Water is one of those investment themes that comes up from time to time. It seems like there are a few different stories:
- Delivery. People understand this story intuitively: everybody needs water, some places don't have enough of it, and since you can move it around in bottles and pipes, water is an excludable good. Excludable goods can be profitably sold.
- Technology and Filtration. Water delivered where you want it does no good if it's dirty, or if it takes forever to get there.
- Retail therapy. There is also the story in which people in places with plenty of water buy more water (sometimes, non-excludable public water from themselves) in order to identify with the values or status implied by branding. Nobody buys VOSS because it tastes so much better. Wind turbines. Iconic bottle design. Carbon neutrality.
Investing in water means in investing in one of these stories. Story #3 isn't really about water, it's about consumer spending and effective marketing, so we can leave that aside. Story #1 is in the news a lot right now, since the drought in the midwest has ruined the corn crop. The primary mechanism for global water delivery is still the natural water cycle, right? Jason Abbruzzese explains over at FT Alphaville why investing in water shortage scenarios is so difficult: the OTC derivatives that can be structured to offset risks for natural water "shorts" (agricultural commodity producers) don't make for attractive general investment vehicles.
That leaves story #2, which is all about using technology to improve the efficiency with we deliver water and its cleanliness upon arrival. The PowerShares Water Resources Portfolio ETF (PHO) is a story #2 play, but as Abbruzzese mentions, the ETF has acted in recent weeks like a proxy for the S&P 500. In fact, PHO looks like a lagging market proxy on a longer timeframe, too.
PHO vs. SPY weekly returns, 2009 – 2012. Source: TD Ameritrade
Do these returns make sense? Let's look at the largest holdings in PHO as of yesterday:
- Flowserve (FLS) – 8.99% – makes pumps, valves, and other machinery for moving water. In terms of stock performance, it's basically a high beta SPX proxy.
- American Water Works (AWK) – 8.23% – is a water and wastewater utility company serving North America. Correlation to the market is high, but the stock has developed an independent streak recently, up 99% in the last three years vs. 38% for the S&P 500.
- Pentair (PNR) – 7.88% – also makes industrial water systems, and has a beta of 1.08.
- Pall (PLL) – 7.17% – specializes in filtration and purification. This is another high-beta stock that has performed well of late.
- Waters (WAT) – 7.12% – focuses on scientific technologies like high-performance liquid chromatography, which is apparently the name for what you do if you want to figure out the components of a mixture. These technologies are applied to ensure the quality of drinking water, although there are so many other business lines in WAT, it's a little surprising that this is such a large holding.
These large holdings have been doing pretty well, and if we hadn't already looked at relative returns we might expect the PHO ETF to be beating the market. I don't know what the turnover is like in this fund, but the drag from laggards like LNN, WTS, and ITRI would go a long way toward explaining its lackluster performance, especially if it turned out that some of these weaker stocks were larger holdings in the past.
So what do we know about investing in water? The retail branding story is tenuous, since for fickle consumers today's designer Norwegian water will be easily replaced by tomorrow's single-source Ethiopian organic coffee or next week's artisanal Benedictine cheese cloth. The delivery story is purely a question of bespoke risk management and idiosyncratic cost, certainly in the absence of a standardized futures contract and delivery infrastructure. (It's interesting to think about the climate science and social justice implications of a trans-American water pipeline.) And so far, a diversified play on the technology/utility angle looks how diversified plays often look – like the broader market.
Disclosure: positions in SPY options