A handful of new mutual funds and exchange-traded funds (ETFs) invest in companies directly involved in that most basic element of human life– water.
While most people take water for granted as a routine part of daily existence, it is actually a commodity of limited supply and unlimited demand–thereby making companies involved in its provision, treatment and delivery a tremendous investment opportunity.
“Water is the one commodity where demand is not subject to the pressures of macroeconomics,” says William Brennan, president of Aqua Terra Asset Management, a specialist in the water infrastructure sector. “Water cannot be duplicated, and has no substitute. Water is virtually inelastic–as prices rise, consumption does not decrease.”
Aqua Terra, a subsidiary of investment and brokerage firm Boenning & Scattergood Holdings, is the sub-adviser of The Kinetics Water Infrastructure Fund, a mutual fund which is expected to launch shortly.
Som Seif, chief executive officer of Claymore Investments, which recently launched the Claymore S&P Global Water ETF (CGW), says fundamentals surrounding the water and water-treatment industry are extremely bullish. “Demand for clean water supply and improved water infrastructure is growing around the globe–driven by rising population, increased industrial demand and the need to upgrade or replace the aging pipes carrying our water,” he says.
Moreover, Seif notes, there has been a gradual transition in the management of water resources away from municipalities towards larger private corporations. Consequently, infrastructure spending on water delivery systems are expected to soar, and much of that is anticipated to come from private investment.
The numbers surrounding water and its supply-demand characteristics are sobering and staggering. Water available for human consumption represents less than 1% of all water on the planet, while the renewable supply has fallen by almost 60%, Brennan notes. “Only 20% of the global population has access to running water and 40% has no access to clean water nor sanitation,” he adds. “Within 50 years over half of the entire earth’s population of more than 9-billion will be living with water shortages affecting 80 countries, including the U.S. And more demand for water means that the already under-supplied resource will become scarcer in the years to come.”
The annual cost of maintaining the infrastructure of global water systems, says Brennan, falls somewhere between $425 billion and $700 billion (including $110-billion in the U.S. alone). Brennan expects spending on the U.S. water infrastructure to accelerate, noting the EPA declared that at least 25% of the nation’s pipes are in poor shape — by 2020, that number will rise to 45%. Indeed, according to the American Society of Civil Engineers, the U.S. water infrastructure will require more than $1 trillion in repairs by 2025.
Stewart Scharf, an equity analyst at Standard & Poor’s, notes that since more than 80% of the U.S. population gets their water from government entities, he thinks municipalities “are eager to find cost-effective private sector solutions such as long-term management contracts or outright asset sales,” resulting in increased M&A activity in the water industry.
“We believe municipalities will continue to turn to private entities to help repair decaying water systems,” he adds.
Brennan cites that private investments and mergers & acquisitions are likely to continue in U.S. water industry, noting that the massive and costly upgrades and repairs required are “beyond the ability of local municipalities to finance.” About 15% of water customers in the U.S. receive their water from private sources, Brennan estimates, while water privatization is far more developed in Western Europe, particularly France.
The water situation in the emerging markets, where infrastructure needs are enormous, is particularly dire. For example, Brennan cites China, which has over a fifth of the world’s population, but only 7% of its freshwater supply. China’s water is so polluted that less than 15% of the nation’s people has access to safe drinking water. The Chinese government has committed over $128 billion in water infrastructure spending over the next five years, but that may not be nearly enough.
As far as investors are concerned, water-related stocks are typically companies which are engaged in either the provision or treatment of potable water, or those firms involved in technology and services related to water consumption. The sector is somewhat loosely defined, but encompasses far more than just the water utilities which investors are already familiar with.
The Claymore water ETF tracks the S&P Global Water Index, which is invested equally between two separate types of water-related businesses: water utilities & infrastructure, and water equipment & materials. CGW has high geographic diversity — as of April 30, it had 28.0% of its assets invested in U.S. stocks, 19.6% in France, 16.4% in Japan and 14.2% in Britain.
PowerShares Capital Management recently introduced the PowerShares Global Water Portfolio (PIO), which complements its existing PowerShares Water Resources Portfolio (PHO).
PHO, which has amassed more than $1.8-billion in assets since its December 2005 launch, is based on the Palisades Water Index. As of June 15, 2007, PHO’s top holdings included such names as Valmont Industries Inc. (VMI), which makes metal products used in irrigation; Tetra Tech Inc. (TTEK), an engineering consultant; and Veolia Environnement (VE), the French energy and water conglomerate.
PIO serves as an international variant of the PHO product–it has 35.9% exposure to the U.S., 10.6% in Japan and 7.9% in U.K. “Water supply/scarcity is a much greater issue in other parts of the world,” says Bruce Bond, president of PowerShares. “So we decided to broaden our exposure by entering international water companies.”
Srikant Dash, S&P index strategist, expects to see more interest from investors for vehicles such as water ETFs. “As we look beyond traditional sector and regional boundaries to global investment themes, we see a lot of interest in such products,” he says. “We recently launched the S&P Global Thematic Index Series based on such themes as clean energy, water, infrastructure, nuclear energy etc. The S&P Global Water Index is a part of the series.”
Brennan points out, however, that given the relative dearth of publicly-traded water pure-plays in the broadly defined water sector, it remains somewhat difficult to create a water index that accurately reflects the underlying dynamics of the global water industry. Some stocks found in water ETFs are multi-industry companies that generate only a small portion of their revenue from water-related activities. For example, Danaher Corp. (DHR), an instrument maker found in many water ETFs, derives only about 20% of its revenue from water-related businesses.
Brennan adds however that “we are seeing more companies whose earnings and revenues are becoming more tied directly to water services. And with water infrastructure companies in the developed markets showing 6%-8% annual growth and those in the emerging markets exhibiting growth in excess of 15%, the investment opportunity is great.”