Water has its own unique dynamics: It's a commodity that doesn't trade like a commodity, and it's a substance that has no substitutes. And, of course, life--and commerce--are impossible without it. As the population grows, it will put inexorable supply-and-demand pressures on water that will only intensify. Many forecasters believe the global scramble for clean, usable water will greatly affect the geopolitical and economic landscapes of the 21st century.

For investors, though, the water sector also presents a compelling opportunity. The market for water products and services is estimated to be $400 billion to $500 billion annually. The market is also complicated-a vast and diffused area cutting across various industries. It includes stodgy utilities that deliver water to your tap, as well as high-tech companies that do state-of-the-art hydrological modeling or make cutting-edge biological and membrane treatments. Some companies make the pumps, pipes and valves that deliver water, while others make meters that measure how much water people use.

Probably the easiest way to invest in water is through the handful of exchange-traded funds and mutual funds that mimic various water-related indexes. But there are also individual companies and venture capital opportunities for investors hoping to latch on to a potential Google or Microsoft of water. That is, if a killer application for water even exists.

"There won't be a silver bullet solving the water issue," says Gerald Sweeney, portfolio manager at Aqua Terra Asset Management, a water-focused money manager. "There are multiple techniques and technologies that address different issues at different levels and geographies."

Thirsty Planet
The big picture is simple (and troubling). Namely, there's not enough clean, fresh water to meet the world's needs. If the global water supply could fit into a 55-gallon drum, roughly 53 gallons would be saltwater. Much of Earth's fresh water is either floating in the atmosphere or is locked frozen in ice caps and glaciers. And the fresh water supply we can access is dwindling--worldwide water usage zoomed sixfold during the 20th century, twice as much as population growth, according to a report by Summit Global Management, a water-focused hedge fund.

Assorted white papers and research reports are filled with factoids and gloomy scenarios about a looming water crisis, from melting glaciers that may no longer be able to serve as huge "banks" of water to the depletion rates of many major aquifers. It's estimated that more than 1 billion people don't have a sufficient drinking water supply, and 2.6 billion don't have access to basic sanitation.

The uneven global distribution of water adds to the problem. According to Summit Global Management, fewer than 10% of all countries possess 60% of the world's supply of fresh water. That could spell trouble for countries such as China, which has grand economic aspirations and more than 20% of the world's population, but only 7% of the renewable water resources.

And the amount people need for drinking and bathing is a proverbial drop in the bucket compared with the water needed for agriculture and industry. It's estimated that 70% of global water use goes toward growing food, and that could rise with population growth and shifting diets as emerging market countries become wealthier and eat more dairy products and meat, which require much more water to produce than crops. Meanwhile, trillions of gallons of fresh water are used for manufacturing in industry.

Investing Through Osmosis
For years, water utilities were synonymous with water investing. And for good reason: These staid local monopolies have been a steady cash cow and dividend producer no matter what the economic climate. In the 10-year period ended 2008, U.S. water utility stocks as a group had total returns of 128% versus 18% for the Dow and losses of 13% and 24% for the S&P 500 and Nasdaq, respectively.  

And they might get a boost from a potential consolidation wave. According to Summit Global Management, global water utilities have the lowest percentage of ownership of all forms of utilities. As of 2006, there were 54,000 community water systems and 16,000 wastewater treatment facilities in the U.S., setting the stage for a slew of water roll-up strategies to create economies of scale.

The water and wastewater utilities group is one of Calvert Investments' top three themes, as is water infrastructure and water technologies. "We think technology companies are poised to deliver once these products reach scale, particularly in metering and filtration," says Lily Donge, Calvert's manager for environment and climate change.

Among the holdings in the Calvert Global Water fund is Kurita Water Industries, a Japanese maker of reverse-osmosis seawater distillation equipment that's expected to see growing demand in Asia. In addition, Kurita has developed a wastewater treatment system using a microorganism called anammox bacteria to break down wastewater sludge.

For many people, desalination is the sexy poster child for solving the world's water crisis. Stick a pipe into the ocean, suck up seawater, remove salt and impurities, and voilà--fresh water. Still, even though desalination technologies are progressing, it remains a costly and energy-intensive process. Nor is there a single company, or group of companies, waiting to corner the market.

"Each desalination plant is different, depending on the location and salinity of the water," says Sweeney. "You don't buy the desalination plant; you buy the makers of membranes, pumps and different chemicals for pre- and post-treatment."

Sweeney suggests investing in desalination through a company such as Tetra Tech, a Pasadena, Calif.-based engineering outfit involved in designing and building desalination plants, among a host of other water-related businesses.

Ryan Connors, an analyst with Boenning & Scattergood, believes the five most compelling water subsectors are metering, desalination, irrigation, conveyance and distribution infrastructure.

Of the desalination companies, Connors likes Energy Recovery Inc., a San Leandro, Calif., company that makes the PX Pressure Exchanger, a rotary device that recovers energy from the waste stream of seawater reverse osmosis systems and helps desalination plants use significantly less energy.

Irrigation is a big theme given the notorious inefficiency of standard irrigation systems. "Traditional flood irrigation systems lose 40% of their water to evaporation," Connors says. His top pick in that field is Lindsay Corp., the Omaha, Neb.-based maker of center pivot irrigation systems that greatly reduce water waste. Connors believes Lindsay could benefit from the increased mechanization of farming in the emerging markets.

One of Connors' top recommendations is Badger Meter Inc., which stands to benefit from the growing water-metering trend in the U.S. Only about half of U.S. households are metered for their water use, but the market opportunity will grow as more communities become concerned about water scarcity, and particularly as more Americans migrate to the dry Southwest and the drought-stricken South. Automated meter reading technologies from the likes of Milwaukee-based Badger currently have just 25% of the meter market share, but they are gaining momentum.

Go With The Flow
Water always flows, but the recent lack of credit flows has stalled some massive water projects either on the books or in the works, causing many water-related companies to nosedive along with the rest of the markets during the downturn. The PFW Water fund, to take one proxy of the market's health, lost 23% in 2008 while the PowerShares Global Water fund dropped 46%. Through early May, performance in the small water funds universe ranged from a 5% loss to a 5% gain.

"No doubt that credit problems slowed some projects in the market," Connors says. "Some desalination projects rely on bank financing, and some of that has fallen apart. But it's clearly a temporary delay."

Indeed, the U.S and other nations dealing with century-old water infrastructure face inevitable upgrade projects whose costs will be in the trillions of dollars. The U.S. tab alone is estimated at $1 trillion over the next 20 years.

But some of the most promising companies aren't public, nor are they the most obvious. "You want to avoid municipal markets and niche industrial markets," says Laura Shenkar, a principal at the Artemis Project, a San Francisco consulting practice that links water technology companies with investors and corporations. "That would remove a lot of what classic water industry people would consider 'the market.'"

Instead, one of Shenkar's focus areas is on storm water control, which the Environmental Protection Agency is actively engaged in regulating. "Another exciting area is anything that dramatically reduces the use of potable water on a site or wastewater coming from a site," she says.

In April, Artemis announced its inaugural list of the top 50 emerging water-related technology companies. The list included AbTech Industries, an Arizona company focused on storm-water filtration; Aqua Pure Technologies, an Israeli company that uses a proprietary nonthermal plasma technology to remove micro-pollutants from contaminated drinking water; and SCFI Group, a sludge treatment company in Ireland.

Shenkar says the venture capital community thus far hasn't turned on the spigot for water-related investments. Indeed, VC investment in the so-called "cleantech" arena-including solar, wind and geothermal energy-totaled roughly $1.7 billion in last year's fourth quarter, whereas the investments for water and wastewater were practically nothing. Shenkar's group has therefore reached out to financial advisors as a funding source. "The investors who are making a difference are usually high-net-worth individuals and family offices," she says.

Her sales pitch isn't about feel-good environmentalism. "We're not selling water because it creates a beautiful environment," she says, adding that emerging technologies are "bottom-line business values based on cost and benefit decisions."