Searching for Exposure to Water

It is March 22 which is officially World Water Day.

Since 1993, the world has marked this day as the day to celebrate the world’s most vital resource and highlight the fact that 2 billion humans do not have access to fresh water. 

It makes sense that investors would want a way to purchase such an essential commodity.

What is the best way to gain access to this resource?

Water covers 71% of the earth’s surface, however, 96.5% is found in the oceans. Just 3.5% is freshwater with 60% trapped in glaciers. That leaves the world approximately 1% of readily accessible water or approximately 114 million billion gallons. U.S. uses 322 billion gallons of water a day by itself. 

This is a scarce resource with limited supply. That raises the ante for investors.

Can I just buy water?

Water officially started trading on the United States futures market in August 2018. These futures are traded on the Chicago Mercantile Exchange (CME). To be clear, water itself is not available for trade. The spot price is in reference to a rate set by the Nasdaq Veles California Water Index (NQH2O). 

The agency is partnered with West Water Research which provides the pricing data. The index tracks the price of water rights across the five most active regions in California. The problem is that there is a high barrier to entry as one needs to demonstrate ownership or water use cases.

These contracts are primarily used by farmers, institutions and hedge funds and are not easily available to retail traders. 

One way to gain exposure is through a water exchange-traded fund. These ETFs invest in companies involved in the treatment, purification, and distribution of water. The ETFs do not invest in water as a commodity or in water rights. The group only has approximately $5.4 billion Assets Under Management (AUM). 

The top two funds are the Invesco Water Resource ETF (PHO) and the First Trust Water ETF (FIW). They are similar in size and make up. Breaking down the two funds we find a lot of similarities. Which is the better option?

PHO is a modified liquidity-weighted index of U.S.-companies that create products to conserve and purify water. Holdings are weighted by liquidity, with no more than five companies capped at 8%. The rest are distributed equally. 

FIW takes companies that derive revenue from potable and wastewater industries. It has a tiered equal-weighting scheme that boosts the weight of small and micro-cap companies which reduces concentration.

The Top 10 Holdings in PHO make up 60% of the weighting compared to 40% for FIW. This highlights the difference in weighting with PHO highly concentrated in its top names.  

Both ETFs focus on the U.S. water segment. Industrials and utilities are the two largest sector weights in each portfolio. These industries make up more than two-thirds of the representation. A deeper dive shows FIW is slightly more tilted toward machinery and construction. 

There is a lot of overlap in the two names. In fact, they both have 36 holdings and 29 companies are in each ETF. The two ETFs have overlap on six of the top ten names: Danaher Corp (DHR); American Water Works (AWK); Roper Technologies (ROP); Pentair (PNR); Xylem (XYL); Advanced Drainage Systems (WMS); and Essential Utilities (WTRG).

For ESG investors, these two names are in an elite club as they are one of only 36 U.S.-listed ETFs that receive the AAA ESG rating from MSCI. 

PHO is the larger of the two options with $1.7 billion AUM. It is also the most liquid with a 3-month average trading volume of 172K compared to 104K for the FIW. 

  PHO FIW SPY
Total Assets $1.75 bln $1.31 bln  
Average Volume 172K 104K  
No of Holdings 38 38  
YTD -12.20% -10.80% -6.40%
1-year 8.51% 7.95% 12.50%
5-year 15.53% 15.67% 15.16%
10-year 11.27% 14.26% 14.27%
Dividend Yield 0.22% 0.42% 1.31%
Expense Ratio 0.60% 0.54%  

 

Neither ETF has outperformed the S&P. The portfolios are heavily weighted in industrial and utilities, two areas that have underperformed the tech space. But these sectors are finding interest in a rising rate environment. 

The industry should benefit from the $1.2 trillion U.S. infrastructure bill passed by Congress in November 2021. Companies in both portfolios will be beneficiaries of the $55 billion earmarked for upgrading the water infrastructure. 

In addition, water is one of the few areas that can find bipartisan support. On April 29, 2021, the Senate voted 89-2 to approve a $35 billion bill to clean up the nation’s water systems. If the two sides need to find common ground, this will be an area that profits.

Water is a worthy investment. However, finding a proper vehicle that tracks the actual value of the commodity is difficult. The two largest water ETFs provide exposure but the correlation is limited as you bring in additional risks from the industrial and utility sectors. 

The choice between PHO vs FIW is whether you want more exposure to large cap or small cap names. 

Breaking down some of the names in the portfolio may unearth more intriguing plays. For instance, AECOM (ACM) and Tetra Tech (TTEK) are two consulting firms that are Top 10 holdings in the FIW. This would allow you exposure to the group and avoid some of the inflationary issues that will be facing other names in the index. These are names worth pursing in your search for water exposure.