We look at investing in the global water industry.
When Mark Twain (allegedly) said "Whiskey is for drinking, water is for fighting over" he was referring to the ruthless competition for water in the early days of California.
After the gold rush and the building of the transcontinental railroad, immigration into the new cities and exploitation of the fertile (when irrigated) land created huge demand for water in the largely arid state. The scarce water resources were the subject of fierce, often unethical, conflict culminating in the California Water Wars.
Imbalances
Similar imbalances in supply and demand are driving investment into water utilities and infrastructure in the developing world today.
The total supply of fresh water re-circulated through the atmosphere is finite. Exploitable supply is reduced by climate change, pollution and loss due to leakage.
Demand is driven by global population growth and rising per capita consumption. Whilst the world's population tripled in the 20th century, water consumption grew six-fold.
A key factor is consumption of so-called "virtual water" -- water used to produce foodstuffs and goods enjoyed by wealthier populations. It takes 1,300 litres of water to produce a 1 kg of wheat, but 15,500 litres to produce 1 kg of beef. It takes 4,000 litres to make a cotton shirt, and 11,000 for a pair of jeans.
At the same time, climate change is pushing water use up the environmental agenda. This month the Carbon Disclosure Project, the independent body which reports on companies' carbon emissions to institutional investors, published its first water disclosure report. If water conservation attains the same political profile as carbon reduction, then investment opportunities in purification and conservation will abound.
The Water Industry
The water industry can broadly be divided into three segments:
- Utilities, which provide fresh water for consumer and industrial use, together with wastewater and sewerage services;
- Infrastructure companies, which supply and service basic infrastructure such as storage, pipes, pumps and valves; and
- Technology companies, which provide the technology involved in treating water or the analytics used in measuring water quality.
Around half of the global water market, estimated at some $360bn per annum, is comprised of water utilities, within which private utilities account for $40bn per annum. Classic defensive stocks, these regulated companies operate in an environment of strict price control, and their performance is only indirectly linked to the supply and demand for water.
In the west, spend on infrastructure is focussed on repairing and replenishing ageing plant and equipment. It is not only London which suffers from crumbling Victorian pipes and sewerage systems. In developing countries, the need for infrastructure is driven by rapidly rising demand for water.
Technology
Relatively new technology includes:
- Membrane filtration, both as a lower-cost method of desalinisation to harvest fresh water from sea water, and to remove pollutants from wastewater;
- Ultraviolet disinfection, as an alternative to chlorination;
- Plastic and coated pipes with superior performance over traditional piping; and
- IT-based water management systems and automated quality monitoring and metering.
ETFs
There are at least four water-themed ETFs listed on the LSE.
The ETFX Janney Global Water Fund (LSE: WATP) tracks an index composed of 60 water utility, infrastructure and technology companies.
Its largest holding is ITT, once International Telephone and Telegraph but whose activities are now fluid technology, defence, and control systems. Second largest is Veolia, the French water, waste, energy and transport conglomerate which is a major player in emerging markets, whilst third largest is Geberit, a Swiss sanitary and pipe producer. United Utilities (LSE: UU) and Severn Trent (LSE: SVT) are in its top ten holdings.
iShares S&P Global Water (LSE: IH2O) tracks the 50 largest companies involved in water related business, with 45% by market cap in utilities. Geberit, United Utilites and Severn Trent are its three largest holdings, accounting for nearly a quarter of the index.
The Lyxor ETF World Water (LSE: LWAT) tracks 20 companies chosen by the green investment group Sustainable Asset Management. Unsurprisingly its top four holdings are United Utilities, Severn Trent, Veolia and Geberit, comprising nearly 40% of the total.
Finally, Powershares Palisades Global Water Fund (LSE: PSHO) tracks 43 companies in six sub-sectors: utilities, treatment, analytical, infrastructure, resource management and multi-business. Though somewhat more diversified, with only 35% invested in utilities, the Palisades index has underperformed the S&P global water index over 1, 3 and 5 years.
Conclusion
Whilst I buy into the broad investment case, in this instance I think the ETFs miss their target, particularly with the heavy utility component. Possibly one of the many managed funds might exploit the theme more intelligently.
Alternatively there may well be nuggets of blue gold out there in the form of technology companies which offer a solution to the world's demand for clean water.
More sector reviews:
