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Water: The Ultimate Commodity

2012-11-23 14:20:28

July 17 2011| Filed Under 401K, ETFs, Mutual Funds, Portfolio Management

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.

Tutorial: Commodity Investing 101

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.

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.

by James E. McWhinney

James McWhinney has been a professional writer for nearly two decades. He has

worked for many of the nation's top mutual fund providers and banks in addition

to numerous magazines, websites and other publications. He specializes in

financial services and travel.