Investing in water: how ETF investors can tap into returns

Water scarcity will initiate a spate of spending on new infrastructure projects for ETF investors to tap into, says Morningstar’s Kenneth Lamont.

In 2019, Legal & General launched the first new water-themed ETF to be listed on the London Stock Exchange for 10 years.This new entrant undercuts its rivals on fees, but how else does it differ? Before we explore the differences, it is worth reminding ourselves of the thesis behind an investment in water.

In order to support the world’s growing population, water is needed in greater quantities: for agricultural irrigation and livestock hydration as well as for human consumption. In recent years, global freshwater consumption has been growing at twice the rate of population growth. With the global population surging, the United Nations forecasts that by 2030 demand will exceed supply and there will be a global water shortfall of 40%.

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Supply shortfall

Fresh water is not distributed equitably across population centres, nations or regions. Moreover, given its weight, water is not easy to transport in large quantities. As the world population grows, supply and demand for water will become progressively more imbalanced, especially in arid regions with contaminated water sources.

Meanwhile, in regions with easily accessible water resources such as rivers and underground aquifers, the risk of overconsumption and inefficient recycling will threaten the sustainability of such resources. Specifically, growth in such regions is expected to be driven by global trends towards greater desalination and water reuse, water conservation, energy efficiency and enhanced technology. Massive investments in water-related infrastructure will be required, as existing water systems (even those in the developed world) are antiquated and inadequate.

To the extent that governments can fund or subsidise these infrastructure projects, global water companies  should benefit from these trends because of their technical expertise.

ETF options

The L&G Clean Water ETF (GLUG) has joined the Lyxor World Water ETF (WAT) and the iShares Global Water ETF (DH2O) in the water ETF space. The older funds have proved popular and currently hold a combined £1.5 billion in assets. With its ongoing charge of 0.49% a year, the L&G fund undercuts its more established peers on cost. The Lyxor and iShares offerings charge annual fees of 0.60% and 0.65% respectively.

Both the iShares and L&G funds plump for full physical replication. This straightforward approach involves buying all the water-related stocks in an index, in their prescribed weights. The Lyxor fund employs a more complex synthetic method by entering into a legal contract to receive the performance of the underlying index. While there are instances where a synthetic approach may be preferable, in this case we think that the approach brings an extra layer of complexity without providing any compensating performance benefits.

While all the funds track the same theme, their different approaches lead to different outcomes. For example, the three funds share only 12 holdings at the time of writing. The Lyxor and iShares funds both attempt to capture the broad water market, which includes water utilities and water infrastructure as well as water treatment firms. Each also weights holdings in proportion to their size but imposes a cap to ensure exposure to a single stock doesn’t get too large. One key difference between the pair is that the iShares fund is broader, as it targets 50 rather than 30 water-related stocks.

Although it shares 30 out of 50 holdings with the iShares fund, the newer L&G fund offers something different. First, beyond utilities and water equipment, it targets stocks exposed to the provision of technological, digital, engineering and other water services, giving it a growth tilt versus its two peers. Its equal weighting methodology also gives it a tilt towards small caps. It includes a light ethical screen that excludes firms involved in coal mining and controversial weapons, as well as those in breach of UN Global Compact principles for the past three years.

Water-themed ETF returns over three timeframes

Fund Ongoing
charge (%)
Number of stocks tracked 3-yr annualised
total return (%)
5-yr annualised
total return (%)
10-yr annualised
total return (%)
iShares Global Water ETF 0.65 50 12.7 13.4 12.5
L&G Clean Water ETF 0.49 51 n/a n/a n/a
Lyxor World Water ETF 0.60 30 9.9 13.5 13.2

Source: Morningstar, as at 7 January 2020

Top performer

Over 10 years, the marginally cheaper Lyxor World Water ETF edged out the iShares fund by returning an annualised 13.6%, beating the MSCI World Index over the period. Having only launched in 2019, the L&G fund has yet to establish a meaningful track record.

Be aware that because of their narrow exposure and elevated risk profile, water ETFs are best used to complement core holdings rather than replace them.

Kenneth Lamont is a senior analyst, manager research, passive strategies, at Morningstar.

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