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Stress-testing the water

Nina Röhrbein investigates water-related investment opportunities, which are now starting to attract institutional investors

UN analysis suggests that if present trends persist, demand for fresh water will outstrip supply by 40% by 2030. By 2050, four billion people will be living in areas facing severe water stress. Add that almost 800m people worldwide do not have access to clean water, while 2.5bn lack basic sanitation, and a worrying picture emerges.

“In addition to the significant implications for meeting vital human needs, it is estimated that 45% of global GDP in 2050 is at risk, about $63trn (€46.6trn),” says Steve Falci, head of strategy development for sustainable investment at Kleinwort Benson Investors. “However, with an estimated $22trn in water infrastructure required to be deployed from 2005 to 2020 alone, we see opportunities for companies to provide solutions to meet our global water challenges.”

Water-intensive industries such as paper, energy and beverages will most likely be hardest hit from any restrictions as supply-demand imbalances increase.

Simon Gottelier, investment manager at Impax Asset Management, says: “Industrial companies and most industrial processes are sophisticated in their approach to water management. Industrial applications are only responsible for approximately 20% of all water use globally, as opposed to 70% by the agricultural sector. Businesses such as hotels are somewhat less sensitive to the price and availability of water than industrial processes but they also have a water bill, which is why it should be a concern nevertheless.”

The EIRIS Water Risk Report from 2011 found that 54% of the 2000 global companies analysed were exposed to water risks. However, less than 1% could demonstrate that they were adequately managing them.

Ran Sanghera, project manager at ESG research company EIRIS, says: “While the majority of companies will take a minimal reactionary approach to water, the companies that seek to identify their risks and develop sustainable water management strategies will be those that continue to profit. Companies that have not considered their water risks in either direct or indirect operations will most likely see falls in their production levels and profit margins, and will come under pressure from regulatory authorities, increased legislation and water pricing. In emerging markets, company demand for water may increasingly come into conflict with domestic needs, fuelling company boycotts and protests, which could lead to companies losing their operating licences and reputation.”

In mainstream equity portfolios, investors can examine the environmental, social and governance records and water-management policies of the companies they hold.

According to Gottelier, investors ought to look for strategies to identify risks, the publication of water-quality targets, disclosure of water data within the annual report or environmental documentation, information on the amount of water used in water-stressed geographies and the reporting against various targets.

A number of tools already help investors to determine the risks to their portfolios, including the WWF Water Risk Filter Tool, the CDP Water Disclosure Programme and the EIRIS Water Risk Criteria.

But Philippe Rohner, senior investment manager of the Pictet Water Fund, warns: “Determining footprints as a practical decisional tool in the case of water allocation is significantly more complex to develop than, for example, for CO2. Currently, such footprints aim at increasing awareness, but they would need to be developed further to be of broader use, such as in developing water-allocation policies.”

But equity investors also have opportunities to invest in water through water utilities. Currently, the water needs of almost one billion people are serviced by private companies. This compares with 563m in 2005 and just 335m in 2000, according to Pictet’s advisory board.

“The water industry has, over the last years, benefited from a higher growth rate than the overall economy, due to high demand from emerging markets, stricter regulation with regard to water quality, and the pressing need to replace or maintain ageing water infrastructure in large countries such as the US and the UK,” says Matthias Fawer, sustainability analyst and water expert at Sarasin bank. “Water stress can be minimised either by increasing access and supply, reducing consumption or recycling and cleaning wastewater.”

Asset manager Swiss & Global invests in two types of water companies – utilities and equipment companies, supplying services and producing components such as pipes, valves and filters.

Roberto Cominotto, co-manager of Swiss & Global’s Natural Resources Fund, says: “We are currently not invested in UK water utilities because we expect a lot of regulatory changes in the UK market over the next one to two years, which creates a lot of uncertainty. But we are invested in the larger European water utilities and in two US utilities. One important driver is the recovering North American housing market, which will have a positive impact on water infrastructure. Chinese water utilities, meanwhile, benefit from rising water tariffs and the growing trend towards privatisation.”

Impax’s investable universe has three principal sub-sectors – infrastructure businesses, suppliers and developers, and water utilities. “Water infrastructure gives exposure to commoditised economically sensitive businesses with exposure to, for example, construction. This is why the companies tend to be somewhat higher-growth,” says Gottelier. “Water treatment companies are relatively defensive which, from an investment perspective, means a dependable earnings stream.”

Kleinwort Benson Investors sees opportunity in water infrastructure stocks. One company it invests in is Pentair, which offers pumps, filters, membranes and softeners and, says Falci, has been successful in strategically growing its water business through acquisitions. Another holding is Canadian small-cap Pure Technologies which, through its Smart Ball product, uses advanced acoustics to detect weaknesses or leaks in piping infrastructure and carry out strategic repairs.

Kleinwort Benson Investors is also looking at a new application of UV (bank) disinfection in the treatment of ballast water. Due to regulation coming into force in 2021, Falci believes the ballast water treatment opportunity is set to grow to $21bn by 2020.

There are some 200 listed companies in the water infrastructure and technologies sector, and around 100 in pollution monitoring and testing equipment, some of which are relatively small, according to Impax. But the market is still under-exploited. To Gottelier’s knowledge, there are only 15 to 20 global funds investing in the area.

Kleinwort Benson’s 12-year-old long-only water fund has been able to outperform global equities in 10 of 12 years, generating an average annual excess return above global equities of approximately 5% since inception.

The Pictet Water Fund, which holds companies across the water supply chain, has outperformed the MSCI Global Equity index every year since its launch in 2000, except in 2003 and 2009. Historically, the fund has attracted retail investors. However, this is starting to change as more institutional investors have begun to look at the longer-term prospects of theme investing.

Kleinwort Benson has also witnessed growing interest among public pension funds, particularly in the US that have first-hand experience of water stress. And it is mainly in the US that another water-related investment opportunity has sprung up.

Impax does not invest in shale gas fracking but it sees investment opportunities in the companies that treat water on fracking sites and manage the levels of groundwater pollution. Swiss & Global is also invested in several companies exposed to the fracking process, such as service companies and one utility.

“This is a promising-looking market because, so far, the treatment of fracking water and its disposal has not been regulated,” says Cominotto. “There is a lot of potential for the treatment and recycling of this wastewater from fracking, as the US government will regulate the treatment of this wastewater more strictly in future.”

 

 

 

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