PHO -- Water ETF as a liquid asset.

PHO, the Powershares water index ETF, based on the Palisades Water Index (ZWI), is one of my core portfolio holdings. I think the macroeconomic arguments for investing in water are enormous.

There is a great and growing shortage of drinkable fresh water thought the world, which has created great demand for water improvement technologies. Unlike energy, demand for water is inelastic and not subject to economic cycles. Because water service is a capital goods/natural resource industry it is resistant to inflation. Historically water and water technologies were very unsexy and have not attracted a great deal of market attention. But that is changing rapidly. 2006 may be the ground floor for a long term bull market for the water sector.

There are several drivers for this bull market:

1. Population growth -- people need water.


2. There is increasing acceptance of the idea of privatizing or outsourcing of government owned water operations to publicly owned utility companies.


3. Many industrial companies are shifting to "green chemistry" by replacing toxic solvents with water. Those companies now have sophisticated needs and requirements for water that they use in industrial processes.


4. More marginal sources of fresh water will need to be exploited in the future, creating a demand for treatment technologies that can improve and reclaim contaminated water.


5. The US water and world infrastructure is aging, the last major round of public spending on water infrastructure in the US was the 1960s before that during the New Deal of the 1930s. Many cities and towns must upgrade or replace older water systems.

The water sector as a whole is becoming somewhat “frothy”, valuations for many of the more speculative companies have become quite high. PHO has had a massive growth in market cap over the past few months. This is certainly been the case for PBW, Powershares Clean energy ETF. However I think the macro element for PBW and PHO remains very compelling even if these funds don’t meet strict value criteria.

PHO/PBW are also a good way to add small cap exposure to a portfolio, but beware that most of their stocks are classified as small cap growth, especially in PBW. The majority of the PHO assets are in industrials and utilities. Both ETF's have the typical powershares expense ratio of 0.60%.

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