By Rob Wherry
May 15, 2008
ITT (ITT1) is well known as a maker of the technology behind modern warfare, from night-vision equipment to radar that detects low-flying cruise missiles to sensors that pick up chemical and biological agents. Some investors may not realize, though, the company makes 39% of its revenues, or $3.5 billion in 2007, from a more mundane industry: water. While soldiers rely heavily on ITT's products on the battlefield, millions of consumers and businesses count on the company's pumps and valves to get H20 to their faucets and factory floors.
To remind investors just how important an industry water is to the global economy — and to its bottom line — ITT tucked a couple of impressive statistics into one of its recent publications. It takes a whopping 62,000 gallons of water to make a ton of steel. The typical automobile requires 39,000 gallons during its manufacturing phase. It takes 3,000 gallons to produce a single semiconductor before it is placed into the nerve center of a computer. In addition, several studies have shown that trillions of dollars of upgrades need to be done to the world's aging water infrastructure in order to keep everything humming right along.
Those big numbers caught the attention of Jim Reardon, president of Peoples Wealth Management in Topeka, Kan. He's one of a growing number of financial advisors who've started using individual stocks, mutual funds and exchange-traded funds to give clients' portfolios exposure to an industry that is booming as global demand for water surges. Of course, making a sector bet, regardless of its growth story, is always filled with risks. But advisors like Reardon are betting water will be a theme that will continue to pay off over the long term.
"I never looked at this as a casino bet," says Reardon. "It's just a fact of life that there is a water shortage."
It's not uncommon these days for the typical portfolio to contain funds that focus on energy or commodities or financial services — the choices are almost endless. While some advisors view those positions with promise, others see them as an easy way to lose a lot of money.
The water business is no different. It's enjoying its day in the sun thanks, in part, to the increasing popularity of the alternative energy investing theme. It has also benefited from the emergence of growing economies in parts of the world like Asia, the global demand on agriculture and the spotlight infrastructure upgrades were put in after last year's bridge collapse in Minnesota and a steam pipe explosion in New York City. However, the water industry is slow-moving, it's expensive to transport the liquid, its use tends to decrease during recessionary times, the industry is fraught with political potholes and water utilities really never know what they are going to run into until they start digging. What was thought to be a pesky leak can turn out to be an all-out system failure.
"It's not something I would ever recommend," says David Hayes, a financial planner in Mount Juliet, Tenn. "My pain threshold is too low."
Reardon, though, recognizes both the risks and the potential rewards. He divides his water investments into what he calls "new world portfolios" — a series of smaller bets that are outside a portfolio's core holdings. In general, these positions would be less than 5% of an entire well-diversified portfolio. We think that's a sound strategy.
Investors could play the water theme by investing in companies like General Electric (GE2), which derives a small portion of its revenues from water-treatment equipment and other products. If investors have time to do homework, they could also explore smaller firms like Itron (ITRI3), a maker of wireless water meters and reading devices. There are also several mutual funds to consider, including Kinetics Water Infrastructure (KWINX4), launched last June.
Many advisors are opting to use exchange-traded funds, since their trading flexibility allows them to more easily get in and out of the position. One of the leading water ETFs is the $2.2 billion PowerShares Water Resources (PHO5) fund. It owns 35 firms with an average weighted market capitalization of $20.7 billion. The fund was launched in late 2005. Since then it returned 22.2% in 2006 and 16.7% in 2007. Year to date, this ETF is up 1.7%, about five percentage points ahead of the broad market, according to Morningstar. It owns an eclectic collection of water utilities, consulting firms, infrastructure companies and conglomerates. Top holdings include Aecom Technology (ACM6), an engineering and construction consulting firm, and Valmont Industries (VMI7), which makes irrigation equipment in addition to other products.
Claymore S&P Global Water (CGW8) owns a large share of water utilities, both here in the U.S. and abroad. These companies have seen customers' water usage decrease as they do some belt tightening during these tough economic times. Indeed, Aqua America (WTR9), a prominent U.S. water utility and a holding of this ETF, has seen its shares drop 18% this year over concerns its earnings were being dinged by macroeconomic issues. At 16 times future earnings, this ETF's portfolio does appear cheap. But it has returned a negative 3.9% this year, almost six percentage points behind the PowerShares product.
Other funds to consider are the PowerShares Global Water Portfolio (PIO10), an international sister fund to the one above, and the SPDR FTSE/Macquarie Global Infrastructure 100 (GII11). The SPDR offering won't only give you access to water; it will be an effective play on the building and upgrades going on in that industry and in the electricity business, too.
