Water, water everywhere…

By Sarfraz Thind

It’s the most fundamental of human needs. But the time when people in the Western world could take water for granted has gone. Companies are pouring money to address the water crisis. So how can investors tap into this essential resource?

“A lot of the water in the UK is from Victorian times and needs to be upgraded.”

Peter Hofbauer

Water is not as ubiquitous as we think. At present only 0.025% of all water on earth is accessible surface water, according to data from the UN. With the global population expected to grow from seven billion to nine billion by 2050, the UN predicts that two-thirds of the world’s inhabitants will be ‘ water stressed’ within the next 40 years. The solution to the water problem lies in more efficient techniques of collection and distribution, improvements in infrastructure, better desalination technologies, as well as adapting to regulatory changes. And all of this presents a solid investment proposition.

“Water, water everywhere, nor any drop to drink.”

At present, the global water industry generates $500m of revenues per year with average growth rates of 6%. Yet, it is still a niche market, with estimates of fewer than 20 specialist water funds working in this area. The returns have been impressive. Over the last three years the S&P Global Water index has delivered 12.91% on an annualised basis, significantly beating the MSCI World and MSCI EM indices which have returned 9.81% and 6.60% respectively.

Individual fund managers have also shown strong performance. Pictet, which currently runs Europe’s largest specialist water fund with $3.1bn in assets under management, has seen its fund outperform the MSCI World index in 11 of the 13 years since inception. RobecoSAM, which started its €1bn water fund in 2001, has outperformed the MSCI World index in eight out of the last 12 years.

“The story behind water is on the long-term needs of the world,” says Arnaud Bisschop, co-manager of the Pictet Water fund. “If you have a long-term perspective we feel you will get better returns.”

Infrastructure needs

The opportunities for water investment fall into in three main streams – utilities, technology/ industrials and infrastructure. The latter has been a particular source of focus of late. According to Steve Falci, head of development at Kleinwort Benson Investors, water is expected to be the largest recipient of global infrastructure investment – approximately $22trn – in the coming decades.

In the US, $40bn – $50bn of annual spending is needed over the next few decades to repair a creaking water infrastructure which is seeing a quarter of a million mains breaks every year, according to Simon Gottelier, who heads up the water strategy at £1bn fund manager Impax.

Gottelier identifies companies like Xylem and Pentair, which make pumps and pipes and could benefit from a government push into construction spending as the US economy continues to recover post-crisis. In emerging markets, water infrastructure spend is an even bigger revenue generator with growth rates of between 12% and 24%, compared to 6% globally, according to Impax.

China, for instance has 21% of the world’s population, but only 7% of the renewable water resources. The migration of the population from rural areas to cities is causing increased pressure on water infrastructure with a total estimate of $450bn of expenditure in the next few decades. Companies like state-owned China Everbright are likely to get a chunk of this funding and offer strong investment propositions, says Gottelier.

Other investments to look for are desalination companies – producing fresh water from sea water – a market that is expected to show robust growth of between 15% and 20%.

Apart from the industrial companies, more traditional and non-cyclical utilities are likely to benefit from the water infrastructure theme. The prospects of investing in a stable water utility attracted the BT Pension Scheme, which last year acquired a 13% stake in Thames Water to become the largest single shareholder in the company. Clearly there is a solid growth rationale underlying the investment. In London, more than 25% of residential water is lost to leakage, much of it due to infrastructure that is over 150 years old. Thames Water has proposed a long-term objective to reduce leakage by approximately 50% by 2035 through an infrastructure overhaul, says Peter Hofbauer, head of infrastructure for Hermes GPE, who advised BT Pension Fund on the deal.

“This should provide steady and stable returns but equally growth,” he adds. “A lot of the water infrastructure in the UK is from Victorian times and needs to be upgraded or replaced. We’ve looked at water assets in the US but it’s in public hands which gives us less opportunity to access it.”

Equity options

Despite the obvious investment rationale there are a number of issues for people investing through equity water funds. For one, agreeing exactly what is a pure water play remains a bone of contention. There are, for instance, no big leaders in the market.

“It is a pretty fragmented market,” says Bisschop. “If you ask five people which are the main water companies on the industrials side you will get five different answers. There are lots of players and companies are generally small or midcap – it’s a sector that lacks leaders.”

Roberto Cominotto, fund manager of the JB Natural Resources Fund at Swiss & Global, which set up a specific water-focused strategy in April, says for larger funds, this lack of choice means that the theme can sometimes be a subsidiary factor in the investment decision: “One of the problems that large water funds have is that they are lacking in investment opportunities,” he says. “They often have to invest in companies that have little water component.”

Bisschop admits this: “What we look for is some exposure to the water industry that is meaningful—but we do struggle with this. Our threshold is that the business needs to have 20% of its minimum value in water. At present 70% of our portfolio is related to water the rest in ancillary activities.”