Although controversial in some quarters, the provision of, or access to, fresh, clean water has evolved into a major investment theme in the 21st century, fuelled by a mismatch between population growth and finite – or, at least, ‘circular’ – supply. For many, access to fresh water is held as a fundamental human right, like drawing in a lungful of fresh air. Indeed, in 2010 it was recognised as such by the United Nations General Assembly.
But does this represent a somewhat disingenuous view given the realities of water management and environmental degradation? After all, fresh water accounts for just 3 per cent of the H2O that covers three-quarters of the globe. Of that, 70 per cent is locked in inaccessible subterranean pockets, while another 29 per cent is frozen in the polar caps. And even of the remainder, or at least that deemed fit for human consumption, the bulk is destined for use in agriculture and industry. In isolation, US oil and gas companies produce 800bn gallons of brackish, toxic wastewater each year, all of which needs to be properly managed. In other words, it’s another example of when people confuse rights with privileges.
Climate change and demographics - major spurs for investment
According to the World Economic Forum, water scarcity has become the most serious issue for the planet in terms of economic, security and environmental risks. This is backed by separate analysis from the International Food Policy Research Institute, which predicts a 40 per cent gap between water demand and supply over the next 15 years.
Forecasters point to an expected 41 per cent rise in demand for H2O between 2010 and 2030; the result of population growth and rising prosperity in emerging markets. As income increases, basic infrastructure spending takes on both individual and social needs from sanitation, hospitals and clinics to schools and power transmission. The demographic pressure is exacerbated by changes in patterns of consumption linked to land- and water-intensive livestock and personal care products.
But for every problem there is a commercial opportunity. Global advisory firm McKinsey & Co estimates that investments totalling $7.5 trillion (£5.78 trillion) are needed between now and 2030 to keep pace with global demand forecasts, with climate change policies also acting as a major spur for infrastructure spending. The World Economic Forum estimates that every dollar spent on water utilities generates an economic return of between 5 and 25 per cent. This multiplier effect isn’t the sole preserve of the emerging markets economies; investors can also tap into the projected spending increases in industrialised countries as governments scramble to replace outdated water infrastructure.
The security question – 21st century water wars
Inadequate supply is already causing global tensions. Wars have been fought over the access and allocation of water. One of the potential flashpoints centres on competing demands for the water resources of the Taurus-Zagros Mountain range, which extends across Iran, northern Iraq and Turkey.
Experts blame droughts in Syria and the resulting economic decline for the civil war that has ravaged the country for more than six years. Decades before this, in the 1980s, access to the Shatt al-Arab river was just one of several sparks in the eight-year battle between neighbouring Iraq and Iran.
Political instability has arisen in other locales, most notably South America, as a result of worsening water scarcity. Bolivia was rocked in the spring of 2000, when tens of thousands in the city of Cochabamba protested against the privatisation of the city’s water services.
Social and environmental disputes over scarce water resources have also played out in neighbouring Peru. Indigenous movements and environmentalists have been locked in battles with central government and regional authorities over the issue of commercial water exploitation in Ecuador, the only country in the world whose constitution codifies water as a human right. Whatever your view on the competing views on these conflicts, they do represent a risk factor for investors.
And there could be more conflict ahead. There are several examples of current stand-offs between countries sharing lakes and rivers across the world: India and Pakistan; Egypt and Ethiopia; Laos and Cambodia/Vietnam; Tajikistan and Uzbekistan. The construction and control of dams and power stations on rivers are fuelling water disruption fears as populations are rising and rainfall is predicted to fall.
Water is also a battleground in the ongoing conflict between Israel and Palestine. Israel diverted the River Jordan to its territories some 50 years ago, resulting in the Dead Sea shrinking by a third. Access to water is becoming as politically contentious as oil in global security considerations.
Tapping into estimated 5-7 per cent annual growth
So, the combination of fixed supply and rising demand is creating an imbalance that will tick boxes on many investor checklists. Portfolios that are not exposed to the world’s most precious resource could miss out on the 5 to 7 per cent annual growth that Simon Gottelier of the Pictet-Water fund says the $600bn market is experiencing. This growth rate is backed by separate analysis from Bank of America/Merrill Lynch.
One way to gain exposure is to invest in an exchange traded fund (ETF). These include iShares Global Water (IH2O), Lyxor ETF World Water (WATL) and PowerShares Global Water (PIO:Nasdaq).
Active funds worth putting on your research list include Pictet-Water (LU0448836600), RobecoSAM Sustainable Water Fund and KBIGI Water Strategy. The latter is not available to retail investors on platforms, but those with larger investment pots could access it through a wealth manager or private bank.
Then there is Impax Environmental Markets (IEM), a broader sustainability-focused investment trust. At the end of September 2016 it had £1.7bn invested in H2o, or around 20 per cent of the portfolio.
Liquid assets – an investable universe of 157 companies
With demand expected to climb in the coming years, water should be treated as a long-term investment. These funds operate on that premise and buy equities that support the water value chain to help boost sustainability in the industry. So there is more to investing in water than simply buying shares in a utility such as Severn Trent (SVT). KBIGI Water Strategy has identified an investable universe of 157 companies, mainly technology and infrastructure-related businesses. This universe is reflected in the Dublin-based fund’s portfolio. KBIGI had £427m invested in 45 companies at the end of March. This portfolio is diverse, split between technology (35.8 per cent), infrastructure (26.4 per cent) and utilities (37.8 per cent). The fund is hardly in bargain basement territory. Investors will have to pay almost 19 times earnings to access the 2.3 per cent yield it offers. Mindful of the usual caveat regarding past performance, KBIGI has generated a 4 per cent annualised return above the MSCI World Equity Index since 2000, according to chief investment officer Noel O’Halloran.
Other funds in this area have produced similar results. The 825m (£694m) RobecoSAM Sustainable Water Fund outperformed the S&P Global Water Index in four of the past six years. It generated a price return of 28 per cent in 2016, up from 6 per cent a year earlier. Meanwhile, Pictet-Water, which has €4.5bn (£3.95bn) of assets under management, recorded a 27.4 per cent price return in 2016, up from 5.6 per cent in the previous 12 months.
Despite water’s status as a relatively static, lower-growth industry, there is no shortage of experience at the top of these funds. Küffer has a 16-year investment track record at Swiss sustainable investor RobecoSAM, while KBIGI’s O’Halloran has led the fund for 17 years. Pictet-Water’s decision makers also have several years of experience. Pictet’s Gottelier joined the firm last year from Impax Environmental Markets, an investment trust that has built an impressive track record. Over the past five years it has recorded a cumulative performance of 136.9 per cent. Over three years the figure is 50.6 per cent and 33 per cent over 12 months, beating the FTSE Environmental Technology 100 Index in each period.
One benefit of this trust is the lack of an entry fee. This is not the case with Pictet-Water and RobecoSAM, where investors might have to pay a 5 per cent levy to get their money in, with ongoing charges of 1.16 per cent to 1.22 per cent. Impax’s investors need to be prepared to pay a 1.2 per cent ongoing charge as well as custody fees and a 1 per cent levy when taking their money out.
These collectives also have the benefit of providing exposure to companies in the US, Asia, emerging markets and Europe. Established businesses such as Veolia Environnement (VIE:PARIS), Suez (SEV:PARIS) and American Water Works (AWK:NYSE) can be found among their holdings alongside smaller, niche names. As well as geographic diversity, these funds also provide access to a range of sectors, including technology, industrials, basic materials and utilities.
Engineering and infrastructure plays
Water is a defensive industry, but just because we cannot live without it does not mean that these funds are risk-free investments. Do not forget that the technology element of these vehicles increases their risk profile, especially if they have products under development.
Those wanting to cut out the middle man and pick their own stocks should think about the cradle-to-grave cycle of water. Companies that focus on addressing the increasing demand for and limited supply of water may represent some of the best growth opportunities for investors. Options include infrastructure heavyweight Balfour Beatty (BBY). The FTSE 250 constituent utilises its technological expertise in the provision of clean and waste water mains, metering and treatment facilities, alongside its transport and power businesses. After three years of losses, the group returned to profitability in 2016 with an underlying profit of £67m, which also resulted in the reinstatement of the final dividend.
Engineering consultancy WS Atkins (ATK) is another London-listed entity working to help solve the world’s water issues. Its contracts include supplying water to houses in Hong Kong and a flood control project in Las Vegas. Its exposure to the US could prove highly lucrative. Investments along the US water value chain are now deemed critical by federal authorities. This could give way to significant investment in water treatment and transportation in the near future, assuming Congress gives free rein to President Trump’s spending proposals.
Another stock worth a look is project manager and technical consultancy WYG (WYG). The group secured a contract in early June with the UK government for a water management programme serving the Climate Resilient Infrastructure Development Facility (CRIDF) in southern Africa. Management expects the initial £5m it will receive for its work in the next two years to expand “significantly”. Moreover, the CRIDF contract forms part of a new, more targeted approach as part of the UK’s overseas development programme – another potential growth area for water infrastructure specialists.
And there are growing opportunities in the pipeline, quite literally. It is estimated that around half the water in major cities in developing economies is lost through leakage. In the US, 1.7 trillion gallons are lost each year, according to the US Geological Survey. One stock worth assessing could be Canadian water and wastewater pipeline specialist Pure Technologies (PUR:TSX). Pure has developed proprietary technologies in water transmission and wastewater management that are feeding into the expansion of replacement programmes in North America and elsewhere.
The incentive for utilities is plain enough: the company points out that a single large-diameter pipe failure can cost between $500,000 and $1.5m to repair without factoring in additional costs from litigation or environment costs. Then there is Mueller Water (MWA:NYSE), which owns leak detection business Echologics, a provider of actionable data on buried (pipeline transfer) infrastructure, helping to optimise capital investments, repair and rehabilitation programs.
Pentair (PNR:NYSE), a water and fluid control specialist, and Xylem (XYL:NYSE), a technology company that provides pumps and monitoring systems, are worth putting under the microscope. As is US outfit Roper Technologies (ROP:NYSE), which fabricates various water-related products, including pumps.
Taking the plunge - structural drivers intensifying
Investing in water is not just for those wanting to make an environmental impact. It has a wider effect on society than just something that we blithely utilise on a daily basis. “If you are investing in water you are not investing in a narrow piece of the economy,” Impax Asset Management’s Bruce Jenkyn-Jones says. “You are exposed to everything because everybody uses it,” the co-head of listed equities and co-manager of the company’s water strategy adds. You need it to grow food, to get oil and gas out of the ground and keep offices functioning, while the UN claims that three in four jobs globally are dependent on water. “An investment in water is an investment in the whole economy,” Mr Jenkyn-Jones says.
Tailwinds for investing in water include scarcity, regulation to ensure it remains accessible and affordable, changing weather patterns and technological advancements, such as analytical equipment, piping and meters. The need to improve water quality will create opportunities for purification and testing companies, such as Danaher (DHR:NYSE). For a start, there’s China’s $330bn fight against water pollution and the estimated 2m tonnes of human waste sent into water sources each day, according to the World Water Assessment Programme.
Political will is also a strong driver. Increasing supply, improving quality, cutting waste and repairing infrastructure are firmly on government agendas. Higher spending on infrastructure could see pipe, plumbing, pump and fluid control system providers benefit alongside irrigation companies and engineering consultancies.
Population growth and migration within the emerging markets are further catalysts. We will have 9.7bn citizens globally by 2050, the UN believes – 2.2bn more than we have today. And around 70 per cent of those people will live in cities, up from the current 50 per cent level.
To keep pace with this growth, infrastructure will have to be upgraded to supply water as well as deal with the resulting rise in wastewater. An example is China, where 350m people are expected to move into urban areas in the coming years, Mr Gottelier says.
Investors looking to spot future trends in the water market should focus on technology. Digitalising the industry to make it more efficient, improve data capture and cut costs will be the catalysts that drive innovation. “We will see an increased focus on bringing the cost of those processes down by using pumps that can be more easily turned up and down at different times of day to make them more efficient,” Mr Gottelier says. “Rather than any amazing breakthroughs, what I see being the more prevalent trend in the next 15 to 20 years is existing technologies will incrementally get more efficient, but they are going to be used for different things,” he adds, pointing to water reuse projects in California that turn sewage into drinkable water.
There are clearly more ways to gain exposure to water’s predicted rising revenues than simply buying shares in a utility. With growth driven by a huge need to improve quality and supply, can you afford to adopt a wait-and-see approach to investing in what is expected to be a megatrend? After all, there will be more of us living on this planet in the coming years and we cannot live without H20.
UK water companies: regulatory pressure
Much of the coverage of UK water companies in recent weeks has been focused on the ongoing troubles of Thames Water. The company came under scrutiny recently as regulators discovered it had incurred an £8.55m fine for missing leakage targets. It was also fined a record £20.3m after admitting to dumping 1.4bn litres of raw sewage into the Thames. The water regulator Ofwat's chief executive, Cathryn Ross, described the company's failure as "unacceptable" and is opening an investigation into the company.
Water, sanitation and drainage in England and Wales are supplied by 32 private companies, following the privatisation of the water and sewerage authorities in 1989. There are 15 water suppliers, each covering a different geographic area. Of these, three are listed in the UK, Severn Trent (SVT), United Utilities (UU) and Pennon (PNN). Privatised water became an issue in the recent general election after the Labour party's manifesto, which cited water bill increases of 40 per cent since privatisation and promised to replace the current system with a network of publicly owned regional companies.
These companies are regulated by Ofwat in large part through the use of outcome delivery incentives (ODIs), a range of targets related to the condition of parts of the network, amounts of sewer flooding, leakage levels and others. These are set at the start of each five-year asset management period, also known as the AMP cycle; companies receive rewards or penalties depending on their performance relative to the target. This creates a financial incentive for the companies to maintain levels of stewardship and sustainability. In the 2016/17 financial year, Severn Trent earned a net reward of £47.6m in rewards for delivery against its ODIs, Pennon's Southwest Water earned £3.6m and United Utilities earned £6.7m.
Justin Winters, portfolio manager at sustainability-focused fund manager Impax, said the fact the companies had to publicly report its accounts also helped to push sustainability efforts to the forefront. "People are looking at their accounts and there's a lot of focus on how they're performing," he said. "They're more focused on finding solutions and prevention." He added the desire to avoid big incidents or loss of supply meant investing in sustainability was often a sensible capital allocation decision. "Companies don't want to be in a position where they've cut dividends because all of a sudden they're being hit with a massive fine,” he said.
This has led to new and novel approaches to monitoring the condition of pipes and other assets, Severn Trent has invested in proactive network modelling, which it said in a presentation in March this year has led to its avoiding £1.5m in customer ODI penalties. Severn Trent spent £540m in 2016/17 on renewals, upgrades and resilience through its capital programme, while Pennon invested £191m in its water and wastewater operations and United Utilities invested £804m.
The listed players have had their troubles, though. In August 2015, United Utilities found traces of the parasite Cryptosporidium in drinking water supplies at one of its water treatment works, leading to more than 300,000 households being told to boil their water before drinking it and the company paying £25m in compensation.
In June this year, Severn Trent was cautioned by the Drinking Water Inspectorate - a government department - following an incident in March 2016 where consumers in 3,700 properties were warned to avoid using their water for 26 hours following the discovery of elevated levels of chlorine. However, DiscoverWater, a website set up by industry organisation Water UK and various regulatory bodies and government departments, found 99.96 per cent of drinking water in England and Wales is up to national standards for quality. TD
