A basket of choice: exchange traded funds give green investors new options.

Green investors used to have two choices: invest in responsible mutual funds or buy individual equities. Lately, Exchange Traded Funds (ETFs) have emerged as a new, important place for green investors to park their money.

What's an ETF? It's simply a portfolio of stocks that trade on a stock exchange the same way individual stocks do. There are thousands of ETFs, tracking virtually every industry or sector of the market.

Often, ETFs are baskets of companies involved in a specific market sector. Over the last couple of years we've seen ETFs launch that track clean energy, clean technology and water. ETFs provide a highly liquid, tax-efficient way to invest at low cost--usually about half a percent compared to the usual 1.5 percent range for mutual funds.

ETFs are bought and sold by investors in the same way stocks are. More advanced investors can also hedge an ETF, "shorting" it, for example, if they believe the price will drop. Of course, some stocks in an ETF will do better than others, so if you feel strongly about an individual company you still might do better by purchasing its shares directly.

Drawbacks and Decisions

While socially responsible mutual funds actively advocate for change with the companies they hold shares in, you won't find that with ETFs.

The first ETF to debut in our field was the PowerShares WilderHill Clean Energy Portfolio (PBW), launched in 2005. The $800 million fund consists of 42 companies that make up the clean energy sector in the U.S. Here you'll find the pure-play companies we all want to succeed, such as Evergreen Solar (ESLR) and Fuel Cell Energy (FCEL). It combines companies most likely to profit from the fight against global warming.

In October 2006, two additional and similar ETFs came on the market. Neither have gained the traction of the first ETF, PBW. The $31 million PowerShares WilderHill Progressive Energy Portfolio (PUW), owned by the founders of PBW, is a basket of 43 U.S.-listed companies that are significantly involved in transitional energy technologies, by increasing the efficiency of, or cleaning up, fossil fuels. Examples of companies include Itron (ITRI), the largest automatic meter reading company, and Toyota (TM). Although PBW is vastly more popular in terms of assets, the PUW has actually performed better; nine percent for 2006 versus 5.09 percent for PBW.

The $33 million PowerShares Cleantech Portfolio (PZD) goes beyond clean energy, investing in companies that have green materials, reduce waste, energy or pollution. The most recent entry to the group is the First Trust NASDAQ Clean Edge U.S. Liquid Series Index (QCLN), which also covers the clean energy group. An international ETF based on the the WilderHill New Energy Global Innovation Index (NEX) should launch soon.

A very popular ETF focuses on water. The $1.4 billion PowerShares Water Resources Portfolio (PHO) consists of 42 companies in the U.S. water industry. Although they aren't chosen for their environmental focus, they give investors exposure to all sectors in the industry, from infrastructure build-out to water treatment. Conglomerates in the index include GE, a company that presents problems for green investors because of nuclear and defense divisions. But GE has greened its operations recently, working closely with the World Resources Institute. Also part of the picture are smaller companies like Badger Meter, another leader in automatic meter reading. The water sector has been on a ride for the past few years--for 2006, the ETF rose 23 percent.

General ETFs have also entered the market. The $79 million iShares KLD Select Social Index (KLD) started in January 2005 and consists of 216 large cap companies. It tracks the Russell 1000. Its largest holdings include IBM, American Express and Johnson & Johnson. The ETF rose by 11 percent for 2006.

The $30 million iShares KLD 400 Social Index Fund (DSI) launched a few months ago. It also consists of large caps and tracks the S&P 500. Both KLD ETFs include companies that excel on both social and environmental performance. Investors gain exposure to a broad set of criteria, such as climate change, treatment of overseas workers and executive compensation.

Other major sustainability indexes in the field--FTSE4 Good indexes and the Dow Jones Sustainability Index--are planning to launch ETFs this year. Clearly, the KLD funds are more appropriate as core holdings in a portfolio. They're for investors that want exposure to fairly conservative large caps with strong environ mental and social records. The holdings aren't perfect though--expect to see fast food, oil and big-box stores. These funds will be less volatile than the specialty funds.

Investors that want to "get in" on the emerging cleantech sector now have several choices. Expect volatility as the field grows and new companies enter; it shouldn't comprise more than five percent of a portfolio.

RONA FRIED is CEO of Sustain ableBusiness.com and Editor of Progressive Investor.