Water ETFs Staying Afloat

Source: http://www.indexuniverse.com/sections/features/12/4603-water-etfs-staying-afloat-vs-alt-energy-rivals.html?Itemid=3&utm_source=straightstocks.com&utm_medium=sidebar&utm_campaign=rss
Posted on Saturday, October 4th, 2008 | In Exchange Traded Funds

Contributed by: IndexUniverse Staff (http://indexuniverse.com) -

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Although outperforming more diversified alternative energy rivals, water ETFs are taking different paths to tap into a growing market.

While investors debate the
merits of dipping into alternative energy markets, a niche set of exchange-traded funds is holding up even better than their more diversified rivals.

Four different ETFs tracking
companies involved in servicing and powering water systems are outperforming broader rivals. In the case of two of
those, the gap has been quite large throughout the year.

So far, PowerShares Water Resources (AMEX: PHO) had returned -16.58% heading into Friday. And First Trust ISE
Water (NYSE: FIW) was down some 18.17%. By comparison, the diversified PowerShares Global Clean Energy Portfolio (AMEX: PBD) had shed more than 39%
in 2008.

The broader market, as
represented by the Vanguard Total Stock Market ETF (NYSE: VTI), was down some 21.8%.

While PBD is a highly diversified renewable
energy ETF with everything from solar to wind to biofuels in its
portfolio, it doesn’t cover water. Neither does another broad-based member of
the group, PowerShares WilderHill Clean Energy (AMEX: PBW). It’s the most
popular alternative energy ETF that focuses only on U.S. companies.

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PBW has lost more than 46% in 2008.

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“The fundamentals of water are
far more well-defined than clean technologies in general,” said Steve Hoffmann,
co-founder of Palisades Water Index Associates, which runs the underlying
benchmark for PHO. “It’s just a much older and established industry.”

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Water shouldn’t be confused with
alternative energy, he adds. “It’s true that some alternative energy
issues also relate to water companies,” Hoffman said. “So the
fundamentals aren’t totally unrelated. But water still should be viewed as a
separate asset class.”

A major difference is that water has
no underlying marketplace to set prices. ”In more developed parts of
the world such as the western U.S., we’ve got a fairly sophisticated scheme of
pricing water rights. But that’s a far cry from having a specific exchange that
trades in futures contracts as we see in oil,” Hoffman said.

Companies in PHO are valued more on
the perceived abilities to provide treatment or engineering services rather
than as raw water suppliers. That’s another point of separation with pure-play
commodities or other forms of alternative energy markets. ”Water is
perceived as a public right,” Hoffmann said. “So by investing in
water, you’re buying stocks in companies that by and large are involved in
providing equipment and services to sanitize and distribute drinking water to
populations around the world.”

Although such fundamental aspects of
water’s role as a distinct asset class separate it from other clean energy and
commodities markets, differences can also be found among the four ETFs
available to investors. On the surface, those are being revealed in these
volatile times by widely fluctuating performance patterns.

Water ETFs Performing Much
Differently

The other two funds in the asset
class are finding choppier waters these days. The PowerShares Global Water
(AMEX: PIO) has dropped better-than 38% this year. And the Claymore S&P Global Water
(NYSE: CGW) is down more than 28% through Thursday.

Hoffman, who also provides the index
for PIO, says the difference is that PHO includes just U.S. stocks and ADRs. By
contrast, only about a quarter of PIO’s holdings are domestic names. And nearly
a third of its constituents are emerging markets countries.

“That exposure to developing global
companies with the most acute water needs is what makes PIO’s index
unique,” Hoffmann said. “That’s what long-term investors in that ETF
should be trying to capture. But it also means short-term volatility can be
much higher at times.”

In fact, PIO’s performance this year
has closely followed more diversified ETFs such as the iShares MSCI Emerging
Markets Index (EEM), which has also fallen more than 30% this year.
“These also tend to be relatively small emerging markets water companies in
PIO’s index,” Hoffmann added.

It’s like watching a tale of two
cities, quips Claymore Securities President Christian Magoon. “With water
ETFs lately, it has been all about whether you have international
exposure,” he said.

Some 60% of CGW’s assets are based
outside the U.S., which gives it a different profile from U.S.-only water ETFs on
the market. “We think over the long-term, water is definitely going to be
more of an international story,” said Magoon.

Sector Differences Impacting Returns

Still, breaking down water ETFs by
domestic and international weightings isn’t always enough. For example, CGW’s
index has roughly a third of the emerging markets exposure as PIO’s does.

Srikant Dash, who heads global
research and design at S&P Index Services, points out that water firms in
developing countries tend to be represented by utilities. As such, CGW’s
underlying index — which was created by S&P — avoids “loading up on
emerging markets,” he said.

The best performing sectors in water
recently have been treatment companies and resource managers. Not surprisingly,
all of the water ETFs have double-digit exposures to those sectors. But FIW, in
particular, had an oversized weighting with more than half its assets resource
management heading into the second-half of the year.

Utilities is the biggest sector in
the industry in terms of pure market-cap size, says Hoffman. But as long as
utilities remain regulated, he doesn’t see utilities as realizing their true
market potential. As a result, utilities comprise about 10% in both PHO and
PIO.

“Especially in the U.S.,
utilities face huge regulatory costs and don’t get fully compensated. That’s
why infrastructure improvements are so need and in demand. The rates haven’t
kept up with the replacement costs,” Hoffmann said.

In PIO, treatment gets a weighting
of 36% in its underlying benchmark; resource management is 26%; infrastructure
is 13%. With PHO, treatment is about 20%, resource management is 25% and
infrastructure is about 22%.

FIW’s outperformance this year has
been even better than PHO’s since it has more in the two areas doing the best.
In treatment, it has about 20% and in resource management FIW holds roughly
54%. It has another 7% in infrastructure and 20% in utilities.

Utilities are more defensive
investments by nature, notes Mark Abssy, a product development specialist at
ISE, which created the index used by FIW. “Utilities typically are seen as
producers of steady streams of income rather than huge growth rates,” he
said.

The ETF has about twice as much in
utilities as PIO or PHO. On the other hand, the First Trust Water ETF invests
less in big projects that could take years to pay off that its
competitors.

Infrastructure includes very large
projects that can take years to bring financial returns. “Infrastructure
as a part of the water industry is a segment where you’re looking for
longer-term growth prospects,” Abssy said.

– This report was submitted by Murray Coleman of IndexUniverse.com.

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Filtering Through Water ETFs (Key
Sector Breakdowns In Underlying Indexes)*

ETF Symbol	Utilities	Treatment	Infrastructure	Resource Mgt.	Foreign
FIW	20%	20%	7%	54%	9.7%
PHO	10%	20%	22%	25%	8.9%
PIO	10%	36%	13%	26%	75.0%
CGW	19.13%	53.98%	16.1	10.7%	61.7%

Source: Companies
*Through June 2008

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About IndexUniverse Staff (http://indexuniverse.com)
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Water ETFs Staying Afloat

Last 5 posts by IndexUniverse Staff

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