The problem I found it seems like every cylinder had trapped water in them on our old JD 310B backhoe.
In the process of blowing an O-ring and fixing it I realized even after I drained the oil out of it and refilled the next time I try to drain at first I got clear water then the milky stuff would start.
It seems if one will just drain a bit and get the clear water out of the sump drain on our backhoe then work it for an hour and drain the clear water again and again that it keeps moving out of the cylinders and back to the transmission sump where it can be bled off as I just stated.
In other words one can not drain out the old fluid and remove the water from the system. I did not use diesel since it is over half the price of real UTF. I did use a lot of expense Sea Foam at first and it helped but nothing was going to get the water out short of pulling the drain plug over and over and draining the new pooling water until you get no more clear water.
One has to be careful and focused not to drop the drain plug or let out more after the clear water stops. It seems 2/3 of our 22 gallons are NOT in the sump but in the lines, cylinders, filters, etc.
Getting the machine hot by working it if possible and draining out the clear water that you can then go right back and move each cylinder on the machine 10 cycles then repeat the drain process.
From doing the bucket flush to get all of the old ATF from the transmission, lines and cooler(s) I learned it is best not to drain from the sump so the same applies to most any hydraulic based machine. In the case of our back hoe after the clear water stops coming after each cylinder (do not forget the steering cylinders) 10x over and over (yes in can take a full day to get the water out and a lot of fluid) draining the fluid from the main sump is the first step but NOT to be repeated.
New fluid should be added to the sump (often where the dipstick inserts) but if drained at a point before the old fluid reaches the sump would be ideal but few will go to that effort. Removing distance lines and letting them flow into a bucket until clean fluid appears is the next best option perhaps.
It seems one will need 2x the fluid the system will hold to actually get the water out. In our case that would be 40 gallons of UTF. In our case the stuff coming out of the back hoe is much better than what is in the tank on the dump truck hoist system so we remove that total cruddy stuff and replace it with the fresher stuff out of the backhoe. I think 100% of seldom used dump trucks have milky hydraulic fluid.
Many equipment operators just run with the milky stuff and keep going.