Water: The Ultimate Commodity

By James E. McWhinney AAA

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The Palisades Water Index is an unmanaged benchmark that many water indexes and ETFs track. Why the interest in water? Like gold and oil, water is a commodity - and it happens to be rather scarce.

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Global Water Resources
About 70% of the earth's surface is covered in water, but 97% of it is saltwater, which is unfit for human use. Saltwater cannot be used for drinking, crop irrigation or most industrial uses. Of the remaining 3% of the world's water resources, only about 1% is readily available for human consumption.

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Global Shortage
Rapid industrialization and increasing agricultural use have contributed to worldwide water shortages. Areas that have experienced water shortages include China, Egypt, India, Israel, Pakistan, Mexico, parts of Africa and the United States (Colorado, California, Las Vegas and the East Coast), to name but a few.

Pollution also highlights the need for clean water. In the U.S., the dead zone off the Gulf Coast highlights the impact of fertilizer runoff, and methyl tertiary butyl ether (MTBE), an additive in unleaded gasoline, can be found in well water from California to Maryland. Overseas, highly publicized incidents in Russia, China and elsewhere demonstrate that pollution isn't limited to the West. Of course, fouled water supplies further limit the amount of fresh water available for human use.

Indexes
Like any other scarcity, the water shortage creates investment opportunities. Here are some of the more popular indexes designed to track various water-related investment opportunities:

  • Palisades Water Index - This index was designed to track the performance of companies involved in the global water industry, including pump and filter manufacturers, water utilities and irrigation equipment manufacturers. The index was set at 1000 as of December 31, 2003 and not even 10 years later is has fluctuated around the 2,000 mark.
  • Dow Jones U.S. Water Index - Composed of approximately 29 stocks, this barometer is comprised of a large number of international and domestic companies which are affiliated with the water business and have a minimum market capitalization of $150 million.
  • ISE-B&S Water Index - Launched in January 2006, this index represents water distribution, water filtration, flow technology and other companies that specialize in water-related solutions. It contains over 35 stocks.
  • S&P 1500 Water Utilities Index - A sub-sector of the Standard & Poor's 1500 Utilities Index, this index is composed of just two companies, American States Water (NYSE:AWR) and Aqua America (NYSE: WTR) .

The Bloomberg World Water Index and the MSCI World Water Index provide a look at the water industry from an international perspective, although it can be rather difficult to find current information about either index. There are also a variety of utility indexes that include some water stocks. (For further reading, see Indexes: The Good, The Bad And The Ugly.)

Investment Opportunities
A look at the holdings of any of the water indexes provides an easy way to begin your search for suitable investments. Companies from blue chip stalwart General Electric to small cap Layne Christensen are all seeking a piece of the water market. In addition to direct stock purchases, some of the larger firms offer dividend reinvestment plans. Firms seeking to profit from water-related businesses include beverage providers, utilities, water treatment/purification firms and equipment makers, such as those that provide pumps, valves and desalination units.

When it comes to bottled water, the market is growing internationally. Demand is on the rise from China to Mexico, following in the footsteps of the spike in U.S. consumer demand. Estimates suggest that within the last ten years American per-capita consumption of bottled water has doubled - the average American drinks approximately 200 bottles of water a years. On the desalination front, some 100 countries currently rely on desalination for at least part of their freshwater consumption needs.

If stock picking doesn't interest you, ETFs, mutual funds and unit investment trusts (UITs) also provide plenty of opportunities to invest in water. The PowerShares Water Resource ETF, mentioned earlier, tracks the Palisades Water Index, and the iShares Dow Jones U.S. Utilities Index ETF (ARCA:IDU) provides some exposure to water-related stocks. The largest water ETF is currently PowerShares Water Resources Portfolio (NYSE:PHO) but other new alternatives such as the PowerShares Global Water Portfolio ETF (NYSE:PIO) and the First Trust ISE Water Index Fund (NYSE:FIW) are also available. Based on popularity, new alternatives are slowly emerging.(To learn more, see Introduction To Exchange-Traded Funds.)

Additionally, two unit investment trusts that specialize in water-related investments are the Claymore-Boenning & Scattergood Global Water Equities UIT and the Claymore-Boenning & Scattergood U.S. Water Equities portfolio.

Conclusion
Recent years have seen an upswing in the demand for investments that seek to profit from the need for fresh, clean water. If the trend continues, and by all indications it will, investors can expect to see a host of new investments that provide exposure to this precious commodity and to the firms that deliver it to the marketplace. There are currently numerous ways to add water exposure to your portfolio - most simply require a bit of research.

Just as with any other investment in commodities or sector funds, wise investors should limit their exposure to water. Generally speaking, highly concentrated investments such as these should not represent more than 10% of the assets in a well-diversified portfolio. Limiting exposure to concentrated positions provides some opportunity to capture positive returns while limiting overall portfolio volatility.

For more information about concentrated portfolios and diversification, see Do Focused Funds Provide A Better Outlook?, Introduction To Diversification and The Importance Of Diversification.

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