By Tim Gray
Water is easy to take for granted. It falls from the sky, and, though it’s vital, we sometimes treat it as if it’s worthless. How often have you seen sprinklers running in the
rain?
Yet the prospect of shortages in the years ahead could make water a precious commodity. That represents an opportunity for investors.
A small group of traditional mutual funds and exchange-traded funds already invest in it, mainly in companies that contribute to the delivery, testing and cleaning of potable water. Those companies stand to grow as governments around the globe strive to stem the expected water shortfalls.
“Water scarcity is a global phenomenon,” said Andreas M. Fruschki, portfolio manager of the AllianzGI Global Water Fund. “And it’s most pronounced in regions with the highest population growth,” like the Indian subcontinent and the Middle East.
Population growth, climate change and pollution are disrupting the world’s freshwater supplies. The
United Nations Environment Program has predicted that half the globe’s population could face severe water stress by 2030. Annual expenditures of $200 billion, up from a historical average of about $40 billion to $45 billion, are needed now to keep spigots running, the United Nations said in a 2016 report.
Even developed countries face rising costs to deliver water, because water is heavy and hard to move long distances. “Rain in New York doesn’t help Southern California,” Fruschki said. On top of this, antiquated water infrastructure needs to be replaced, he said. That’s leading to water-main breaks and the loss of 2 trillion gallons of drinking water a year in the United States, according to the American Society of Civil Engineers’ 2017 Infrastructure Report Card.
The 35 companies held by the AllianzGI fund provide products or services to help overcome water scarcity and remedy infrastructure shortcomings, Fruschki said. The fund’s largest holding, American Water Works, is a utility that operates in 16 states, including New York and New Jersey. Another top holding, Xylem, supplies a spate of water technologies as diverse as pumps and smart meters.
A quirk of this sector is that, though water is a commodity, it can’t be bought directly in the way many other commodities can be. “It’s not a tradable good like oil,” Fruschki said. Australia has a water market, called Waterfind. But in the United States, betting on the price of water requires buying land that has water rights associated with it. Harvard University’s endowment, for example, has bought up California vineyards and thus acquired control of their water rights.
Created in 2008, the AllianzGI fund returned an annual average of 9.83% over the 10 years that ended in June, compared with 5.37% for its average Morningstar peer. The fund is unusual in this niche in that it’s actively managed. The bulk of the water mutual funds and ETFs available to retail investors track indexes and are not actively managed.
Take the Calvert Global Water Fund. It’s built upon an index that the fund’s sponsor, Calvert Research and Management, created to include not just companies that help supply potable water but also big users with exemplary practices, said Jade S. Huang, a vice president and environmental, social and governance portfolio manager for Calvert. While the fund owns American Water Works and Xylem, it also counts Taiwan Semiconductor Manufacturing among its 111 holdings.
“Taiwan is a water-scarce area, so Taiwan Semiconductor has developed innovative practices,” Huang said. “They recapture, refilter and reuse their water three times.”
Semiconductor plants gulp down huge quantities of water, and, though Taiwan receives plenty of rainfall, it has little ability to store it. Huang said Calvert views smart water handling as prudent risk management for chipmakers like Taiwan Semiconductor. “It puts them in a better position competitively, and they’re a market leader in the semiconductor space.”
The companies in the Calvert index are divided into four subgroups — utilities, infrastructure outfits, technology providers and efficient users like Taiwan Semiconductor. Each group accounts for a quarter of the fund’s assets, Huang said. The fund returned an annual average of 8.56% over the 10 years that ended in June.
For water ETFs, Invesco is the dominant player, with three offerings. Two of its funds — Invesco Water Resources ETF and Invesco Global Water ETF — are constructed around Nasdaq indexes. The Water Resources holdings are focused on the United States, while those of Global Water are spread around the world, though companies listed in the United States account for about half its assets. Water Resources returned an annual average of 9.89% over the decade that ended in June, while Global Water returned an annual average of 8.1%.
One way water investments differ from those in some other sectors is their greater exposure to regulatory and political risk. In the developed world, water supplies are often closely regulated, and in the United States, governments are both big customers and potential competitors.
That’s why a fund’s diversification, especially its country diversification, matters, Bloom said. Even if the United States were to tighten water regulation, other countries wouldn’t necessarily follow.
Matthew C. Sheldon, senior portfolio manager for water strategy at KBI Global Investors in Boston said, “different investors come to water from different angles. Some are looking to dilute their other natural-resource exposures. Others are looking for an infrastructure play. Some have a strong interest in environmental, social and governance investing. Some just want a diversifier.”
An internal analysis conducted by KBI found that adding a water ETF to an already diverse portfolio both increased its overall return and reduced its risk.
But water wagers create ethical quandaries for some investors, said Monika J. Freyman, director for investor engagement, water, at Ceres, a Boston nonprofit. “Water’s needed for life itself,” she said. “So if you’re jacking up rates, you are going to run into social justice issues. Do you turn off a poor family’s water?”
Some investors shy from the sector because “a lot of people see publicly traded water utilities as water privatizers,” said Julie K. Gorte, senior vice president for sustainable investing at Impax Asset Management. Water, in this view, should be publicly owned and controlled to ensure that everyone has access to it. In reality, “municipalities often contract with water utilities” and regulate their service provision, Gorte said.
Robert Glennon, a water-law expert at the University of Arizona’s Rogers College of Law, said some of the distrust of private-sector control of water supplies may stem from misunderstandings of what customers pay for and where most
fresh water goes. “Water may be a gift from God, but God doesn’t give us pipes, and pipes are expensive,” he said.
Household water accounts for only a small portion of water consumption — in the United States, about 7%, Glennon said. The rest is used by farms and industry. And they have little incentive to use it prudently because nearly everyone in the United States pays little for water, he said.
“Our water supply is like a giant milkshake, and each diversion is a straw in the glass,” he said. “People have a sense of our water supply as infinite, but in reality, it’s finite and exhaustible.”