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Water ETFs Ride Big Wave Of Returns

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When it comes to natural resources, none is as critical to our survival as water. Though our dependence on water is occasionally highlighted by events such as the California droughts or the Flint water crisis, access to this resource in America is something we usually take for granted.

But as valuable and necessary water is, it isn’t often considered as an investable idea for your portfolio, with water-related ETFs holding a mere $4 billion in assets under management.

Yet these ETFs can be a tactical play for your portfolio, as there are times when they outperform the broad market.

Year-to-date, the three largest water ETFs have outperformed the SPDR S&P 500 ETF Trust (SPY). Much of the outperformance has occurred in the month of July, with water-focused names boosted by related proposals in the infrastructure package currently working its way through the Senate.

 

Chart courtesy of StockCharts.com

 

Equities included in water ETFs can fall into several categories. Water utilities and infrastructure providers tend to make up the bulk of the portfolios.

However, funds can also include companies involved in the development of water purification technologies, companies focused on water efficiency, and companies that are involved in providing solutions to global water challenges.

What’s Driving Returns

As part of the Infrastructure Investment and Jobs Act, more than $55 billion has been committed to water-related projects. This represents the largest investment in clean drinking water and wastewater infrastructure in American history.

The funding will be dedicated to replacing lead service lines and pipes in an effort to deliver clean drinking water to up to 10 million American families, according to the White House. In addition, more than 400,000 schools and child care facilities that currently don’t have it, including in tribal nations and disadvantaged communities, would be funded as well.

Extreme Weather Events

This investment in water infrastructure is critical, especially in light of the growing threat of climate change. Extreme “100 year” weather events have become increasingly common, putting a strain on the aging water infrastructure in the U.S. 

Of the six water ETFs that are available, two of them focus on the U.S. water segment. The Invesco Water Resources ETF (PHO) is the largest water ETF, at $1.8 billion AUM. This fund tracks a modified liquidity-weighted index of U.S.-listed companies that create products to conserve and purify water.

The First Trust Water ETF (FIW) is the second largest, with $1.2 billion in AUM.

The four other water ETFs take a global view on the theme.

Comparing ETFs

Looking at the two largest water ETFs on the ETF.com ETF Comparison Tool shows that these U.S.-focused water ETFs have some similarities—and a few differences as well.

Though both funds hold more than $1 billion in assets, average daily volume for each ETF is only a few million dollars, leading to higher spreads relative to funds of similar size.

 

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As is often the case with thematic ETFs, both funds are heavily concentrated in the top 10 holdings. PHO holds 61% of the portfolio in the 10 largest names. FIW takes a slightly less concentrated approach, with 43% of the portfolio in the top 10.

 

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Between the two funds, six names overlap within the top 10 names. Each fund has 37 holdings, with 29 of the names being included in both ETFs.

Industrials and utilities are the two largest sector weights in each portfolio. The two sectors make up more than two-thirds of each portfolio. Digging into the sectors, FIW is slightly more tilted toward machinery and construction names, but overall, the portfolios are similar.

This explains why performance has moved in tandem. Over the trailing three years, PHO has gained 82.8%, while FIW has risen by 78.8%.

 

Chart courtesy of StockCharts.com

 

Both funds have high ESG ratings, though PHO slightly edges out FIW, garnering an AAA rating. There are only 36 U.S.-listed ETFs in total that have received the top ESG rating from MSCI.

Along with more standardized requirements, securities held within the index that PHO tracks must be classified as participating in the “green economy,” as determined by SustainableBusiness.com.

 

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Looking Ahead

With both ETFs providing access to similar portfolios and return streams, either would be well-positioned to take advantage of the infrastructure bill’s proposed water-related spending over the next few years.

First Trust’s FIW has a very slight edge in terms of cost, while Invesco’s PHO is a little better for investors with an ESG focus.

Contact Jessica Ferringer at jferringer@etf.com or follow her on Twitter

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