California and Texas, the nation?s most populous states, with a combined population of 65 million people, share another key trait: They are both parched. According to the National Oceanic and Atmospheric Administration, both states are experiencing a drought across roughly 80% of their land mass.
That?s a real crisis when you consider how important agriculture is in those two states. And the phrase ?mega-drought? may soon enter our lexicon. The American Meteorological Society's Journal of Climate now warns that the U.S. Southwest may be facing decades of such extreme dry conditions.
A solution may lie offshore: Seawater can be scrubbed through reverse osmosis filters, providing potable water to increasingly parched Southern California. Companies such as Consolidated Water (Nasdaq: CWCO) build and operate such plants. Other dry areas, such as the Middle East, are starting to boost investments in this technology.
Solutions for the U.S. heartland will likely require greater water efficiency. The Oglala aquifer, which supplies water to many farms in the Central United States, has seen rapid depletion. As a result, conservation measures are expanding to curb water waste.
On a broader scale, water scarcity and water quality are becoming key concerns across the globe. In China, for example, more than half of the country?s largest lakes and reservoirs were so contaminated in 2011 that they were unsuitable for human consumption, according to The New York Times.
Yet from California to China, clear solutions exist. In the years ahead, look for heavy investments in water treatment plants, desalination complexes and more efficient irrigation systems.
According to consulting firm Booz Allen Hamilton Holding Corp., $20 billion in global spending will be needed on water infrastructure through 2030. Such a massive level of infrastructure investment spells opportunity, especially for exchange-traded funds (ETFs) that invest in fresh water and waste water treatment equipment. Here are three on my radar:
First Trust ISE Water Index Fund (NYSE: FIW)
This fund focuses on U.S.-based firms that sell water treatment equipment -- such as Watts Water Technologies (NYSE: WTS) -- and operate water treatment plants -- such as California Water Service Group (NYSE: CWT). These kinds of companies haven?t been in favor over the current bull market, mostly due to the fact that they generate decent, but unspectacular, revenue growth. The First Trust ETF has generated a 13% annualized gain over the past five years, lagging the broader market; however, the macro backdrop for water quality and water scarcity in the United States should ensure ongoing solid demand for the companies in this fund. The 0.60% expense ratio is roughly in line with the ETF industry average.
PowerShares Water Resources ETF (NYSE: PHO)
This has a similar focus to the First Trust Water Index fund, though the list of top holdings differs, giving investors a chance to examine the quality of the portfolio to determine which ETF holds greater appeal. The expense ratio is similar, at 0.61%.
I am more intrigued by the fund firm?s other water ETF, the PowerShares Global Water ETF (NYSE: PIO), as it has a greater focus on international water businesses. In addition to U.S. firms such as Pentair Plc. (NYSE: PNR) and Flowserve Corp. (NYSE: FLS), it has large positions in France?s Veolia Environnement S.A. (NYSE: VE) and Switzerland?s Geberit. Yet the ETF?s 0.82% expense ratio is a bit stiff, and equally important, average daily trading volumes below 40,000 make it hard to heartily recommend. Such low volumes lead to high bid/ask spreads. You should mostly focus on ETFs that trade more than 100,000 shares a day.
Guggenheim S&P Global Water Index (NYSE: CGW)
This is the most geographically diverse fund, with more than 60% of the portfolio invested in foreign firms. It is also the most diverse in terms of end-market exposure, owning companies that build and operate water treatment plants, companies that make the components needed to operate such plants and the raw materials, such as ioniziers, that are used by the component suppliers. The 0.70% expense ratio seems a bit high considering the relatively low annual asset turnover of 21%.
Risks to Consider: These firms benefit from issues regarding water quality and water scarcity, and as a result, one rainy season can reduce drought conditions and impact the demand for their equipment and services.
Action to Take --> One way to use these ETFs is as a source of specific stock ideas. You can peruse their portfolios, and then drill down into the underlying holdings. I am partial to pivot irrigation firm Lindsay Corp. (NYSE: LNN), and Pentair, which has become a soup-to-nuts equipment supplier to the water treatment industry. Ongoing water depletion rates suggest that these firms will see solid demand well into the future.
Any company that makes strides toward solving the world's water woes is a game-changer. If you want to learn about other game-changers, my colleague, Andy Obermueller, just released a report "The Hottest Investment Opportunities For 2015." In it you can find his latest predictions for new companies and technologies that can move the markets. For more information, click here.