The past two years have proven passive equity index investing is risky to an investor’s portfolio. An investor needs to employ an tactical asset allocation strategy  that is flexible enough to avoid overvalued assets and invest more aggressively when assets are undervalued. One of the benefits of an active strategy is the ability to look for investments with strategic advantages, and include them within a properly diversified portfolio.

Return on investment is driven by supply and demand. If demand outstrips supply; the return on that product or service will have to be higher than average to attract investors into investing and meeting that need. Therefore, everything being equal, investing where demand is high and growing will yield higher than average rates of return on investment.  Industries or companies that meet these criteria have a long term strategic advantage.

The lack of pure water is one of the greatest challenges in the world today. While there is no shortage of water, there is a serious shortage of clean, potable water. In the developing nations, 80% of all diseases are a result of unsafe water. Contaminated water kills more people worldwide than any single disease, including AIDS or cancer. 

World population growth is only a small part of the growing demand for water.  As nations become more developed they consume more goods and services, particularly agricultural products.  Two-thirds of all water consumed goes to irrigate crops. As nations like China and India increase their standard of living, water consumption can rise two or three times the population growth.

Water has some unique properties. Water is not a commodity, but a necessity. For example, unlike oil or most commodities, water cannot be replaced by another product.  There is no substitute for water. No technological innovation can replace water. Demand is not affected by changing tastes, interest rates, recession, inflation, or deflation.

In order to meet the need for water in this century trillions of dollars of investment capital are going to be required.  This means a higher than average rate of return will be required to attract investment capital to companies that focus on technology and services that purify, filter, transport, store, and bottle water.

Unfortunately, there are not a lot of good choices for individual investors to invest in water today.  Water is too small a percentage of revenues and profits to make a difference in the large companies like General Electric (GE) that are investing in water.  There are many smaller and more risky opportunities, but to be prudent, diversification would require investors to buy a portfolio of these stocks. The advantages of Exchange Traded Funds (ETFs) are extraordinary because they are a basket of stocks that trade like a single stock.  ETF’s provide investors an inexpensive way to diversify small portions of a portfolio in targeted sectors.

ETF PowerShares Water Resources (PHO) enables an investor to own approximately 30 different stocks that focus on the provision of potable water. PHO gives an investor who wants to invest in water instant diversification and the ability to increase or decrease that position efficiently because it trades just like a stock.

Like all investment opportunities, investments in water should be a small part of a well diversified asset allocated portfolio. Both over-diversification and under-diversification are major reasons for poor investment portfolio performance.  Much thought, planning and research should be put into how each investment fits into a portfolio.