The Long View: is water the new oil promising a flood of returns?

The water industry could be delivering exceptional returns in the not-too-distant future.

Yes, if you believe Jean-Louis Chaussade, chief executive at French utility company Suez. Explaining his company’s recent $3.5 billion (£2.7 billion) purchase of General Electric’s water business, he told the Financial Times that the day is coming when water will cost more than the black stuff.

Chaussade is not alone in taking this view. Willem Buiter, a special economic adviser at Citigroup and former member of the Bank of England’s Monetary Policy Committee, anticipates that there will be “a globally integrated market for fresh water within 25-30 years”. He has consistently argued that water will one day be the most precious of all commodities, more valuable than oil and even precious metals.

Fundamental importance

Sometimes it already is. Jacob Bossaer, the founder and chief executive of Bosaq, a market leader in water sustainability, points out that bottled water sold in supermarkets now costs more than oil, but also that we are now moving towards a more fundamental change. He says: “Water availability will one day surpass the importance of oil availability, with drastic economic repercussions, including rising water prices. Moreover, just as oil prices directly affect the global economic cycle, so will water prices. The water industry is going to become one of the world’s most important global industries, one on which all others depend.”

To understand why, consider the realities of a world where the global population continues to rise while climate change threatens to deplete natural resources in many regions.

Already 1.2 billion people, almost a fifth of the world’s population, live in areas where water is scarce, according to the United Nations, with another 500 million people at risk of scarcity. The problem is compounded by the water demands of the growth in the global economy needed to sustain the world’s increasing population. Demand will grow in a broad range of sectors: from agriculture, which accounts for 70% of commercial water use, to digital technology, where Google, for example, uses diverted sewer water to cool huge servers.

The Water Resources Group believes that demand for water, if its current rate of growth continues, will be 40% higher by 2030 than it is today. However, there is no prospect of a similar increase in water supply.

The threat of water shortages is now so serious that the US’s director of national intelligence has warned that disputes over water are likely to trigger conflicts, particularly in more arid areas of the world such as Africa and the Middle East. In South Africa a three-year drought prompted a water crisis in Cape Town in 2017; city officials threatened to shut off people’s taps.

“Water management problems are not limited to the emerging world: parts of the US and Australia, for example, are suffering droughts,” says Cédric Lecamp, an investment manager in the thematic equities team at Pictet Asset Management. “Globally, the motivation to preserve surface water and underground aquifers is only likely to get stronger. Rainfall patterns are changing, the global population is growing and natural fresh water resources – surface and underground – are being drained.”

In this context, the future for water, in economic terms at least, looks to be crystal clear. Rising demand combined with static or even falling supply equals higher prices. And in investment terms, this changes the way we should look at the water sector.

Traditionally, shares in water utilities have been viewed as defensive holdings that deliver solid, if unspectacular, returns in markets where prices and capital investment are often heavily regulated. In future, however, the water industry is likely to be a much more exciting sector than it is today – driven by technology and innovation.

Water exploration could help us find rich new water sources. Meanwhile, in the Middle East for example, significant capital is being invested in new water purification and desalination technologies. In the US, a burgeoning industry is exploring the use of photo-voltaic panels to extract water from air.

Water management and efficiency measures will move centre stage. In the agriculture sector, aeroponic indoor farming uses 90% less water than conventional methods. Around the world companies are investing in smart meters to detect water leaks and reduce demand. Upgrades to water infrastructure continue at pace.

Investors will soon have easier access to the investment opportunity described by Buiter. Australia already has several water exchanges that facilitate the buying and selling of water for water customers with temporary or even permanent requirements. Waterfind, the best-known of these exchanges, has 12,000 active traders.

Charles Fishman, author of The Secret Life and Turbulent Future of Water and a journalist specialising in the sector, argues that effectively there are now two separate but parallel water industries.

He says: “There is the utility world providing water to communities and cities, mostly in pipes, a business dominated in most places by government agencies. The other water industry segment develops the machinery, technology and expertise to find, clean, reuse and provide water. That segment incorporates a range of businesses around the world, from big players to small start-ups, looking for all kinds of solutions, and right now that is where the creativity and energy is to be found.”

A graph showing water industry returns on the rise

 

Mouth-watering returns

The water industry as we know it today has expanded massively and offers the prospect of strong returns. The industry – already worth $625 billion, according to management consultancy McKinsey – will generate annual returns of between 5% and 25%, according to the World Economic Forum.

Investors are already beginning to enjoy such returns. The S&P Global Water Index, which tracks the performance of 50 companies around the world in water-related businesses, delivered an annualised return of 12.1% over 10 years to the beginning of December 2018. The MSCI World Index, managed 11.5% a year over the same period.

This outperformance has come from an index exposed to both types of water companies: the utilities as well as the technologists and innovators. In other words, investors have not had to take excessive risk to earn superior returns. The defensive characteristics of traditional water businesses provide a counterpoint to the more speculative index constituents.

That said, investing in water is not without risk. It is unclear which technologies will triumph in the decades to come. Some smaller businesses offering novel solutions to the intensifying water crisis will prosper, while others will fall by the wayside. Moreover, regulation and political intervention are potential headwinds for the industry. Inevitably – and rightly – attempts will be made to ensure firms providing fresh water do not demand blank cheques for their services.

Indeed, not everyone is persuaded by the case for water as the new oil. Some asset managers that have sought to exploit this theme have been disappointed by the results. Liontrust, for example, launched a specialist water and agriculture fund at the beginning of 2016 only to close it 18 months later when it failed to attract investors.

Nevertheless, Fishman believes it is possible to balance the importance of providing clean water to all who need it with commercial opportunity. “Water needs to be modernised and smartly delivered, but it does not ever need to be so expensive that ordinary people can’t afford what they require for everyday purposes,” he says.

Go with the flow: tips on taking the plunge

A focused investment in the water industry carries signi­ficant risk, argues Jason Hollands, managing director at wealth manager Tilney. “The long-term thesis makes sense, but such big-picture mega-trends play out over decades,” he says. “We would therefore typically achieve exposure to companies in the water sector though funds investing in broader infrastructure and utilities.”

Still, for investors prepared to take the plunge, Holland has a recommendation. “I would opt for Pictet Water,” he says. “Pictet specialises in thematic investing and has a sizeable team. The portfolio holds around 60 stocks and is heavily biased towards innovative water technology companies, rather than just utility ­firms in developed markets.”

Philippa Gee, managing director at Philippa Gee Wealth Management, suggests that a passive approach to investing in water will be attractive for many – with one important caveat. “Many specialist ETFs are US-based and global in nature, so while they offer a low-cost route into the sector, you’re adding currency risk to investment risk,” she warns.

With that caveat in mind, Gee suggests three ETFs that focus on the water business: the Invesco Water Resources ETF, listed on Nasdaq and therefore dollar-denominated, and the Lyxor World Water ETF and iShares Global Water ETF, both London-traded funds.

Martin Bamford, managing director at ­financial adviser Informed Choice, suggests Invesco’s S&P Global Water Index fund, which tracks the S&P Global Water Index and is therefore more defensive than Invesco’s other water fund, which is more technology-focused.

“Be prepared to take a very long-term view and for the introduction of disruptive water technologies that could render the value of companies held in these indices worthless,” Bamford advises.

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