So, this is how I come to write today about investing in water. I was talking earlier this week to an investment manager who added a water-infrastructure exchange-traded fund to the portfolio. I've always liked the idea of water infrastructure as a long-term investing thesis. It made me think I should consider some funds for myself, particularly since my decision last year to buy a single stock in the sector – Layne Christensen Co. – has been a disaster. (It's down 53.67 per cent in the last 12 months.)
As I started my research, it occurred to me that it was a decent topic for an article. And then, unsolicited, I got an e-mail from the Canadian Water Resources Association stating that this is Canada Water Week, and Sunday is World Water Day.
I don't believe in fate. But the e-mail was the tipping point that made me decide water ETFs would be a fine thing to talk about today.
So what is that long-term water thesis? The world is facing an acute water shortage. Large regions of major countries – such as the United States – are in drought or have questionable long-term access to a water supply. And entire countries, such as China, have a severe shortage of water.
"The access that we need to have to water is a really important play down the road, because there are parts of the world that do not have access to clean water, and it's going to become a geopolitical issue going forward," said John DeGoey, vice-president and portfolio manager at BBSL, who was recommending the iShares Global Water Index ETF (TSX:CWW) on BNN this week as part of a selection of infrastructure-related funds.
The iShares fund is the only ETF or mutual fund in Canada with a water focus, believes Christopher Davis, Morningstar's director of fund analysis. It tracks the S&P Global Water Index, a group of 50 companies, divided equally between two categories: one, water utilities and infrastructure, and two, water equipment and materials. No one stock can take up more than 10 per cent of the index. Among the requirements to get in: a $250-million (U.S.) market capitalization (although most of the companies are $1-billion-plus) and a stock listing in a developed nation.
Its results suggest the water-investing theme is widely embraced: It has a three-year return of 21.9 per cent, which includes 34.6 per cent in 2013 and a 9-per-cent gain year to date, according to Morningstar. (Because it's denominated in Canadian dollars, its return is roughly double those of the U.S. funds, owing to the loonie's decline.) Its expense ratio is 0.66 per cent.
There are no Canadian-headquartered companies in the fund; about 37 per cent are based in the U.S. Its top holding, at 7.7 per cent, is Swiss company Geberit AG, a maker of water products for residential and commercial construction. Pentair PLC, a U.K. maker of valves, controls and filtration systems, is the second-largest holding at 7.26 per cent.
Pentair, actually, demonstrates how hard it is to develop a distinct water investment fund. In addition to the iShares Canadian product, it's in the top five holdings of all four major U.S.-listed ETFs. There are, however, some distinctions among the bunch that investors can consider. (Although the Guggenheim S&P Global Water ETF Index (CGW) tracks the same S&P index as the iShares Canadian ETF, so its holdings are essentially the same.)
Pentair is the top holding in the First Trust ISE Water ETF (FIW), which tracks the ISE Water Index. With 36 holdings, it has fewer names than the S&P-based iShares product. At the same time, however, it's less concentrated: Pentair is just 4.4 per cent of the fund, and the top five holdings make up just over 21 per cent of the assets, the lowest proportion of any of the water funds.
On the flip side, the PowerShares Global Water ETF is the most concentrated, with its top five holdings making up nearly 42 per cent of the fund. Along with Geberit and Pentair, the fund's top holdings include Pall Corp. and Flowserve Corp., two U.S. companies that aren't in the S&P Global Water Index at all; and Veolia Environnement SA, a French environmental company that used to be part of Vivendi SA.
For Americans with a parochial focus, there's the Powershares Water Resources ETF (PHO), which requires that its holdings be listed on a U.S. exchange. That still allows the odd international concern – Pentair has a U.S. listing – but at least 90 per cent of the holdings are considered U.S. equities by Morningstar. That allows Roper Industries Inc., a software company that sells to a wide range of non-water industries, to join Pall, Pentair and Flowserve among the top holdings. (Investors have also placed more money in this fund – $880-million – than in the other three U.S.-listed funds combined.)
Before Morningstar dropped coverage of PHO, analyst John Gabriel offered a take on the fund that's useful in considering all the offerings. "There are too few companies that focus solely on water-related treatment and equipment to produce a high-quality, pure-play 'water' index," he said. Most of the fund's money is invested in industrial firms that, while they had expertise in water, also have notable revenues outside the water business. And water utilities, he noted, have regulated rates of return that limit their upside.
"That is not to say that the firms included in this exchange-traded fund's index will not participate in the potential water infrastructure investment boom," he said. "However, investors should be cognizant of the risk that the water-related investment theme could be overshadowed by other industry- and firm-specific factors."
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David Milstead