Investing in Water and Water ETFs 15 comments
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To start with, I want to say that I own the PowerShares Water Resources Portfolio ETF (PHO). In this post I will explain why I invest in water and why PHO is my security of choice. The links for all sources noted are at the bottom of this post and should provide a bit of a linkfest for those looking to do further research.
Water is, of course, a necessity. It is a fundamental need to sustain all life on this planet. The earth is 70.8% covered by water on its surface. Only about 2.5% of that is fresh water, 68.7% of which is currently in the form of ice (source: Wikipedia).
I
grew up and live in New York State where I have enjoyed excellent water
quality and sanitation services throughout my life for all of my daily
needs. I am lucky and I do not take it for granted.
I
have been researching the state of global fresh water for many years
and been fascinated by many of the numbers. The need for adequate water
supply is not just a concern for the future, but for this very day in
many parts of the world:
- 1 billion people do not have access to safe drinking water
- 2.6 billion people lack basic sanitation
- 2.2 million people a year die from illness caused by contaminated water
- 5,000 children a day die from diarrhea
- water use will increase by about 50 percent in the next 30 years
- an estimated 4 billion people - one half of the world’s population - will live under conditions of severe water stress in 2025
(sources: OECD, UNICEF, World Bank, WHO, WWC)
Many developing countries have grown quickly in the past few years and are emerging into world powers right now.
- developing economies grew 7.3%, or more than twice the rate in high-income countries at 3.1%
- 10.7% growth in China and 9.2% growth in India played a significant role in the recent strength of developing countries, but even excluding these two, developing countries grew 5.9 percent
(As measured by 2006 GDP. Source: World Bank).
Technological advances, an inexpensive labor supply and abundant supplies of natural resources are some of the factors that have stimulated growth in these regions. As these countries have matured, the needs for basic modern amenities have grown. To provide these essential services requires better infrastructure and resource management throughout the countries. Roads and services are part of this, but the most basic ingredients for facilitating modernization are clean water and sanitation. The World Water Council suggests developing countries will need $4.5 trillion in water infrastructure investments over the next 25 years
Developing countries are only half of the story. The developed world has growing water needs as well. In the US and parts of Europe, much of the water infrastructure is old and in need of replacement and modernization. The WWF reports:
- water loss from aging water mains in London could fill up 300 Olympic-size swimming pools daily
- countries in northern Europe and on the Atlantic are suffering recurring droughts
- in Australia, the world's driest country, salinity is a major threat to agriculture
- contamination of water supplies in Japan is a very serious issue in many areas
- in large parts of the US, increasing consumption has led to a situation where the water supply can no longer meet demands
- a combination of climate change, loss of wetlands (which store a lot of freshwater), poorly laid-out water infrastructure and water resource mismanagement, is making the water crisis truly global
(source: WWF)
In Europe, according to Kaj Bärlund, then Director of the Environment and Human Settlements Division of the United Nations Economic Commission for Europe:
- in most countries of the UN-ECE region the system of pipes to supply water is in a desperate state
- pipe systems date from before World War I and they haven't been upgraded since
- on average between 40 and 60% of the water which is produced is lost before arriving at the tap
- in some cities the lost water amounts to 80% of production
- conservative estimates are that around $10 billion (US) a year in terms of clean water is wasted
- in many cities the entire water system would need to be rebuilt
(source: UN-ECE)
Low water levels and poor management right here in the US have also helped push water concerns high up on the domestic agenda. Recent attention on drought in the Southeast is one serious example right here domestically.
- Southeast drought hits crisis point (USA Today)
- Atlanta Shudders at Prospect of Empty Faucets (NY Times)
Altogether in the US:
- 54,000 community drinking water systems provide drinking water to more than 250 million Americans
- total drinking water and waste water infrastructure needs over a twenty-year period are about $1 trillion dollars
- at least 25% of the nation's pipes are in poor shape
- by 2020, that number is expected to rise to 45%
- in systems that serve more than 100,000 people, about 30% of the pipes were between 40 and 80 years old and about 10% of the pipes were more than 80 years old
- 6 billion gallons of treated water leak from water lines every day
- community water systems nationwide have an immediate need of $12.1 billion in infrastructure investment (primarily to protect against microbiological contamination)
- more than 40 percent of lakes, ponds and reservoirs in North America are impaired because of pollution
(sources: WIN, EPA, ASCE)
The Water Infrastructure Network estimates that drinking water utilities alone will need about $480 billion over the next 20 years. The EPA's estimate is lower at around $150 billion. Each organization has their own estimates and you can do further research to see their philosophical differences.
Rep. John Duncan Jr. from Tennessee and Hon. Bruce Tobey, Mayor, Gloucester, Massachusetts said this of the total US freshwater and wastewater system:
- we need to be spending an additional $23 billion a year over and above current investments (currently about $60 billion) to keep our drinking water and waterways clean and safe
- we are seeing the simultaneous expiration of the useful life of water infrastructure installed at various points in time in history (the majority of the problem lies underground in old pipes)
- populations have reached the point of having surpassed the capacity of our water and wastewater systems to handle them
(source: US House of Representatives)
When there is inadequate water present in an area, its people have only three options:
- create infrastructure to bring in new water
- find better technology and methods to treat, distribute and conserve the water they have
- move
No matter which option is selected, in the US or abroad, there is no way to escape the high cost of water, our primary requirement for survival.
The research I have done has shown me that, in the US alone, the cost of all maintenance and repairs for freshwater and sanitation needs for the next twenty years is well over $1 trillion (despite what may actually be spent). On a global scale, the cost over the next twenty years is more than $5 trillion.
If there does exist $250 billion in water related needs each year globally, this presents an opportunity for investors. Even if only half of this money were actually spent, it will be very profitable for some companies.
Over the years I have owned a few individual water utilities and infrastructure companies. I never really found one though that gave me a comprehensive investment in water. Then, in 2005, PowerShares launched the PowerShares Water Resources Portfolio ETF. This was the first concentrated fund investing in water related infrastructure, utilities and technology. I began holding this ETF soon after its inception. I have found it to be a wonderful way to get exposure to global spending trends in fresh water and sanitation needs. It is a core long term holding in my Roth IRA.
A a water ETF from Claymore (CGW) was launched in May this year. The biggest difference in the philosophy is that CGW is considered a global ETF and PHO is considered US based (it invests in US listed companies and ADRs). However, it should be noted that many of the US based companies held in PHO have sales and operations overseas and are in a prime position for global growth. When CGW came out I researched it and compared it to PHO to see if CGW may offer a better opportunity. Some articles I read around the Claymore launch seemed to suggest that CGW was the better diversified of the two.
Veolia and Suez, two French companies, comprise 20.35% of CGW's holdings as the largest positions. In fact, the top five holdings in CGW (out of 51 as of this writing) are 35.9% of the fund. The top ten holdings are 54.56% of the fund. PHO's top five and top ten holdings comprise 19.93% and 38.05% of the ETF respectively. CGW may be more diversified geographically, but certainly not in its holdings. CGW has 31.8% concentration in the US and 32.5% in France and the UK combined.
PowerShares Global Water ETF (PIO) and First Trust ISE Water (FIW) were also launched this summer (in 2007). PIO, the second water ETF from PowerShares, still has 24.92% direct exposure to US companies. There was initially a good amount of overlap between PIO and PHO. Lately, however, PowerShares has been smart and created more of a separation. This gives investors the option of augmenting PHO with PIO for a domestic and an international water ETF.
FIW is quite similar to PHO. They each invest about 89% of their assets in US companies and 4% in French based ADR's. The biggest difference in holdings is FIW's Brazilian exposure and greater holdings in the diversified machinery and metal fabrication sectors. PHO is heavier in engineering and construction. Also, FIW's top ten holdings (out of 36) comprise 43.3% of the fund.
Let us look deeper at the numbers (click to enlarge all charts):
All ETF data is according to the Bloomberg terminal on 11/23/07.
Another point I have seen mentioned a couple of times is that GE (GE) is roughly 2.99% of PHO's holdings. Some seem to think this is too high a percentage for a company where the water business accounts for 2% of sales. It should be noted though, that there are only 35 stocks held in the PHO ETF, which, if held in equal weight, would be a 2.86% position each. GE is the 17th largest holding.
I can understand the problem here for investors and for PHO management. GE is important to the global water business. You can not overlook its contribution to the industry. But how do you invest for such a small stake in the overall business? I think PHO made the right choice to include it and appreciate the fact that they have made it a lower percentage holding. Some may continue to say a 2.99% holding is too high, but in relation to a 35 stock portfolio, I think it is reasonable.
CGW, PIO and FIW are all fine ETFs. I actually like the global exposure in CGW and PIO despite the fact that I feel they are too concentrated at the top. Also, these three ETFs have existed for less than one year. CGW has assets of $315.65M, FIW of $10.49M and PIO of $241.09M.
PHO has assets of $2.14B which shows it may be the water ETF of choice among investors. I find that even though PHO is concentrated in US listed companies and ADR's, many of those companies have strong global sales. PHO holdings are also weighted far more equally than the other ETFs mentioned. Additionally I like the high concentration in engineering and construction companies. I already own PHO and I am satisfied with its performance so far. I see no reason to make a change.
Some of the stocks included in these ETFs have had a good run over the past year or so. Some have also recently corrected. The beauty of investing in a water ETF is twofold: you avoid single company risk and, through one instrument, you get coverage in utilities, infrastructure, technology and other water related industries.
This piece is solely concerned with water as a long term investment. By long term investment, I mean decades. I recommend that you thoroughly research this sector, or any sector, yourself before you put your money to work. Remember, your strategy is likely very different from mine.
Disclosure: Long PHO.
Data sources and sites for further research:
- Organization for Economic Co-operation and Development [OECD]
- -UNSAFE WATER, SANITATION AND HYGIENE: ASSOCIATED HEALTH IMPACTS AND THE COSTS AND BENEFITS OF POLICY INTERVENTIONS AT THE GLOBAL LEVEL
- United Nations Economic Commission for Europe [UN-ECE]
- -Interview with Kaj Bärlund
- UNICEF
- -Progress for Children
- US House of Representatives
- -Statements of Rep. John Duncan Jr. from Tennessee, chairman of the Subcommittee on Water Resources and Environment and Hon. Bruce Tobey, Mayor, Gloucester, Massachusetts, on behalf of the National League of Cities
- Wikipedia
- The Water Infrastructure Network (WIN)
- -Clean and Safe Water for the 21st Century
- World Bank
- -Private Participation in Infrastructure (PPI) Project Database (The site includes a snapshot of the number, category and costs of infrastructure projects by country, region and sector)
- -Outlook for high-income countries
- -WATER RESOURCES SECTOR STRATEGY
- STRATEGIC DIRECTIONS FOR WORLD BANK ENGAGEMENT
- World Health Organization (WHO)
- -Water for Life
- World Water Council [WWC]
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This article has 15 comments:
And water utilities? Good luck for them trying to raise water prices (even when rate increases are sorely needed) - that's been a disaster worldwide with terrible returns on capital. Some of the other companies are just 3rd-rate manufacturers with no pricing power whatsoever getting killed by high metal prices.
And even many of those in the water biz are highly suspect. How much earnings/revenues does GE get from its water biz - 10% max? Why would anyone think that the performance of the GE's water biz be a significant driver of GE's stock price –same for many others like Siemens.
ETFs like PHO are just gimmick products thrown together with to make money, but don’t really follow the purported investment theme. Apparently the $2.1 billion in PHO suggest that the average small investor or retail investment advisor haven’t done enough homework to know that the index manager has little idea what he/she is doing. Many ETFs such as those supposedly investing in “alternative energy’, ‘nanotech’, and ‘water’ sounds good in theory, but a little homework shows that index quality varies wildly. If you want to invest in water - this is not the way to do it.
The latter two ETFs on the list look a better –but I haven’t done enough due diligence on them. Remember: the water sector is a tough one in which to invest (most of the best companies are buried inside big conglomerates. As such the remaining pure-play water companies are typically pretty lousy while the water utilities typically struggle to earn their cost of capital.
edoc.difu.de/orlis/DF9...
Otherwise:
en.wikipedia.org/wiki/...
I hope it`s good for starting!
Good piece. Are any of these companies involved in desalination? It seems if we can get desalination of ocean water at a decent price, there will be plenty of water for everyone.
JA
In my article I wanted to look at the global water situation and then compare the ETF's that were available in that industry right now. I do not claim they are perfect, but I am satisfied so far with my holding in PHO. I feel that in and of themselves, most of the companies are solid despite their importance as a pure play on water. Honestly, I think it is a good fund despite the fact that it is called a water ETF.
GE has 3% of its business in water. This is small. However, they are one of the most important companies in the water industry. It would be hard to ignore them completely in a water fund despite the dilemma. As I stated above though, I am comfortable with how this position is treated. In addition, I will say that GE, or Siemens are still excellent companies. I have no problem with exposure to them.
Franklin Electric? They design and build water well pumping systems. They had two acquisitions this year to pump up that division - Pump Brands, Ltd. (South Africa), completed in June 2007, and the pump division of Monarch Industries (Canada), completed in September 2007. Water sales were down in the most recent quarter.
(10-Q)
sec.gov/Archives/edgar...
Millipore cites strong demand for laboratory water products and higher sales in growing Asia/Pacific markets. It is not 100% of their business, but it is large and growing.
sec.gov/Archives/edgar...
Agilent also noted strong growth in water and waste testing despite the size of that business.
sec.gov/Archives/edgar...
Yes, some water utilities are in a tough spot, but in the long run, they will need to raise prices to deliver water. There is simply no way around it if the world wants water delivered to their homes. It will not happen overnight, but this is a long term investment for me, so I can be patient.
In truth, I look at these ETF's more broadly than just pure water plays. I look at PHO as an industrial ETF with exposure to utilities and tech. It is a focused fund and I like the companies. Perhaps I should have spent more time addressing this point.
Are these four specific water ETFs a gimmick? You may be able to make that point, but I do not think the need for water is a gimmick. Water is a fundamental need for all life and is not like "alternative energy" and "nanotech" which are emerging, untested industries.
The truth is this that these ETFs are not "right" or "wrong" investment vehicles. Your research may show you they are not for you. That is fine. If we all had the same strategy, no one would make money. I have done the research and am satisfied to have the 3/4 sized position I hold in my Roth IRA.
One other point, the alternative to holding a water ETF is to hold several individual companies. My account targets 12-15 security positions, so for me, this is the best way to play the industry despite its imperfections.
Thanks for your comments. They really made me think.
Good luck.
The phenomenon which the index is trying to reflect is poorly captured. In other words, the index performance will have a sub-par correlation with what it's 'trying' to track.
In addition this ETF grew so fast (nice idea in theory and easily marketable) that its huge growth in in assets drove up many stock prices that invested in. A self-fulfilling prophecy not unlike some of the wilderhill funds (much worse than this one)
Millipore? if you really look close at it's business, it's mostly in filtration for biomed/pharma/semicond... And a lot of what it's filtering isn't water.
Agilent, Emerson? water's a tiny percentage of their businesses. Roper? Maybe one third. Pall? Maybe 20%. Siemens and GE? Tiny.
The Index is nice in theory, but runs out of steam pretty quick.
Moreover, what the heck kind of weighting strategy is being used here? Look at the percentage of the float of some of these companies. Good luck at rebalancing time when Index Advisor has to annouce 5 days in advance what the rebalanced holdings will be. It's a field day for hedge funds and arbs at shareholder expense.
If you are looking for a desalination company, check out Consolidated Water (CWCO). They are based in the Cayman Islands and use reverse osmosis to desalinate water. They develop and operate water systems primarily in the Caribbean.
It is a small company with a market cap of $450 million. Their P/E has been between 30 and 60 for almost 3 years. P/Sales was between roughly 8 and 12 for the same time period. Short interest has exploded since August with the ratio now over 22. Insiders own about 10% of the shares outstanding and institutions about 55%.
Of course, do your own research.
I do not own CWCO, but it is held in PHO which I own.
I would like your input on my next water ETF, this one I would like it to be more international. which one is better the CGW, FIW ot PIO. I did my homework, but I am a rookie!.
Thanks again