Four ETFs That Aren't All Wet

 | Dec 19, 2011 | 1:00 PM EST
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This commentary originally appeared Dec. 19 on ETF Profits – to access all the strategies from our team of ETF professionals, click here.

As the lineup of exchange-traded products has grown steadily over the last several years, investors have gained access to a growing number of asset classes and strategies -- many of them rather targeted in nature. The past year, for example, has seen the launch of exchange-traded funds targeting smartphone companies, cloud computing firms, and fishing stocks. So, in addition to a robust roster of sector-specific and country-specific ETFs, investors now have the ability to achieve even greater degrees of granularity.

Most of these "niche" ETFs are still quite small, not quite catching on with investors yet. But there's one corner of the market that has been surprisingly popular: there are four ETFs focusing on water-related stocks, combining to account for about $1.2 billion in assets under management. If that seems like a massive total for such a targeted and bizarre investment strategy, that's because it probably is.

The investment thesis behind water is quite compelling. Though investors often focus on the limited availability of resources such as wheat and livestock, many believe that a water shortage is inevitable, especially as emerging markets continue to grow and urbanize at blistering paces. Access to clean, drinkable water is taken for granted in the U.S., but in other areas of the world, it's a major source of conflict and anxiety. It is estimated that at least 80 countries now face water shortages and that 40% of the global population has no access to clean water. The challenge is straightforward, yet serious: with current technology, water supply cannot keep pace with demand over the long run.

Water scarcity is almost certain to become a pressing issue in coming decades, prompting the development of multiple investment products focusing on securities that could potentially benefit from this development. Water ETFs have been around for quite a while; the Water Resource Portfolio (PHO) debuted in late 2005, and the other three ETFs targeting this space , the PowerShares Global Water (PIO), Guggenheim S&P Global Water Index (CGQ) and First Trust ISE Water Index (FIW), have been up and running for at least four years.

PHO's portfolio consists of about 30 stocks, each focused on the provision of potable water, the treatment of water, and the technology and services that are directly related to water consumption. In other words, this ETF includes companies whose operations focus around increasing the supply of drinkable water around the world. The largest holding in PHO, Pall Corp. (PLL), manufactures and sells a variety of filtration devices, portable water stations, and other purification products.

If strains on the existing water infrastructure intensify, demand for these services could increase substantially in coming years. Governments and private entities around the world could seek out the firms that make up PHO to secure water independence and eliminate what could become a serious threat to economic growth.

Water-related stocks, like many other equities, have struggled somewhat in 2011. PHO is down about 14% on the year. The recent price declines could create an attractive entry point for an asset that maintains considerable upside potential over the long term, and that could act as a hedge against developments that would likely weight heavily on broad global equity markets.

I like a small 5% allocation in PHO as a satellite position for those utilizing a core-and-explore approach to managing a portfolio. This ETF will likely see considerable volatility in the short term, but maintain tremendous growth potential over the long run.



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