The world might be waiting for green shoots but followers of the "climate economy" and those making socially responsible investments (SRIs) have even greater interest in matters green, writes CAROLINE MADDEN.

GENERALLY AT times of economic crisis, environmental issues are placed on the back burner. This time around the opposite is true – many countries have closely linked their economic recovery plans to the green agenda.

According to research carried out by HSBC, governments around the world have allocated almost $480 billion (€340 billion) in fiscal stimulus to the growing “climate economy” (which covers renewables, energy efficiency, water, low-carbon transport and so on), with the US and China leading the way.

Already these “green stimulus” packages are beginning to have a material economic and industrial impact.

It appears that the green investment theme has finally gone mainstream, at least from an economic policy perspective. Should the small retail investor now follow the lead of Obama et al? And if so, will they have to accept a lower rate of return as a trade-off for making a conscience-salving socially responsible investment (SRI)? And should they be worried that the hotly-tipped green theme could turn out to be the next bubble?

“Sustainable investing has done its time in terms of apprenticeship,” says Nick Robins, head of HSBC’s Climate Change Centre of Excellence. “People have been working in it for 10 or 15 years, people know how to do it. There’s no reason why you should actually have to sacrifice any returns for this.”

Within the broad SRI umbrella, funds with a largely ethical focus (eg they don’t invest in “vice” industries, such as tobacco or gambling) have tended to perform in line with, or a little below, the market, says Robins. However, funds with more of a “sustainability” focus (ie addressing climate challenges) tended to outperform – at least they did until the end of 2007.

During the stock market wipeout of 2008, sustainability funds generally fell in line with the market, he says, although a number of funds were particularly badly hit, such as those in clean energy. These funds are perceived to be higher risk, he explains, because they are often invested in smaller companies. “So when markets react to a crisis, people move to larger, safer companies,” he says. He predicts that as markets pick up, the stocks in this sector will bounce back quicker than others.

But if investors rush to invest in the renewables and the clean energy space simply because of the massive injection of government fiscal stimulus into this area, isn’t there a risk of a bubble forming?

“In a sense there have already been bubbles,” he says. “The clean-tech sector was . . . caught up in the dotcom bubble. If you look at some of the wind technology companies – they were taken up and they came down.” In more recent years, the amount of capital chasing opportunities in the green sector, and, in particular, the solar area, sparked fears that another bubble might be forming.

“I think that is a continual risk [of a bubble], but what I’ve seen is that you do have now a lot of very smart fund managers who can spot that,” he adds. As the sector broadens, investors have more choice and can move out of themes that show signs of overheating. “You have now more choice globally,” he says.

Nevertheless, rather than simply following the $480 billion “green stimulus” money trail, investors must do their homework and consider whether an investment proposition stacks up, and offers real value and sustainable returns, before putting their own cash on the line.

When selecting a fund, Robins advises investors to take care to identify the style being offered by the fund manager, because funds that fall under the “sustainable” label can vary widely. “There isn’t a sort of “one size fits all” approach so . . . look under the hood, find out what the fund manager is doing,” he recommends.

“The fundamental criteria for selecting an investment strategy are the same in this space as they are elsewhere,” says Jean Ryan, investment specialist at Dublin-based KBC Asset Management, the main player in the green funds sector in Ireland. Investors should look for long-term growth drivers. In addition, the fund manager should have a proven track record, and the fund must offer adequate diversification.

Last year showed that although investment themes such as renewable energy and water may have strong long-term return characteristics, they can be volatile, says Ryan. Therefore, diversification is essential in order to minimise the impact of falls in particular areas of the green sector. First, she recommends that investors should make sure that the fund is well-diversified across the market capitalisation spectrum. Ideally the fund should contain a mix of large-cap, mid-cap and small-cap companies.

Second, she advises checking that the fund is well-diversified across regions and sectors. “You really don’t want a renewable fund that has 30 per cent in geothermal for example, because you’re going to be terribly vulnerable to a downturn in the prospects for that particular sector, or if one of the market leaders has a bad set of results,” she says. It’s also advisable that retail investors only allocate a maximum of 20 to 25 per cent of their overall portfolio to green investments.

So far, investor confidence in this area remains muted despite the green stimulus packages, but there are signs of a tentative pick-up. For example, sales of European screened SRI funds turned positive in April at €682.5 million, reversing outflows of €25.3 million from these funds in March.

Ryan has noticed a little more retail investor activity in the last four or five weeks, but says that there is still a high level of risk aversion. “People are being more discerning and more directional in terms of where they’re making investments as opposed to just buying back generally into the market,” she observes.

Areas that people would traditionally have invested in, such as banking and property, they now “wouldnt touch with a bargepole”. Investors are now looking for areas that offer strong growth prospects, but which are consistent with “the new world we’re living in,” she says, and so the green investment “thesis” is starting to look more attractive than ever.