Mutual funds have long been the investment of choice for socially responsibly investors looking to diversify their portfolios. Now a newer kid on the block, the exchange traded fund, is beginning to play more in this investment space.

Morningstar Inc. categorizes 24 ETFs as socially responsible, up from 17 in December 2008 and just a couple five years ago. The newest, Pax World Management's ESG Shares North America Sustainability Index ETF (NASI), debuted in May. The two other members of this family, the ESG Shares Europe Asia Pacific Sustainability Index ETF (EAPS) and the ESG Shares FTSE Environmental Technologies (ET50) Index ETF (ETFY), are expected to launch any day.

ETFs, baskets of equities which trade like stocks, are winning fans in many investment circles for their generally lower fees, tax advantages, intra-day trading capabilities and full transparency. For now, all socially responsible ETFs are passively managed, tracking indexes. Actively managed ETFs have won Securities and Exchange Commission approval under certain conditions.

ESG Shares has already received "a very strong, positive response from advisors, particularly in the sustainable investing area," says Pax World president and CEO Joe Keefe. "Financial advisors are making much greater demand for ETFs and green. (ESG Shares) is at the intersection of those two trends."

NASI tracks performance of the FTSE KLD North America Sustainability Index, a diversified, sector-neutral global index of companies with superior environmental, social and corporate governance (ESG) ratings. EAPS will track the FTSE KLD Europe Asia Pacific Sustainability Index. "Put those two together and you have the entire global developed market with a sustainability and ESG overlay," says Keefe.

ETFY will track the FTSE ET50 Index, comprised of the world's 50 largest pure-play environmental companies by market capitalization. Many of them derive a substantial portion of their revenues from clean tech and are likely to buy up small start-ups, he says.

"We think this will be a booming asset class over the next three to five to 10 years with the global shift to a more sustainable economic paradigm," says Keefe. Offering ETFs along with its mutual funds gives investors even broader exposure, he says.

Social Investment Forum deputy director and research director Meg Voorhes is pleased to see the socially responsible ETF universe expanding. "It can only be a good thing when more investment options and asset classes are offered in the ESG field," she says.

Voorhes suspects the SRI community's interest in ETFs is growing based on anecdotal information. Actual data will appear in the SIF's Report on SRI Trends in the United States scheduled for November release. Money managers and advisors responding to this current online survey can indicate through a drop-down menu if they're using ETFs to fulfill ESG criteria.

The Social Equity Group, a Berkeley, Calif.-based registered investment advisory firm with managed separate accounts, has about 5% of its $42 million of assets under management in ETFs, says president and portfolio manager Duncan Meaney. He likes their diversity and midday trading ability. And since they don't trade at a discount or premium to the net asset value of their holdings like closed-end funds, "they're easier to predict and understand," he says.

He also likes the global exposure of many of his ETF holdings, which include the Claymore/MAC Global Solar Energy Index ETF (TAN), PowerShares WilderHill Clean Energy Portfolio (PBW), First Trust ISE Global Wind Energy Index Fund (FAN), First Trust NASDAQ Clean Edge Green Energy Index Fund (QCLN), and iShares FTSE KLD 400 Social Index Fund (DSI).

DSI has outperformed the iShares Russell 1000 and the S&P 500 over the past year and on an annualized basis the past three years, according to Morningstar. Meaney expects green energy ETFs to come back in favor. For now, "we've got a lot of cross winds battering alternative energy stocks," including shrinking alternative energy subsidies in Europe and relatively lower oil prices, he says.

Owning a basket of alternative energy companies is not for the fainthearted since many are banking on one innovative product, notes John Gabriel, an ETF strategist with Morningstar. "It's a boom or bust type industry; they won't all survive," he says.

Gabriel encourages investors to review ETF holdings to see if they meet their own ESG comfort zone. For example, a top holding of the iShares FTSE KLD Select Social Index Fund (KLD) is Chevron Corp., the U.S.'s No. 2 oil company. "You do have to look under the hood. You can't stop at the name," he says. Investors should also be aware that while socially responsible ETFs sport lower fees than mutual funds, there's still a premium over plain vanilla ETFs, he says.

"ETF education is not just a short process," says Tom Lydon, president of Irvine, Calif.-based registered investment advisor Global Trends Investments and editor of information Web site ETFtrends.com. "The industry is evolving, there are new players, new regulations, new strategies-so it's important for advisors to make sure they keep up with these evolutions as they occur." Although there are currently no socially responsible leveraged or inverse ETFs, he suggests learning how these more volatile funds work.

Lydon, author of The ETF Trend Following Playbook, says ETF providers such as iShares, PowerShares and SPDR State Street Global Advisors have comprehensive education sections on their Web sites. Many also host webinars and conferences. Pax World will offer webinars and more tools through ESGshares.com, says Keefe.