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Money Pouring Into Water Industry

Published: Sunday, 15 Nov 2009 | 6:22 PM ET

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By: Chris Taylor
Special to CNBC.com

Water may not be as shiny as solar energy or as picturesque as wind power, but it's one sector in the green space that's easy for investors to swallow.

Siemans Water Treatment Plant
Source: Siemens
A Siemens wastewater treatment facility.
A growing number of funds now specialize in water, having ballooned to $1.8 billion in total assets, up by 40 percent in size in the last six months.

“Water’s getting a lot of attention, and it has everything to do with sustainability,” says Jeff Tjornehoj, senior research analyst with fund-tracking firm Lipper. “There’s an expectation that critical water needs are not being met, and that it’s only going to get worse in future.”

Indeed, demand is growing at an estimated 6 percent annually, as spiking population and ramped-up agricultural production strain current infrastructure. Only too happy to step in are conglomerates like Siemens [SI Loading... () ] and General Electric [GE Loading... () ] (the parent company of CNBC), each with sizable water-services divisions; and more targeted plays like French giant Veolia, with water-treatment projects everywhere from Bangladesh to Brazil.

“It’s a flattening world,” says Paul Justice, ETF strategist with research firm Morningstar. “Emerging economies are continuing to develop, and there’s still a lot of progress to be made, so investors are focused on the growing need for potable water.”

As a result seven funds have crowded into the space in recent years, dominated by two PowerShares exchange-traded funds, Water Resources [PHO Loading... () ] and Global Water [PIO Loading... () ], which track versions of the Palisades Water Index.

Other water-focused funds include names like First Trust ISE Water Index [FIX Loading... () ], Allianz RCM Global Water [AWTAX Loading... () ], Kinetics Water Infrastructure [KWINX Loading... () ], SAM Sustainable Water [SMWNX Loading... () ] and Calvert Global Water [CFWAX Loading... () ].

Year-to-date, most water funds have risen roughly in line with the S&P 500's 20 percent gain. Differences tend to emerge over the percentage of foreign holdings, since those with an international focus essentially act as a dollar hedge. Powershares Water Resources is up 13 percent for the year, for instance, but its sibling Global Water is up 36 percent, related largely to the decline in the greenback.

Since it’s a sector with few pure plays, investors should consider whether they already have sufficient exposure—through GE, for instance, whose Water & Process Technologies group runs projects from China to Saudi Arabia.

Stocks rated attractive by Morningstar include Veolia, whose fair value is estimated by Morningstar to be $37, well above its current $32 price. With a dominant role in the sector, and a footprint in growing regions like the Middle East and Asia.

“We think Veolia is well-positioned to benefit from favorable international outsourcing trends,” writes analyst Bradley Meeks.Other potential picks include Atlanta’s Mueller Water Products [MWA Loading... () ] , rated four stars out of five by Morningstar. Meanwhile be wary of Minneapolis manufacturer Pentair [PNR Loading... () ] and Long Island, N.Y. filtration specialists Pall Corp.[PLL Loading... () ], which already look pricey and rate two stars.

If you want to dedicate some capital to water investments, make it no more than a few percentage points of your portfolio, suggests Lipper’s Tjornehoj (perhaps more for younger investors with a longer time horizon). Since many water plays are small- or micro-caps, be cognizant that volatility could be relatively high.

And as is the case with many ETFs serving narrow niches, keep an eye on possible closures. If a fund doesn’t gain enough traction in terms of dollars invested, not only might expenses be relatively high, but it’s in danger of getting shut down entirely. The funds least prone to that are the two PowerShares offerings, which together hold 93 percent of the market.

Finally, keep in mind that with such a critical resource, politics can come into play. While global infrastructure is clearly weak—one in three around the globe deals with water scarcity, according to the World Health Organization—authorities hardly have the wherewithal to pay for all needed upgrades. “Most governments are tapped out right now in terms of spending and credit,” says Tjornehoj. “Infrastructure projects are having trouble getting a lot of traction.”

For similar investments but for far less cost, opt for a popular fund like the Industrial Select SPDR [XLI Loading... () ], suggests Justice. The overlap in holdings with water ETFs can be well over 90 percent, but at barely a third of the fees. It may not sound quite as green— but you’ll keep more green in your account.