The Next Big ThingMove aside, tree huggers. More and more hardheaded entrepreneurs are tapping into the growing green market.

It's 2040, and America's corporate titans have convened for a conference boondoggle to compare net worth and catch up on the latest gossip. A mellow Bill Gates presides over it all with the kindly mien of an elderly uncle. But tech is not the star of the show. No, that guy chugging a brew was one of the first entrepreneurs to invest in fuel cells, the very ones that are used in every American car and that now constitute a multibillion-dollar industry. The lanky woman dancing on the deck, which is made of recycled plastic bags, is a much-feared solar baron. The burly guy with the bulging biceps? He's made a fortune in real estate, building environmentally certified houses and condominiums. And the rude guest sniffing the food runs a chain of organic supermarkets that has Wal-Mart seriously concerned. The big economic winners of the past few decades, it turns out, have been those who decided that green is good--and a good way to get rich.

This scenario is fiction, of course, but not quite a fantasy. After years--in some cases, decades--of searching, businesspeople have finally discovered the existence of a green market. And it is growing, in some sectors phenomenally. Sales of organic foods are increasing 20% a year; the federal government's General Services Administration is requiring all new buildings it authorizes to be energy-efficient; the sale of hybrid cars has cruised from zero to 36,000 in just a few years; and the share of venture capital going to green-energy technologies has tripled since 1999.

What's more, we appear to be at the beginning of a major cultural shift--the kind that could finally make green businesses viable in the mass market in the next decade or so. The war in Iraq has put the spotlight once again on our fossil fuel crutch. Even some conservatives are raising concerns about global warming. Large corporations like General Electric are investing in wind power. Fuel cells have become a hot technology among Silicon Valley entrepreneurs. President Bush wants to allocate $1.2 billion to develop hydrogen-powered cars. And more than a dozen states are requiring utilities to increase their supply of green power. (Fifteen percent of Illinois's power will come from renewable resources by 2020.)

But let's not get too carried away. Last year Americans bought almost 17 million cars; 99.8% of them were not hybrids. Venture capitalists are happy to answer phone calls from green inventors, but green energy accounts for only 2.3% of investments, according to Joel Mackower, co-founder of Oakland-based Clean Edge Technology, an investing consultant. Yes, the green market exists; no, it won't make you a millionaire overnight.

Market-research types like to talk about the "production-diffusion S curve." That is the idea that a successful product starts slowly, and after it secures itself in the market, sales begin to accelerate. A few green products, such as organic foods, have hit the accelerator; many more are still in the slow-growth stage and may never crawl out. Businesspeople who can identify the green products that are most likely to go from niche to mainstream to mass consumption--well, they just might be invited to that bigwig cocktail party in 2040.

How to get there? By being at least as good at business as you are committed to the environment. (To see 14 entrepreneurs who are doing just that, see their profiles, Here Comes the Gold Rush.) The U.S. market is very tough on products that are clean and green but that fail in regard to price, quality, or convenience. Even a company that prides itself on its green ethos, such as New Belgium Brewing Co. in Colorado, got rid of its water-saving urinals because--to put it bluntly--they reeked. If even the greenest companies won't make that kind of sacrifice, it's a safe bet that customers won't either. "If you look at the green consumer," says environmental-marketing consultant Jacquelyn Ottman, the "consumer part is more important than the green part. People buy laundry detergent to get their clothes clean, not to save the planet." The trick is, if you can clean people's clothes and the world at the same time, you'll have a real competitive edge.

That view is confirmed by an annual survey of green attitudes conducted by the market researchers at RoperASW. Their findings: About 9% of Americans are "true-blue greens"; they are the most likely to "walk their environmental talk." Another 6% are "greenback greens"; they are folks who are likely to buy green but not at the expense of comfort or convenience (only a quarter of them bother to recycle). Another 31% are "sprouts"; they go back and forth on green issues. And the rest don't really care. All told, only about one in five Americans participates in some form of environmental activity, ranging from recycling to donating money. The message, then, is that for business to make money out of greenery requires a steely-eyed recognition of reality--that people do not and will not weigh the social, ethical, and environmental consequences of every purchasing decision.

Need more evidence? The Toronto-based International Institute for Sustainable Development figures that no more than 2% of North American consumers are "deep green"--that is, willing to seek out and pay for environmentally superior products. If that seems low, it's because you've probably seen surveys (much loved by green groups) in which people announce they'd be willing to pay more for green products. About half of all respondents told that to RoperASW, for example, when they were asked about purchasing cars, power, homes, and appliances. How to explain the disparity? Not to put too fine a point on it, but those respondents are lying.

Take a look at power. More than 300 utilities in 32 states now offer "green pricing." In those programs consumers can decide to have some or all of the power they pay for generated by renewable technologies such as wind, landfill gas, geothermal, hydropower, solar, and biomass. For about $21 a month--about the price of a Starbucks Frappuccino once a week--an average American home could green its entire power supply.

Nearly half of all electric consumers have access to such programs, says Lori Bird, senior energy analyst at the National Renewable Energy Laboratory, but only about 425,000 have signed up. That's less than 1%. The most successful utility, Moorhead Public Service in Minnesota, has enrolled almost 6% (Minnesota always seems to be first in these things). Green pricing is new and hasn't been marketed particularly well. Still, it's hard to look at this example and conclude that there exists a huge market, clamoring for the opportunity to spring for greenery.

The key for green entrepreneurs, then, is not to rely on consumer virtue but to compete on price and quality. For instance, Philadelphia's White Dog Cafe is about as green as it gets, running tours to local farms and taking care to source its products from responsible vendors. But at heart the White Dog is about serving good food. Only after delivering on its core product can it sell environmentalism as an added value. Green entrepreneurs are most successful not when they get people with a tortured social conscience to buy but when they also sell to those who don't really give a damn--and that requires getting the price down.

That's an issue that wind-power companies have begun to face head-on. The combination of an environmental push from state governments interested in diversifying their power supply and the economic pull of falling prices has made wind the country's fastest-growing power source. In fact wind power may be less than a decade away from affordability. Solar-power companies, however, are still lagging behind. Much of the industry remains heavily dependent on subsidies and do-goodism. Successful solar companies like PowerLight say they welcome the challenge of weaning themselves from government largesse, and solar costs, too, have dropped substantially. But even though solar in some respects is greener than wind--windmills kill birds and take up a lot of land--the comparative economics mean it is much further from joining the mainstream.

One sector that has had success selling green goods to the great unwashed is the building industry. Green building--construction that emphasizes energy efficiency, resource conservation, indoor air quality, and the use of environmentally sensitive materials and techniques--is still in the minority. At best, say real estate market researchers American LIVES, less than 2% of new homes meet any kind of green ethos. (Some 1.6 million new homes are built a year in the U.S.) America's first green residential high-rise is only now being built: the Solaire, a 27-story luxury building in New York's Battery Park City, a stone's throw from ground zero.

What's interesting, though, is not the state of the green building industry now, but where it is going. And it is charging headfirst into the mainstream. Says John Knott Jr., a South Carolina-based developer: "There is not a single major manufacturer that does not have a major focus on green design features. You cannot find one that does not have a major initiative in this area." As recently as five years ago such a statement would have been ridiculous.

Places that have been most systematic about encouraging green building are seeing tremendous growth. This year 1,000 of Atlanta's 40,000 housing starts will be EarthCraft-certified--a designation awarded by the Southface Energy Institute for buildings that meet various environmental requirements. A similar program in Colorado, known as Built Green Colorado, already has a 12% market share of new residential construction. There are rating systems in 15 other states, and more are in the works. And commercial developers have gone greener faster, thanks to national guidelines known as LEED (Leadership in Energy and Environmental Design), which is probably just a few years away from becoming standard.

Why are so many builders flocking to meet those requirements? Because once they do, they are able to charge a premium for their homes. Sure, green buildings may cost more to construct, but the public has been convinced that they will receive health benefits and a sturdier home, things that they're willing to pay for. So developers can get their price without ever appealing to the buyer's sense of environmental guilt. In fact, green builders tend to emphasize not the green aspects of their work but the ancillary benefits, such as lower energy costs, better construction, and improved indoor air quality.

The building trade offers some useful tips for other businesses that want to break out of the green ghetto. One lesson is that agreed-upon standards can help. Before the various rating programs, homebuyers couldn't easily evaluate claims to greenery; a recognized certification does the work for them. Second, green works best when it is linked to other values, like health and quality. Third, consumers are likelier to try going green when it's easy and convenient for them to do so.

Like the building industry, organic food has made it into the mainstream, not so much by selling the environmental benefits of free-range chickens or pesticide-free soil but as a healthy alternative to factory-farmed "Frankenfoods." "While we do our best not to use negative stories to accelerate sales," says Bob Scowcroft, executive director of the Organic Farming Research Foundation, consumer interest "spiked around organic every time a major news story came out" regarding subjects like mad cows or infected milk. The Department of Agriculture, which implemented standards in 2002 to label organic foods, is careful to say that there is no proof that organic food is healthier. But despite those efforts, people tend to think it is, which works in the industry's favor. So does the idea--generally true, in fact--that organic foods are grown by small-scale salt-of-the-earth family farmers, not massive agribusinesses. So to the typical consumer buying organic doesn't just mean buying green; it also means choosing healthier food and supporting a near-extinct way of life.

Since 1990, says Heather Givens of the Organic Trade Association, the market for organic foods has increased some 20% a year, reaching $11 billion in 2002. At least one in five U.S. households buys organic occasionally or more often. To be sure, that's still only a drop in the food bucket--about 2% of the nation's grocery bill. But with organic sales growing five times as fast of those of conventional food, market share will undoubtedly expand.

Organic producers will not be able to compete on price anytime soon; a cruise through a local market found that organic apples cost $4 a pound (vs. $2.50 for conventional ones), organic milk $3.39 for a half-gallon (vs. $1.99), and so on. Until the price gap narrows considerably, America's grocery carts are not going to be brimming with organics; for a family of four to go totally organic would cost an extra $2,800 a year. But the market is still nowhere near peaking. For one thing, organics are easier than ever to buy, no longer requiring a pilgrimage to some dingy co-op on the edge of town. Almost 40% of organic food is sold through conventional grocery outlets like Safeway and Krogers, not natural-food stores or farmers' markets. Heck, Wal-Mart sells organic.

Conventional food producers are also getting into the act, a clear sign that the industry is hitting critical mass. Danone bought a major share of Stonyfield Farm; Heinz bought a piece of Hain Celestial; General Mills bought Small Planet Foods; Kellogg bought Worthington Foods; Philip Morris (!), now Altria Group, bought Boca Foods; PepsiCo's Frito-Lay division is testing organic snacks. That's virtually a shopping list for Middle America.

I'm afraid the touchy-feely days of the industry are over," mourns a participant in an organic foods Internet chatroom. But for those who want to build a big and vibrant green market, that's precisely the point--to make the jump from movement to mass, from touchy-feely to normal capitalism. Whole Foods Market, an organic supermarket chain (page 82), didn't get to $2.7 billion in annual sales by limiting itself to the lentils-and-Birkenstocks brigade; it went after yuppies and soccer moms, and the whole organic industry has benefited.

What it comes down to, then, is that the best way to tap into the green dollar is indirectly. Don't limit your vision to the true believers. Sniffs Jeff Seabright, director of Green Strategies, an environmental consultant: "Owners of SUVs are not green consumers." That's exactly the wrong attitude to have. The fact is, they are--just take a peep at the gas-guzzlers that fill the parking lot of any suburban Whole Foods Market.

That's a lesson the 14 companies we profile over the next several pages are taking to heart--and turning into exciting, promising businesses. You'll also find an interview with Geoffrey Ballard, the opinionated pioneer of the fuel-cell industry, as well as our take on green investing. If smart businesses approach this growing market intelligently, they should see plenty of green--both environmental and the other kind.

Is It Finally Time to Invest Green? So-called socially responsible funds used to mean a clean conscience but lackluster returns. That's no longer true.

Investing ethically is hardly a new concept--for thousands of years Jewish law has dictated that all business investment should support the entire community--but only in the past few decades has that approach caught on among American investors. Unfortunately, throughout most of the 1990s those investors often had to choose from mutual funds that were well-intentioned but offered wilting returns at best. In fact, a majority of so-called socially responsible funds often lagged behind the overall market.

That's changed recently, though, as the bear market has reoriented the investing universe. According to financial research firm Lipper, so-called socially responsible funds have performed about in line with regular diversified equity funds over the past three-year and five-year periods. Because of that, people who want to keep their money in the market but still sleep well at night have been voting with their dollars. Just last year, at a time when investors withdrew nearly $10.5 billion from diversified U.S. equity funds, they added $1.5 billion to socially responsible investing (SRI) funds. Says Tim Fidler, director of research at Ariel Funds, a Kansas City company that specializes in green investing: "People are realizing you don't need to sacrifice performance."

There are some decided advantages to these investments. A big one is the amount of research behind them. Portfolio managers in the category typically apply rigorous environmental and social screens to their companies, and because of that the fund companies need to do a lot more qualitative research. Result? They get to know their portfolio companies extremely well. "Nothing can replace direct contact with management," says Jerry Dodson, founder of Parnassus Investments, one of the oldest socially responsible investment houses in the country. Hedge fund manager Jane Siebels, who founded Green Cay Asset Management, will go so far as to check out what cars the executives are driving. "Things like that can tell you a lot about the company that you won't get from just an interview with the CEO," she says.

One caution, though, is that "green" can mean different things to different managers. Defense contractors are almost always ruled out, as are cigarette manufacturers and companies that make alcoholic beverages. But beyond those obvious categories the rules become a lot more subjective. For example, some managers will not invest in pharmaceutical firms because of their history of polluting, while others try to applaud their efforts to clean up the industry. Those questions come up with other businesses as well. "Just take a look at Carnival Cruise Lines," says Ariel's Fidler. "They've gotten in trouble for dumping sewage water into the ocean. If it happens once or twice, we're fine with that. If it becomes a recurring problem, then that's a big negative."

There's also the matter of intentions. Pax World Investments flat-out refuses to invest in companies that don't meet its arduous screens. But Siebels doesn't see the value in that approach. "I've found that going to a company and saying you're not going to invest in it has no effect," she says. "There are plenty of other people who will." Instead, she looks at industries traditionally viewed as harmful to the environment, such as oil drilling, and tries to find those rare companies taking active steps to improve their record. Then, as a shareholder, she gains a voice in the management of the company. Many of the leading SRI firms employ similar tactics. Armed with only a shareholder proxy, Calvert Group recently helped persuade Dell Computer to adopt a computer-recycling program.

Because of all the variables and differing approaches, green investing can be mazelike for newcomers. To make your life easier, we've selected a couple of investments that any environmentally conscious investor--in fact, any investor--would be happy to own.

Stock FundParnassus Equity Income

Parnassus Equity Income quickly dispels the myth that socially responsible investing entails sacrificing returns. This fund, which invests primarily in mid- and large-cap stocks that pay dividends, has destroyed the competition over the past five years, outperforming 99% of its large-cap value peers. In 2002 alone, a year in which the S&P 500 declined by over 22%, Equity Income managed to lose just 3.7%. Jerry Dodson, who founded Parnassus Investments in 1984, chalks up the fund's success to its value-oriented bent, which tends to limit a stock's downside. "We only invest in stocks trading at two-thirds of what we consider their intrinsic value," he says.

Dodson handed over the day-to-day reins of Equity Income in 2001 to manager Todd Ahlsten so that he could focus on the less conservative Parnassus fund. So far Ahlsten has done a good job of meeting and even exceeding his mentor's performance. Last year Equity Income outpaced Parnassus, which took a beating on telecommunications stocks. "Telecom looked cheap at the time, but we completely missed how overbuilt the infrastructure was," Dodson explains. Currently both funds are betting big on health care. With more than a quarter of the funds' assets in that sector, Dodson says, it's not only a defensive play in a rough economy. "We just see a lot of good values there," he says.

Similarly, Dodson likes a company called Baldor Electric (BEZ), a manufacturer of environmentally friendly electric motors that power everything from pencil sharpeners to backup generators. In the industry they're considered "mid-sized" motors, and Baldor is the market leader, with a 32% share. Now, however, it's developing bigger motors--venturing into territory currently dominated by companies like GE and Emerson Electric. To compete, Dodson says, Baldor has come up with a low-emission generator half the size of diesel-powered options. It produces the same amount of energy, costs $5,000 less, and spits out no emissions because it runs entirely on natural gas.

Bond FundCalvert Social Investment Bond

Manager Greg Habeeb buys the bonds of companies that pass rigorous environmental and social screens, with one small twist: He turns over the entire portfolio 955% a year, while the average intermediate-term bond fund clocks in at 227%. In other words, Habeeb is buying and selling all his holdings almost every month. This hyperactive style is intended to keep the average bond duration (i.e., the time till the bonds mature) fairly constant. You'd expect such active management to lead to higher expenses (it doesn't) and to higher taxes (it does), but Habeeb still bested his group average over the past five years. Moreover, about 59% of the fund is invested in AAA corporate bonds, the highest corporate rating, and almost 95% of it is in investment-grade bonds, so shareholders don't need to be concerned with the credit problems that can plague other bond funds.

With interest rates at their lowest point in decades and economists scratching their heads, Habeeb is hedging against a potential rise in interest rates by investing 65% of the fund in bonds with durations of three years or under and another 22% in ten years or over. Reno Martini, chief investment officer, explains that it's a kind of hedge. "No matter where interest rates go," he says, "we think we'll be able to handle it."

Stock and Bond FundPax World Balanced Fund

Launched in 1971, Pax World Balanced was the first socially responsible fund in the U.S. And although the original portfolio manager, Anthony Brown, retired in 1998, his son, Christopher, has since followed many of the same rules that have made this fund so successful. But unlike his father, a firm domestic value investor, Christopher Brown has no problem with investing in growth stocks both here and overseas. "We've broadened our horizons," he says. "I've moved into technology and ADRs [American depositary receipts, representing stock of foreign companies, which are traded on U.S. exchanges], and I'm less reliant on traditional consumer staples and consumer cyclicals."

It's working. While maintaining a fairly conservative split of 60% stocks and 25% investment-grade bonds, Brown has beaten 90% of his competitors since taking over the fund. In the past five years he's outpaced the S&P 500 by more than 6.5 percentage points a year. And he's done all that while ensuring below-average risk. Tax-conscious investors will also be pleasantly surprised at the fund's low turnover of around 30%.

Right now Brown's hot on home-improvement superstore Lowe's (LOW), a beneficiary of the recent housing boom. It's doing well against Home Depot in metropolitan areas, Brown says, and it continues to grow its margins through new product lines. Making Lowe's even more attractive is its maintenance of a Healthy Forests Advisory Board that addresses ongoing environmental issues like illegal logging in foreign countries, and every one of its employees receives training in ways to minimize waste and reduce pollution.

Index FundVanguard Calvert Social Index Fund

For investors who prefer index funds, Vanguard Calvert Social Index has shown promise in the three years since it was launched. As with any index fund, manager George Sauter invests in a set list of stocks--in this case the Calvert Social Index--rather than actively picking and choosing his investments. Calvert starts out with the 1,000 largest companies in the country and applies a couple of different screens to rule out companies with, say, bad environmental records or labor practices. The final list includes about 650 names, and most of the top holdings are similar to what you'd find in most major index funds--Microsoft, Johnson & Johnson, IBM, Bank of America.

What you won't find, though, are the corporate bad boys that didn't make it through the screens. For example, Cree (CREE), a maker of light-emitting diodes for things like car dashboards and video monitors, was booted in June 2002 because the company's production plants are increasing their output of toxins. And in December 2002, Computer Associates (CA) was taken off the index because of a pile of shareholder lawsuits. (A Cree spokeswoman says the company is taking steps to reduce emissions, and CA has replaced most of its board since the company's financial problems started.)

Calvert runs its own index fund--with an identical list of portfolio holdings--so why go to Vanguard? Expenses, expenses, expenses. Since they both invest in the same stocks in the same proportions, the only difference is the expense ratio. Vanguard's fund is 20 basis points cheaper, which has permitted Sauter to eke out slightly better gains over time.

Hedge FundGreen Cay Asset Management

Jane Siebels, founder of hedge fund shop Green Cay Asset Management, thinks Wall Street has lost its way in the past decade. "They rely too much on computer-driven quantitative analysis at the expense of nitty-gritty qualitative research," she says. Green Cay's socially responsible mandate requires her to kick the tires on all the companies she's looking to buy--interviewing management, the board, even interviewing workers at the 7-Eleven near a company headquarters to see what they think of its operation. To her, it's just good investing sense. "If you look at Warren Buffett, he's essentially doing the same thing," she says. "He's talking not only about the financial side, but the values of the company." Her methods have thus far paid off. Hedge funds aren't regulated by the SEC, so her results aren't made public, but Siebels's four funds--Emerging Markets, American Relative Value, Hard Assets, and Global Technology--have handily beaten the S&P 500 since inception, and all four are in the top quartile of their respective categories.

Hedge funds aren't for everyone, and Green Cay is no exception. To qualify, you need $5 million in liquid assets, plus a $1 million initial investment. And the performance at some of them can be volatile, because the managers are short-selling the stock of companies they expect to underperform. (Essentially, short-selling is the old adage of "Buy low, sell high" in reverse. That is, short-sellers borrow stock to sell, with the promise that they will buy those shares back in the future, hopefully at a lower price).

In a twist, though, Siebels shorts companies that don't meet Green Cay's social criteria. Examples? She shorted Enron, Tyco, WorldCom, and Dynegy long before the market caught on to their problems. "We identified the bad underlying corporate values even though their underlying businesses looked pretty good at the time," she says.

Private Asset ManagementWalden Asset Management

If you have the means, another option is to hire your own private money manager. Walden Asset Management, which has been in business for nearly 30 years, requires a $1 million investment and will assign you a manager to custom tailor a socially responsible investment portfolio. They apply the social screens you're most interested in and trade the portfolio to accommodate your specific investment goals. "What's good for one client is not necessarily good for another," says portfolio manager Kenneth Scott. "Often you find clients may be passionate about one issue, like the environment, so we can gear the portfolio to account for that passion."

To the delight of ardent social investors, Walden is far from a passive investment house. It has a five-person team whose sole responsibility is to actively push its portfolio companies to improve corporate values. In the past few years alone, Walden has filed shareholder proxies that have successfully lobbied Coca-Cola and Pepsi to improve their recycling efforts.

Angel InvestingInvestors' Circle

Launched in 1992, Investors' Circle is the oldest angel-investing group in the country. Angels invest in early-stage companies, and the Investors' Circle $1,195 annual membership fee buys you access to 300 deals a year that have been thoroughly vetted to meet financial and socially responsible criteria. That fee also gives you entrance to regular meetings at which CEOs of young companies pitch their ideas. Chairman Woody Tasch adds that there are other intangible benefits, such as networking with people who share the same concerns.

If you're worried that angel investing may be out of your league, Tasch explains that Investors' Circle's 110 members come from different backgrounds with varying levels of financial sophistication. "They range from venture capital funds to first-time investors," he says. While the median investment is about $250,000, members have written checks as small as $10,000 and as large as $5 million. Since 1992, Investors' Circle members have funneled more than $85 million into about 130 small companies and socially responsible venture capital funds. Some of its previous environmentally related investments include Energia Global, a company focused on developing renewable energy that was acquired by Italian electric utility Enel, and Evergreen Solar, a solar power manufacturer that went public in the fall of 2000.

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Written by: Cait Murphy & Andrew Rafalaf, Fortune



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