SRI GreenFund) shown below in light blue "Load Expense Ratio." Larger investments in load funds may qualify for a somewhat reducedsales charge or load, as a percentage of the amount invested.

No-load funds do not have an up-front charge, but typically have aslightly higher annual expense ratio, shown below in orange. TheCalvert, DWS, and Gabelli funds allow both options, which is why theyhave two ticker symbols. Typically the no-load shares are calledClass C shares, while the load shares are usually called Class Ashares. No-load class C shares charge annual expense ratiosranging from 1.45% for the Winslow Green Growth Fund, to as much as2.85% for the Calvert Global Alternative Energy Fund. Other shareclasses are often available to institutional investors, but I havechosen not to display them here since they are unlikely to be relevantto most of my readers.

Mutual Fund Expenses

Even the least expensive of these fund charges more than 1% each yearto manage your money. Over time, that is a large drag on fundperformance, so an investor should be confident that the fund manageris adding considerable value before investing in one of thesefunds. If the manager is not adding considerable value, it makesmore sense to invest using a typical cleanenergyExchangeTraded Fund (ETFs). I've included theexpenses for a typical ETF in the chart for comparison. In thecase of an ETF, the "load" is the fixed brokerage commission you pay tobuy the ETF; I assumed a $10 commission on a $1000 investment.

Fund Size and Expenses

It's no coincidence that the largest funds (shown at the bottom of thechart) have the lowest expenses. There are a large number offixed costs involved in running a mutual fund, and these show up inhigher expenses (as a percentage of invested assets) forinvestors.

Other Expenses

While a manager cannot do a lot about the size of his fund, one sourceof expense he can control is trading costs. Each time a portfoliomanager makes a trade, he incurs transaction costs in terms ofbrokerage fees, liquidity costs, and potential capital gains. Depending on how liquid the stocks are, and if the fund frequentlytrades in foreign markets, brokerage commissions and liquidity costscan range from 0.5% to as much as 2% or more of the value of atrade. If the fund has made profitable investments, any gain on asale will have to be distributed to fund shareholders at the end of theyear in the form of a capital gain distribution, on which tax must bepaid. This is an added burden of trading for taxable investors.

A fund's annual turnover ratio measures how often the manager trades inand out of positions, measured as the percentage of the portfolio thatis traded every year. Funds with annual turnover ratios in excessof 100% trade each position more than once per year. Each fund'sannual turnover ratio is shown in the chart above.

Conclusion

On the (fairly conservative) assumption that trading costs amount toabout 1% of trade value, I have combined typical fund expenses withestimated trading costs. The results are shown below. Thedark blue band represents the cost of the front-end load spread over aten year holding period, while the dark blue and light blue togetherrepresent the cost of the load if it only spread over five years. The three dark green to pale yellow bands should also be readcumulatively, with the lighter bands added on if we assume the fund'strading costs are higher rather than lower. The lighter shades ofblue and yellow represent a lower likelihood that these costs willoccur.

Expenses Including Trading Costs

Solely in terms of cost, the clean energy ETFs remain by far the bestoption. After that, the no-load funds the WinslowGreenGrowthFund(WGGFX), the FirsthandAlternativeEnergyFund (ALTEX), and the GuinnessAtkinsonAlternativeEnergy Fund (GAAEX)all have roughly comparable costs depending on your assumption aboutinternal transaction costs, with low estimates of transaction costsfavoring the low-turnover Guinness Atkinson fund. For a ten yearholding period, the total costs of the NewAlternativesFund(NALFX) are by far the best deal, but this load fund is onlycomparable to these no-load funds over a five year holding period, andwould be considerably worse over shorter holding periods.

In contrastthe GabelliSRIGreenFund (SRIGX and SRICX),the DWSClimate Change Fund (WRMAX and WRMSX),theAllianzGlobalEcoTrends Fund (AECOX), and the CalvertGlobal Alternative Energy Fund (CGACX and CGAEX)aremoreexpensive than the three funds listed above, let alone thesector ETFs. The Gabellifund not only has extremely highexpenses due to its tiny size, but it then adds to these expenseswith frenetic trading expressed in an unmatched turnover ratio of190%. The Calvert funds could also do much better as well:although theyhave done a reasonable job fighting transaction costs by keepingturnover down, the large fund size, at four times that of theconsiderably less expensive Guinness Atkinson fund, leavesconsiderable scope for reducing investor costs.

Investors who choose the Firsthand, Guinness Atkinson, Winslow GreenGrowth, Firsthand, or New Alternatives funds will pay roughly 1 to 1.5percent per year for the active management available in thesefunds. Given that Alternative Energy is a new and evolving sectorwithout extensive analyst coverage, active managers may be able to gainenough of a market edge to pay for those additional costs. I willlook deeper into these four fund managers' strategies and holdings infuture articles to try to determine which ones are most likely to beproducing value for money.

DISCLOSURE: No Positions. GAAEXis an advertiser on AltEnergyStocks.com.
DISCLAIMER: The information andtrades provided here are for informational purposes only and are not asolicitation to buy or sell any of these securities. Investing involvessubstantial risk and you should evaluate your own risk levels beforeyou make any investment. Past results are not an indication of futureperformance. Please take the time to read the full disclaimerhere.
Posted by Tom Konrad on November 3, 2010 01:43 PM | Alternative Energy and Climate Change Mutual Funds, Part I

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Comments

I would definitely be interested in some sort of value added analysis. My simple-minded analysis of a few minutes shows that if I had bought NALFX in June 2008 instead of GEX and QCLN (following your advice, but I'm not bitching ;), I'd be a lot less under water right now.

QCLN -32%
GEX -66%

NALFX -19%

However, GAAEX is -50% in the same period, so not any better.

Is NALFX lucky or good?

Is there more of a difference between managed and unmanaged in volatile times like these (see NALFX), or just as much opportunity to mess up (see GAAEX)?

Posted by: Steve Marton

| November 7, 2010 02:01 AM

I have been recommending the ETFs over the mutual funds over the last few years on the basis of price, and I now wonder if that was a mistake.

In any case, you should not compare GEX and QCLN to GAAEX, but rather to my favorite mutual funds of the same time.

I did not pick a favorite mutual fund until Feb 2009, but since then it has been WGGFX, which has strongly outperformed GAAEX since then.

But you're right, the ETFs have generally underperformed the mutual funds. Over the last couple of years I've come around to the belief that active management is quite valuable in this sector (and I'm always criticizing the ETFs for too large an allocation to Solar.)

I've always written that a stock portfolio like my annual 10 clean energy picks is a better alternative than the ETFs because of better sector selection, but now I'm beginning to think that some of the mutual funds might be better, too.

Here's a spoiler: I don't currently have a favorite mutual fund, but if you have to pick one, it should be one of NALFX, WGGFX, or SRIGX. Keep reading to find out why.

Another alternative if you're not ready to build your own portfolio is an investment advisor who will actively manage a stock portfolio and knows green energy. I know of two who are less expensive than these mutual funds... email me if you want names.

Posted by: Tom Konrad

| November 7, 2010 04:43 PM

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