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A liquid asset that straddles growth and value

A liquid asset that straddles growth and value
August 15, 2022
A liquid asset that straddles growth and value

“Water, water everywhere and not a drop to drink” – well, not quite. But many UK households are now faced with hosepipe bans, and perhaps other restrictions on water use, as parts of England experience the driest conditions since 1976. Visitors from overseas must be slightly bemused by the prospect of UK water restrictions given that the country is synonymous with persistent drizzle. Yet we’re not quite as sodden as some people imagine. The UK holds a mid-table position when countries are ranked according to their annual precipitation, although it’s perhaps more telling that the country is in the top quartile when judged by population density and third on the list of European nations behind the Netherlands and Belgium on that basis.

Regrettably, however, the fact that the world’s sixth-largest economy finds itself high and dry has less to do with demographics than it does with central government policy failure. Our current woes on the water front were wholly avoidable but inertia on the part of successive governments, inadequate infrastructure investment and a flawed privatisation model have brought us to this pass.

A National Audit Office report indicates that water leakage in the UK is equivalent to one-fifth of average daily demand. Industry regulator Ofwat has been pushing hard for water companies to cut leakage in recent years, including challenging the sector to reduce leakage by at least 16 per cent in the five-year period through to 2025. As things stand, fewer than half of the privately-owned water companies are on track to meet the target.

Storage capacity, specifically an inadequate number of reservoirs, is also central to the issue. The UK hasn’t built a new reservoir in 30 years, yet the population has grown by around 18 per cent over the same period. And prospects are looking decidedly parched. In another 20 years, it’s anticipated that demand for water in England will exceed supply as the population swells.

It’s enough to drive you to drink, but what does any of this mean for investors? Well, what we’re going through in terms of our water supplies – and indeed the provision of energy – is bound to reignite calls for renationalisation. Polls taken at the time of the 2019 general election suggest that pledges on this basis were among the more palatable aspects of Jeremy Corbyn’s manifesto. Indeed, 63 per cent of respondents to a YouGov poll were in favour of renationalisation. Corbyn’s successor, Sir Keir Starmer, recently said he would not be “ideological” about nationalising public utilities, although the electorate might be more receptive to overtures six months from now, even if this proves to be another case of nationalising the losses.

A return to public ownership represents a risk factor for investors in the sector, particularly if the government were to acquire the water industry’s assets for less than the market price. However, any government willing to go down that road would also be aware that taxpayers would be on the hook for long-term investment requirements running into tens of billions. Also at stake are the sizeable (and predictable) income streams that prop-up many UK pension funds.

Leaving aside legacy issues linked to water privatisation in the UK, it's worth remembering that water has more structural drivers in place than just about any other commodity that you could mention, rare earth metals included. In 2015 NASA found that 57 per cent of world’s aquifers had been in decline for at least two decades and the process is accelerating, while contamination of groundwater in urban areas is also increasing as city populations boom.

As with many of our other environmental problems, there are remedial measures we can take, ranging from more efficient waste water treatments to advanced graphene-desalination. Huge investments are needed along the entire water supply chain to upgrade existing infrastructural networks and develop new ones, but the long-term rewards are likely to be commensurate. As if to bear this out, research from the London-based Business Research Company reveals that the global water and sewage market is now worth $631bn (£517bn) and is expected to rise to $853bn by 2026 at a CAGR of 7.8 per cent, while policymakers in Saudi Arabia have been imagining a time beyond petroleum by recently committing to 60 new water projects worth $9.33bn.

Put simply, investors can help alleviate a critical structural problem while adding growth potential to their portfolios on the back of urbanisation and population growth. It’s also worth noting that water companies who undertake the capital commitments are likely to receive a high degree of government support given wider strategic considerations.

If you buy into the water industry from a thematic angle, you could do worse than to gain broad exposure through a vehicle like the iShares Global Water UCITS ETF (IH20) which targets direct investments in the top 50 global water companies. It has delivered positive returns in eight out of the last 10 years, generating an annualised return of 10.7 per cent. One caveat: S&P Dow Jones Indices recently launched consultations to potentially change the underlying benchmarks of iShares' water, agribusiness and timber exchange traded funds.