The Bull Case for Water (ETF: PHO)

I wrote an article in March outlining the macroeconomic case for investing in water. The PowerShares Water Portfolio (PHO) has moved up 5% since then, and I still believe it plays a crucial role in most portfolios. Let’s review factors in favor of water investment:

Opportunity for growth: The Water industry is quickly evolving. As global demand increases for potable water, the companies which collect, purify, and monitor water become more valuable. The water industry receives heavy investment from both the public and private sectors. Furthermore, the structured-equity approach used by PowerShares generally favors small and mid-cap stocks. These sectors have outperformed the large-cap indexes consistently over the past five years.

Preservation of Capital: PHO has an excellent risk-adjusted return. It’s heavily resilient to economic cycles and inflation. At what point in time has the demand for clean water decreased? Common sense would suggest water is the commodity in highest demand on earth. This is a great dual play on natural resources and utilities.

Portfolio Diversification: PHO is comprised of small, mid, and large cap stocks mostly in the industrial and utilities sectors. However, it also has exposure to health care and information technology stocks. As mentioned above, water companies have shown strong risk-adjusted returns in the past five years.

Tax-efficiency: Prior to the creation of this ETF, mutual funds were the best way to gain exposure to water utilities. But even the best utility funds don’t have the tax-efficient structure or total return of PHO.

Expenses: PHO costs you 60 basis points and consistently outperforms the broader markets. You can’t ask for much more than that from an ETF. The other utility ETF which you might use for this sort of portfolio exposure which is cheaper than 60 basis points is IDU, the utility iShare. Owning IDU for the past 5 months would have you underperforming PHO by 20%.

What further pushes me towards water as a valuable natural resource is recent press linking tap water to bladder cancer in men. The New York Post ran an article on Saturday summarizing the results of six completed studies in which all six men who consumed tap water based drinks were linked to a higher risk of bladder cancer. Note that PHO is careful to correlate to the increasing demand for bottled water. Bottled water prices have outpaced inflation, on average, by 20% annually.

I also believe investing in water is a side play on the current craze for alternative energy stocks. As the world becomes more polluted, water purification and filtration systems increase in price and demand. An article from Summit Global Management Inc states that improving water infrastructure systems will be a top priority for governments in the next ten years.

So I repeat, in your quest for alpha, consider adding PHO to your portfolio.