According to the World Resources Institute, global water consumption grew at twice the rate of the population during the 20th century.

Hydrogen Ventures estimates that $660 billion will be needed for water infrastructure in the next 20 years.

There's a variety of companies seeking to capitalize on this potentially lucrative water theme, from $376 billion market-cap behemoths like General Electric ( GE) to $290 million micro-caps like Layne Christensen ( LAYN). The challenge for investors is that GE's water business is a long way from having a meaningful impact on the entire company, and one little misstep from a micro-cap like Layne could result in a major blowup.

Seeing the potential for the water sector, PowerShares has contracted to create the PowerShares Water Resources Portfolio ( PHO), a new exchange-traded fund that is based on the Palisades Water Index (ZWI). PHO is scheduled to list and begin trading on the American Stock Exchange on Dec. 6 (today).

To evaluate this ETF, I plugged its components into Morningstar's portfolio tracker. PHO has a median market cap of $1.6 billion, which isn't that surprising given that 40% of the fund is small-cap growth and 24% is small-cap value. Earnings for the inaugural version of the portfolio are expected to grow 12% faster than the S&P 500.

PHO does have a few mega-cap conglomerates in the mix, including GE, 3M ( MMM) and Siemens ( SI), but those three have only 0.80% respective weightings. PHO is heaviest in the industrial sector, 49%, and utilities, 33%.

Morningstar places the portfolio's yield at 1.5%, and PowerShares has capped the expense at 0.60%, which implies a yield of 0.90%. However, this is my calculation only, and PowerShares has not announced a dividend.

Palisades Water Index (ZWI) and iShares Russell 2000 (IWM)
Tight correlation
Source: Your Source Financial

The above chart goes as far back I could find. It's no surprise that the underlying Palisades Water Index (ZWI) has a tight correlation to the small-cap sector as measured by iShares Russell 2000 Index Fund (IWM). But what might be surprising, according to the PowerShares literature, is that ZWI's beta (a measure of volatility in which 1.0 equals the S&P 500) is 0.68, comparing favorably to IWM's beta of 1.29.

In addition to potentially being a low-impact, small-cap play, I believe that the kicker of the water story coming to fruition offers an upside catalyst to PHO that small-caps in general do not have.

Therefore, if these numbers hold up, PHO provides a low-beta alternative to capturing small-cap growth, and this could be very important given that by all historical measures the small-cap leadership should soon end.

No review of a product like this would be complete without attempting to assess the risk. This is not an emerging market investment, but PHO does stand to benefit from development in emerging market countries. There also is the danger that some unknown event could derail the modernization theme in a country or region.

Also, the water industry is an emerging industry. To own PHO is to believe that the index-keepers will be smart about additions and deletions going forward.

I believe PHO offers a clear and obvious framework for long-term outperformance, but I would expect it to struggle if there is a short-term downturn for the small-caps.

For investors who like water as an investment theme but do want the small-cap exposure that goes with PHO, they could look at several of the larger components of PHO, such as Suez ( SZE), which has a $28 billion cap, Veolia Environnement ( VE), $17 billion, or United Utilities PLC ( UU), $10 billion.

As for me, the water theme makes sense intuitively. I will be a buyer of PHO personally and for clients in very short order after the listing. To be clear, this is a longer-term idea. But as the water theme evolves in awareness and social importance, I would expect something like PHO to add some real leadership in a diversified portfolio.
At the time of publication, Nusbaum was long Suez and Caterpillar, although positions may change at any time.

Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, Ariz., and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback; click here to send him an email.

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