Water ETFs Staying Afloat

October 03, 2008

Although outperforming more diversified alternative energy rivals, water ETFs are taking different paths to tap into a growing market.


While investors debate the merits of dipping into alternative energy markets, a niche set of exchange-traded funds is holding up even better than their more diversified rivals.

Four different ETFs tracking companies involved in servicing and powering water systems are outperforming broader rivals. In the case of two of those, the gap has been quite large throughout the year.

So far, PowerShares Water Resources (AMEX: PHO) had returned -16.58% heading into Friday. And First Trust ISE Water (NYSEArca: FIW) was down some 18.17%. By comparison, the diversified PowerShares Global Clean Energy Portfolio (AMEX: PBD) had shed more than 39% in 2008.

The broader market, as represented by the Vanguard Total Stock Market ETF (NYSEArca: VTI), was down some 21.8%.

While PBD is a highly diversified renewable energy ETF with everything from solar to wind to biofuels in its portfolio, it doesn't cover water. Neither does another broad-based member of the group, PowerShares WilderHill Clean Energy (AMEX: PBW). It's the most popular alternative energy ETF that focuses only on U.S. companies.

PBW has lost more than 46% in 2008.  

Water Vs. Clean Tech

"The fundamentals of water are far more well-defined than clean technologies in general," said Steve Hoffmann, co-founder of Palisades Water Index Associates, which runs the underlying benchmark for PHO. "It's just a much older and established industry."

Water shouldn't be confused with alternative energy, he adds. "It's true that some alternative energy issues also relate to water companies," Hoffmann said. "So the fundamentals aren't totally unrelated. But water still should be viewed as a separate asset class."

A major difference is that water has no underlying marketplace to set prices. "In more developed parts of the world such as the western U.S., we've got a fairly sophisticated scheme of pricing water rights. But that's a far cry from having a specific exchange that trades in futures contracts as we see in oil," Hoffmann said.

Companies in PHO are valued more on the perceived abilities to provide treatment or engineering services rather than as raw water suppliers. That's another point of separation with pure-play commodities or other forms of alternative energy markets. "Water is perceived as a public right," Hoffmann said. "So by investing in water, you're buying stocks in companies that by and large are involved in providing equipment and services to sanitize and distribute drinking water to populations around the world."

Although such fundamental aspects of water's role as a distinct asset class separate it from other clean energy and commodities markets, differences can also be found among the four ETFs available to investors. On the surface, those are being revealed in these volatile times by widely fluctuating performance patterns.

Water ETFs Performing Much Differently

The other two funds in the asset class are finding choppier waters these days. The PowerShares Global Water (AMEX: PIO) has dropped better than 38% this year. And the Claymore S&P Global Water (AMEX: CGW) is down more than 28% through Thursday.

Hoffmann, who also provides the index for PIO, says the difference is that PHO includes just U.S. stocks and ADRs. By contrast, only about a quarter of PIO's holdings are domestic names. And nearly a third of its constituents are emerging markets countries.

"That exposure to developing global companies with the most acute water needs is what makes PIO's index unique," Hoffmann said. "That's what long-term investors in that ETF should be trying to capture. But it also means short-term volatility can be much higher at times."

In fact, PIO's performance this year has closely followed more diversified ETFs such as the iShares MSCI Emerging Markets Index (NYSEArca: EEM), which has also fallen more than 30% this year. "These also tend to be relatively small emerging markets water companies in PIO's index," Hoffmann added.

It's like watching a tale of two cities, quips Claymore Securities President Christian Magoon. "With water ETFs lately, it has been all about whether you have international exposure," he said.

Some 60% of CGW's assets are based outside the U.S., which gives it a different profile from U.S.-only water ETFs on the market. "We think over the long term, water is definitely going to be more of an international story," said Magoon.

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