We can't live without water, and exchange-traded fund (ETF) managers have taken note by creating water ETFs. Whether it's renewing and replacing aging infrastructure, conserving, purifying, bottling, or transporting water, many companies are involved in this often-overlooked industry. Find out if these funds are right for you and which are the best water ETFs in 2020.
Investing in a water ETF can be a convenient way to gain exposure to the water industry with one fund. A typical water ETF invests in water utilities and companies involved in water purification, sewer and pipeline construction, and related equipment.
The Benefits of Investing in Water ETFs
Here are the primary benefits of investing in water ETFs:
Low expenses: Similar to index mutual funds, ETFs are passively managed, which means that the expense ratios are low compared to actively-managed funds.
Professional management: Although management is passive, you still get a professionally managed portfolio of water stocks. This is a benefit for you if you don’t want to do your own research and analysis.
Diversification: Rather than investing in just a few water company stocks, water ETF shareholders can get access to dozens of stocks across various areas of the water industry.
Potential Risks of Investing in Water ETFs
Investing in water carries a special kind of market risk because it's not a widely studied area of the market like large-cap U.S. stocks.
This relative obscurity can create market volatility because water stocks tend to be thinly traded, and the volatility in price can be more sensitive to smaller amounts of traders buying and selling the stocks.
A lack of liquidity leads to a higher bid/ask spread, which is like a markup on your ETF purchases and sales. This added expense, coupled with volatility, increases a water ETF’s risk. Therefore, it’s important to educate yourself about the ETF you’re interested in.
The U.S. Securities and Exchange Commission recommends reading through an ETF's summary and full prospectus to understand the ETF’s history, strategy, and objective.
If you're unfamiliar with the water industry and some of the problems they face, the American Water Works Association releases a yearly State of the Water Industry Report that sums up the sector and its future outlook. Reading the main points can help you decide if it's an industry you want to consider investing in.
The Best Water ETFs and Why We Chose Them
There are only a handful of water ETFs in the investment universe but investors are wise to narrow down the selection to a few final choices before choosing which is best for their needs. Here are the main criteria we used to select the best water ETFs:
Assets under management (AUM): Since water ETFs are not widely traded, it’s important to look first at the funds that have the highest AUM.
A higher AUM can help to reduce the volatility caused by swings in the bid/ask spread.
Performance History: It's also important for an ETF to have at least a three-year performance record with assets higher than average for the category. This provides a performance history to review and some assurance that the fund is relatively liquid, which is vital for obtaining the best pricing in the open market.
Low expenses: If you are comparing two water ETFs that track the same benchmark, the one with the lowest expense ratio is generally the best choice. This is because expenses reduce the net return for the ETF, which means low expenses generally translate to higher returns in the long run.
Based on those criteria, we chose the top water ETFs for 2020:
Invesco Water Resources ETF (PHO)
This water ETF tracks the NASDAQ OMX US Water Index, which consists of 34 water stocks, most of which are mid- to large-size U.S. equities. The companies represented in the fund create products designed to conserve and purify water for homes, businesses, and industries listed on the U.S. exchange. Assets under management are $981.5 million, which makes PHO the largest water ETF on the market. Its expense ratio is 0.60%, or $60 for every $10,000 invested.
Invesco S&P Global Water Index ETF (CGW)
On its surface, CGW looks similar to PHO. But this ETF from Invesco tracks the S&P Global Water Index, which consists of 49 water stocks, most of which are companies from the utility, industrial, and information technology sectors. The regional allocation is split nearly evenly (51.74% to 48.26%) between the U.S. and non-U.S. stocks. Assets under management for CGW are $602.4 million. Its expense ratio: 0.62%, or $62 for every $10,000 invested.
First Trust ISE Water Index ETF (FIW)
This ETF from First Trust tracks the ISE Clean Edge Water Index, which is a modified market capitalization-weighted index of the top 34 listed companies working with the potable and wastewater industries. Assets under management for FIW are $482.8 million and its expense ratio is 0.55%, or $55 for every $10,000 invested.
The Bottom Line
Investing in water ETFs can be a convenient, low-cost way to gain access to a basket of stocks of water utilities, companies involved in water purification, and related businesses. However, investors should avoid allocating too much of a portfolio to just one sector fund that concentrates on a niche area of the market.
If you are building a portfolio of ETFs, a good way to begin is with a core holding that invests in a broad index, such as the S&P 500. From there, you can then add the satellite holdings, such as sector ETFs.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.