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Are Water Funds the Next Wave? Rising Tide of Demand Could Surge Interest

First there were environmental mutual funds that rewarded do-good companies and those with sustainability sensitivities. Next came alternative energy and climate change funds.

Now the next wave in mutual funds could be those that invest in water-related companies.

"Water is unique. It is the most important element and is at the heart of every manufacturing process and at the very heart of life itself," said Neil Berlant, portfolio manager of the $14 million PFW Water Fund managed by SBG Capital Management of Pasadena, Calif.

The water sector has been largely ignored until now because water has been relatively inexpensive, said Berlant, who also serves as the senior vice president and managing director of the water group at Crowell Weeden Co., and has managed the fund since its transformation from the Bender Growth Fund last June.

"Anything that doesn't cost much money tends not to be taken seriously," he said.

In contrast, the highly successful bottled water industry has been taken seriously because it costs a great deal more than tap water. Consumers believe that bottled water is vastly better than tap water and they've adopted a certain mindset justifying the cost, he noted.

But Wall Street could soon be awash in interest in the water sector if only because water prices are escalating. Berlant expects water prices to rise two to three times current prices over the next three years.

"Water permeates every aspect of our economy," he said, including water used for drinking, showering and washing clothes as well as manufacturers' and agricultural firms' growing dependence on it.

The PFW Water Fund is one of only two mutual funds that focus solely on water-related companies. The funds debuted last June and July and have so far attracted modest assets.

Both invest in an array of companies with at least half of their businesses steeped in the water industry. This includes those that produce, collect, transport, or treat water - such as providing purification and desalination - and those that have technologies related to water services.

A third water-centric fund was registered two weeks ago by Allianz Global Investors Fund Management of New York and is expected to launch in a few weeks.

The RCM Global Water Fund, for which Allianz will serve as the advisor and RCM Capital Management's London office will serve as the subadvisor, will invest 80% of assets in water-related companies. The fund does not specify how much of a company's business needs to be related to water.

But according to the prospectus, the fund will invest in firms that relate to the "quality or availability of or demand for potable (drinking quality) water and non-potable water." The fund's managers will not have geographic or capitalization constraints.

The new water fund will be the first sector Allianz will spin off from its RCM Global EcoTrends Fund that debuted last February.

The EcoTrends fund focuses on the water, recycling and alternative energy sectors. Allianz launched a similar fund in Europe at the end of 2006 and one in Taiwan in early 2007, said Brian Jacobs, managing director and head of sales at Allianz. The US fund did very well performance-wise and attracted financial advisors, he added. So the firm chose to focus this new fund on the narrower water sector.

We are hearing threats of "wars being fought over water and how water is the new oil," Jacobs said. Additionally, "pure drinking water is becoming more and more important."

Many water-related companies have been able to grow organically and have shown their strength through all market cycles, said Bill Brennan, president and managing partner of Aqua Terra Asset Management of West Conshohocken, Penna., the subadvisor to the $7 million Kinetics Water Infrastructure Fund which launched last June. The fund is advised by Kinetics Asset Management of Sleepy Hollow, NY.

Even in a recessionary economy, people will not stop showering or flushing the toilet.

"Water is the backbone of manufacturing and industry," Brennan said.

Additionally, the water infrastructure needs in the U.S. have not been adequately addressed and systems have become dilapidated, Brennan said. Spending to improve that infrastructure jumped from $250 billion in 2001, to $506 billion in 2006, and as much as $1 trillion is expected to flow to improvements by 2012, he said.

"We've seen an increase in water-related offerings," confirmed Michael Herbst, a mutual fund analyst with Morningstar who is skeptical about such narrowly-focused products.

That universe includes two water-based ETFs from PowerShares Capital Management as well as an ETF and unit investment trust from Claymore Securities.

Supply and demand issues are emerging in China, parts of the Middle East and even the Southeastern US.

But the government's involvement in the water industry, along with regulations and lack of clarity on some issues, poses a political risk, Herbst said.

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