How To Play The Coming Water Boom

November 09, 2010

The four water ETFs may all look the same from the outside—but which one makes the most sense for your portfolio right now?


Water: It's the most precious commodity on Earth, without which we or any other species couldn't survive. Yet as the human population expands, safe, accessible sources of potable water have become increasingly difficult to find. So it doesn't take a market whiz to realize that "blue gold" could become the world's next great commodity market.

While we're still a long way from water futures, water sector equities are freely available, and these days investors have more options than ever to play the space. For my money, however, exchange-traded funds are my investment of choice, as they offer access to a range of (pardon the pun) liquid water stocks all at once.

There are currently four water-related equities ETFs that trade on U.S.-based exchanges. From an outsider's view, it would be natural to assume all four ETFs are similar and that choosing the right one is not that important. In reality, however, the four ETFs are very different from each other, making it critical to analyze each fund thoroughly.


Wading Through The Water ETFs

The original water ETF is the PowerShares Water Resources ETF (NYSEArca: PHO), which began trading in late 2005. The ETF is composed of 32 water-related stocks, all of which trade in the U.S.  The fund's allocation is overwhelmingly in the industrial sector, at 78 percent, with a specific focus on water infrastructure stocks, like water treatment plants and irrigation pump manufacturers.

Even though PHO only invests in stocks that trade in the U.S., it does possess small exposure to companies based overseas. For example, the No. 2 holding, Veolia Environnement (NYSE: VE), the world's largest water utility, is based in France.

PHO's expense ratio is 0.60 percent and it has a 12-month yield of 0.56 percent.  Over the past year, the fund is up 11.72 percent.

Launched in 2007, the PowerShares Global Water ETF (NYSEArca: PIO) takes a similar approach as PHO, except it broadens its reach to a global scale. With 29 stocks in its portfolio, PIO allocates 29 percent to the U.S., followed by Japan and the U.K., at 11 percent each.

At 35 percent, PIO also offers a larger focus on water utilities than PHO (of which utilities make up a mere 12 percent). At the same time, industrials only comprise 49 percent—which is less than PHO, but still a significant portion.

PIO carries a 12-month yield of 1.32 percent. The expense ratio is slightly higher than PHO's, at 0.75 percent, while its one-year returns are slightly lower, at 10.69 percent.


Another similar globally minded ETF with higher returns is the Guggenheim S&P Global Water Index ETF (NYSEArca: CGW), which is up 15.41 percent over the past year.

CGW comprises 48 stocks from around the globe, with 40 percent coming from the U.S., 23 percent the U.K., and 11 percent from Switzerland. The allocation to industrials and utilities is identical, at 44 percent each. What separates CGW from PIO, however, is CGW's higher concentration in its top stocks: The No. 1 holding, sanitary technology manufacturer Geberit AG, makes up over 10 percent of the fund. The second-highest percentage, wastewater management firm United Utilities Group, makes up over 7 percent.

CGW has a yield of 1.1 percent and the expense ratio is 0.65 percent.

But the best performer in the group since 2008 has been the First Trust ISE Water Index ETF (NYSEArca: FIW), which has gained a whopping 18.26 percent over the past year.

FIW is more similar to PHO than the other global water ETFs, as it also places major focus on the industrial sector (at 59 percent) and only invests in U.S.-listed companies. Nine of the top 10 stocks are based in the U.S., with the lone foreign company being a Brazilian water utility (SBS).

FIW has a net expense ratio of 0.60 percent and a dividend yield of 0.9 percent.


Water ETF Funds Returns


Which Water ETF Works Best?

After laying out the stats on all four water-related ETFs, we can decide which fund makes the most sense for investors going forward.

Right off the bat, I will eliminate CGW, because its concentration in its top stocks lowers the diversification we expect with an ETF.

I also eliminate PHO, given its structural similarity to FIW and relative underperformance. The top holdings of FIW are also more attractive going forward.

Still, even though I like FIW as an investment option, I will choose PIO as the best water-related ETF—at this time. PIO gives investors the international exposure that I believe is imperative, as well as a good mix of water utilities and infrastructure.

PIO's underperformance versus its peers can mainly be traced back to lingering effects from the global recession. But as the global economy continues to rebound, PIO is better poised than FIW to take advantage of a worldwide increase in water demand, and thus, should be the top performer in the years ahead.


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