It's quite the strange duality when you think about it. Undoubtedly, water is the single most important thing on Earth ... OK, so maybe it's the second most important thing (sorry, oxygen) - but you get the idea. If I go to the store and there's no bread, I would be shocked, and certainly annoyed, and that'd be about it. But if I turn on my faucet and nothing comes out, I'm about 15 hours away from turning into Mad Max - and so are you.

So why is water so underappreciated? Why, when I live in a state that's experiencing a once-in-a-generation drought that could become economically catastrophic in a heartbeat, can my home water bill be just 75 bucks a month? It's because water doesn't act like crude oil, or any other commodity for that matter. It's heavily regulated at the municipal, state, and federal level. It explains why projects like the Carlsbad Desalinization Plant, which will soon be the largest desalinization facility in the western hemisphere, don't have 100% slam-dunk economics in their favor from day one.

No, we're far from the day when an Elon Musk type comes in with a massive private effort to supply water and reinvigorate the industry: the costs are just too great to get started, the time to get approvals too long, the current state of our infrastructure too poor, and the potential profits too murky to justify the capital outlay.

So What's the Answer?

I won't bury the lead here...I don't know what the answers are. I don't know what the technological answers are, I don't know where the money is supposed to come from, and I would never be so masochistic as to try to understand the local politics involved.

But I know that we need fresh water for quenching the thirst and irrigating the crops for an ever-growing population, and since less than 1% of our planet's water is fresh water, desalinization sure seems like a no-brainer. Yes, it's horribly energy-inefficient right now, but if history is any guide at all, we can innovate that imbalance away. My cell phone today has 10 times the RAM that my desktop had 18 years ago. All we need is the will and we can figure out most anything. So far, the will hasn't been there, but I'm convinced we'll see it soon, either by choice or necessity. Unfortunately, it will probably be the latter.

ETF Plays in the Water Space

All the murkiness in the future of water makes it ideal to approach with ETFs rather than trying to pick individual stocks. There are four main ETFs that focus on water utilities, infrastructure suppliers, and related services.

I want to find the best single name in this group of four ETFs, so I've loaded up a custom peer group in Capital Cube to review their most important metrics side-by-side. As a basis for comparison, I've also loaded up the largest sector ETFs for utilities and industrial stocks (XLU and XLI), as well as the SPY to represent the broad market:

Water ETFs Performance Comparison Table from CapitalCube

The PowerShares Water Resources Portfolio (NYSE Arca:PHO) is the largest of the bunch, with just under $1 billion in assets under management. It's a rather focused ETF, having only 29 holdings in companies that "create products designed to conserve and purify water for homes, businesses, and industries". The underlying index is focused on U.S.-based companies, as we can see from the Capital Cube breakdown:

PowerShares Water Resources Portfolio (NYSE Arca-PHO) Country Allocation

There is a also a first cousin fund to the PHO in the PowerShares Global Water Portfolio (NYSE Arca:PIO), a $284 million AUM fund that contains 38 holdings and is free to invest via non-U.S. stock exchanges. As a result, only 47% of the assets are in U.S. - domiciled companies, although many of the same top 10 holdings show up in both funds, specifically "picks & shovels" plays like Flowserve Corp (NYSE:FLS) and Waters Corp (NYSE:WAT).

Rounding out the four is the First Trust ISE Water Index Fund (NYSE Arca:FIW) and the Guggenheim S&P Global Water Index ETF (NYSE Arca:CGW). The FIW is a bit illiquid for my taste, at just $190 million in assets, but it has notably outperformed its peers over the past three and five years. Both the FIW and the Guggenheim offering are heavily invested in the water utility companies, parking over 25% of assets there. And it makes me wary of choosing either fund.

Not Keen on the Water Utilities Angle

I try to always find the big, secular trends first, then go find the companies poised to benefit the most. In the case of water, I'm not sure that the utilities - the folks that actually deliver the water to your tap - are poised to benefit. They are very restricted in the prices they can charge, and the water utility industry is highly fragmented, so the few publicly-traded stocks that we do have are pitifully small (the top 5 amount to less than $14 billion in combined market cap). And lest we forget -- these utilities operate within a crumbling infrastructure that will require actual movement in state & federal legislatures; in other words, I'm not holding my breath for change.

Investor Takeaways

  • Invest in the "picks and shovels" companies that supply water treatment solutions, and infrastructure equipment - specifically in the area of water distribution, storage, and transport. This is where we have the biggest need for an upgrade. Whether the money comes from the government or the private sector, we can confidently assume that these companies will be winning the bulk of new construction and service contracts.
  • If you're as bullish as I am on the future prospects for water-based industries, consider swapping in some PHO or PIO for your existing equity exposure; I'd lean towards PHO for the extra liquidity and the U.S. focus.
  • If you decide that you want some exposure to the water utilities, go with the CGW over the FIW; the Guggenheim ETF is more diversified, has twice the assets under management, and a lower annual volatility.
  • All of these ETFs are reconstituted annually, so if a new company invents something marvelous that adds economic benefit to the water industries, chances are these ETFs will add the stock to the fold in due time. Utilize the benefits of ETFs and outsource some of your research when it comes to water stocks.

The views and opinions expressed above are those of the author and do not necessarily reflect the views of CapitalCube.com, AnalytixInsight, Inc., its affiliates, or its employees.

Disclaimer