Renewable energy ETFs have attracted popular approval, and not just with socially conscious investors. Still, are these ETFs good investments?

A number of renewable energy ETFs have emerged over the past few years as concerns over the environment have grown. However, some of the stocks in those renewable energy ETFs may have only limited investment appeal.

Indeed, some are only profitable—if at all—because they receive government subsidies. But those subsidies are in danger of being cut in many places given budget deficits and long-term debt levels.

To cut your risk, we recommend that you largely focus on individual renewable energy stocks instead of a renewable energy ETF. Above all, look for stocks that already have a sound base of other operations—such as a wind-farm operator that also operates natural-gas fired power plants. This diversification helps offset the risks of expanding into renewable-power production.

Themed ETFs like renewable energy may have a lot of emotional appeal. But when you indulge in theme investing, you may allow a theme or concept to take a central place in your investing decisions. Usually the theme or concept includes some prediction about the future that has some truth in it, and will make noticeable changes in society. You may assume that if you can just get on-board that theme or find an investment with its future tied to it, you are bound to make money.

In other words, you are buying what you might call a “Big Idea” without making certain that a particular investment has a workable business concept, or the management strength and integrity that it needs to overcome competition and profit from it.

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Themes like renewable energy ETFs can cause you to overlook crucial details. A key problem is that if the theme is your overriding investment consideration, it’s all too easy to get lazy about examining the details. You may feel that all the hard work has been done for you. You may come around to the view that the theme is so powerful that you can safely disregard p/e ratios and other measures of value and risk. You may wind up basing investment decisions on offhand projections or self-serving advice from promoters. That can distract you from looking at the stocks, and their fundamentals, that an ETF holds.

Keeping those facts in mind can help you spot stocks with extra potential. But if you let the theme make the decision for you, you are sure to overlook some risks.

In general, we like ETFs. Their MERs (Management Expense Ratios) are usually much lower than those of mutual funds. That’s because most ETFs take a much simpler approach to investing. Instead of actively managing clients’ investments, ETF providers invest so as to mirror the holdings and performance of a particular stock-market index.

• ETFs are less expensive to hold. Some ETFs give you a low-cost way to invest in a narrow market segment. But at the same time, that’s typically cheaper than investing in a mutual fund with a similar focus. Fees can be as low as 0.10% a year for many ETFs vs. mutual funds that can charge you 2% to 3% or higher on their fund. That means ETFs can save you a lot of money and boost your returns if you are investing over time.
• ETFs trade on stock exchanges, just like stocks. That’s different from mutual funds, which you can only buy at the end of the day at a price that reflects the fund’s value at the close of trading.
• Low turnover. Shares are only added or removed when the underlying index changes. As a result of this low turnover, you won’t incur the regular capital gains taxes generated by the yearly distributions most conventional mutual funds pay out to unitholders.

ETFs do have their risks. For example, if you’re considering investing in a renewable energy ETF, consider our advice below:

• ETFs can be volatile, depending on the stocks they hold, even with the diversification they offer.
• Know how broad the fund is, so you can determine its volatility. The broader the ETF, the likely less volatile it will be. A sector-based ETF like one that tracks resource stocks may be very volatile.
• Know the economic stability of countries when investing in international ETFs. It’s also good to mention that foreign leaders may not be your ally when it comes to passing legislation that can affect your investments
• Know the liquidity of ETFs you invest in, look at the volume of shares that trade hands on a daily basis.
• Determine if the ETFs you buy will include capital gains distributions.
• Consider buying ETFs in a lump sum rather than periodic small amounts to cut down on brokerage fees.
• Never forget that fads change. When a fad fades, as they all do, the fund’s liquidity many die out with it. The manager may have to dump the fund’s holdings when demand is at its weakest, forcing prices lower than they would otherwise go. Likewise, the same investors who are excited about investing in renewable energy companies are also apt to flee when stock prices start falling.
• Don’t invest in ETFs that show wide disparities between the stocks they hold and the investments that the sales literature describes. Despite the increased attention on ETFs in 2024, many ETF managers continue to describe their investing style in vague terms.

Are you invested in a renewable energy ETF? Has its price growth met your expectations? Share your experience with us in the comments.

This article was originally published in 2016 and is regularly updated.