Published in partnership with Pictet Asset Management
Only a fraction of all the water on earth can be used by humans. Not only is water both scarce and finite, but the United Nations (UN) also describes it as “vital to the functioning of the global economy”.
How water resources are managed and conserved as populations and economies continue to grow is a critical issue facing every nation on earth – developed, as well as developing.
Environmental reporting not-for-profit organisation CDP says less than 1.2 per cent of all the water on earth is useful to humans. Its very scarcity, and the need to manage it carefully, presents opportunities to invest in businesses or industries whose supply chain includes water – this includes agriculture, perhaps most obviously; in businesses that can reshape their processes to use less; in companies developing new ways to conserve fresh water and recycle used water; and in projects to clean up waterways and oceans.
There are reasons beyond simple risk and return issues and maximising pensions for beneficiaries as to why investing in water is such an important issue. Critically, investing in the better stewardship of water resources is also seen as fundamental to addressing climate change and ensuring the long-term health of the environment.
Fresh water is one of the nine so-called Planetary Boundaries (PB) framework (below) that the Stockholm Resilience Centre says are “processes that regulate the stability and resilience of the Earth’s system, and “within which humanity can continue to develop and thrive for generations to come”.
However, the centre notes that six of those nine boundaries have already been crossed – including freshwater use – which “increases the risk of generating large-scale abrupt or irreversible environmental changes”.
“Drastic changes will not necessarily happen overnight, but together the boundaries mark a critical threshold for increasing risks to people and the ecosystems we are part of,” it says.
In addition, the United Nations addresses access to clean water and sanitation in its Sustainable Development Goals (SDGs). The UN says that by 2030 there will be a global water availability shortfall approaching 40 per cent – so using what there is much better than it’s being used now isn’t optional.
Pictet Asset Management’s (Pictet AM) investment manager of active thematic equities, Charlie Carnegie says an investment strategy focused on water is “very much tied up in SDG 6 – this is access to clean drinking water and sanitation”.
“Water is now defined by the UN as a human right, and quite amazingly, over 40 per cent of the world still lacks access to this basic infrastructure,” he says.
“That’s something that we have no reason not to be able to provide going forward.
Investing in solutions
Carnegie says Pictet AM’s approach to water as an investment thematic is “really about investing in the solution providers to the water challenges that we face. We believe this represents around $1.4 trillion in annual revenues and is growing above GDP”.
Pictet AM has worked with strategic consultancies, academics and business leaders to devise a framework that tracks both the evolution and industry effects of 21 megatrends, which form six clusters: technology and science; environment; global governance; demography; economy; and society. Where megatrends intersect, Pictet AM believes investment themes emerge. The investment theme behind the water strategy comes from the intersection of the economic megatrends of commercialisation and economic growth; the demographic megatrend of urbanisation; the society megatrend of a focus on health; and the environment megatrends of environmental quality, climate change and resource scarcity.
“[Water] touches us all the way from human health, through to industrial activity and through to agriculture and our food systems,” Carnegie says. “Within that we have various constraints and human impairments on the water cycle that require intervention and investment to resolve.
“Our water strategy is playing at that intersection between the challenges and the solutions.”
Carnegie says a critical but sometimes overlooked aspect of investing in water is “not investing in certain parts of it”.
“We don’t, for example, invest in bottled water,” he says.
“That’s water, but it’s not a solution provider to a problem or a challenge that the water cycle faces. Ultimately, it’s a convenience product, that tends to come with significant environmental costs associated with it. So, we don’t consider bottled water a thematic growth opportunity.
“We also don’t focus on water users, the customers of the water cycle. We’re looking at the people who are providing solutions to them. You have big industrial users of water, whether it’s textiles, chemicals, the oil and gas industry; they need a lot of advanced capital goods to support their processes. We’re looking for companies that are providing that. Not stewards of water, so to speak, but more the ultimate solution providers.”
Some investors view opportunities to invest in better use and management of water as part-and-parcel of an approach to tackling climate change. Peter Cashion, managing director of sustainable investments at the $500 billion CalPERS told the Top1000funds.com Fiduciary Investors Symposium at Stanford University there are two elements addressing climate change.
The first is the sheer scale of the required energy transition, Cashion said.
“In 2023, $1.7 trillion was spent on transition, up from $900 billion in 2019, so there’s really been a considerable increase, and that’s only going to grow,” he said.
“The second element is the importance of resource efficiency…so whether that’s water, power, energy efficiency – just inputs in general – that’s going to translate into lower costs, higher profitability and higher valuations.
“We’ve really seen, particularly in public equity, those strategies have really outperformed over the last years that are resource-specific measures.”
Not without risks
But despite the apparently compelling big picture, in practice investing in water isn’t without risks. Some pension funds have learned the hard way that they must pay as much attention to how utilities are regulated ans trsuctered as they pay to the fundamentals of water as an investment theme.
For example, the $100 billion University Superannuation Scheme (USS), the largest private pension scheme in the UK, revealed in its latest annual report that losses on an investment in the troubled UK utility Thames Water had led it to a “serious reflection” on investment in regulated assets in the future.
“Economically regulated assets should be a good fit for long-term patient investors like USS, particularly where, as with infrastructure, they require long-term investment to address historical challenges,” said Simon Pilcher, chief executive of USS Investment Management.
Pilcher noted that success is dependent on similarly long-term, consistent regulation that recognises the need for that investment and strikes a fair balance between risk and returns over the long term.
Pension fund investors have stepped-up investment in water-related assets and infrastructure, albeit from a very low base half a dozen or so years ago. A White Paper published by the World Water Council estimated that in 2018 that just 1 per cent of pension funds globally were invested in infrastructure overall, most of that was in transport and renewable energy, and hardly any in water-related opportunities.
But increasingly, funds are now recognising that the better use of water is a key plank in the sustainability of the businesses and industries they invest in, and is integral to the environmental health of the planet.
Norges Bank Investment Management, manager of the $1.78 trillion Norwegian Government Pension Fund Global sets out clear expectations of the companies and industries it invests in, including those with “operations or value chains in sectors with high water dependency and in regions exposed to water scarcity, water pollution and other water-associated risks”.
“Companies can seek guidance from relevant international principles, guidelines or industry initiatives, and UN Sustainable Development Goal 6 – Clean Water and Sanitation,” it says.
“Unilateral water management has limitations and may present companies with dilemmas. Collective impact assessments and action from multiple water users in a basin may play an important role in reducing risks.
“As an investor, we expect companies to be transparent about the topics raised in this document. For selected companies, we use such information to assess their water risk exposure, management and performance.”
While infrastructure and industrial companies tend to be at the core of Pictet AM’s strategy, Carnegie says a focus on impairments to the water cycle means the breadth of investment opportunities can be quite wide, and includes consumer-product companies, such as manufacturers of water-efficient home appliances and filtration systems; healthcare, where you find manufacturers of advanced analytical instruments for analysing water pollution; and even IT, “where we are finding a growing range of software providers building tools to help model and manage complex water infrastructure”.
Carnegie says investors in water solutions can choose between unlisted or private assets, and publicly listed assets. The route taken depends on the investor’s return requirements and risk appetite. Carnegie says Pictet AM’s water strategy invests solely in listed equity.
“Publicly listed equity gives us the necessary liquidity, transparency, disclosure and scale to tackle the sizeable opportunities ahead,” Carnegie says.
“We think it gives us a very good, clean route to the market. We’re not saying it’s the only one, to be clear; but it’s certainly the one that’s delivered very interesting, solid, compounding returns since inception in 2000.”
A lower-risk alternative
It’s also possible to participate as a fixed income investor with the intention of improving water quality while generating comparable investment returns to alternative opportunities that don’t share the same environmental objectives.
Ulrika Linden, senior portfolio manager, fixed income and green bonds, at the $84 billion Swedish AP7, says the fund invests in programs aimed at cleaning up oceans, which it participates in by buying blue bonds – these are bonds that comply with green bond principles, but which have a specific focus on water-related issues.
The World Bank defines a blue bond as “a debt instrument issued by governments, development banks or others to raise capital from impact investors to finance marine and ocean-based projects that have positive environmental, economic and climate benefits”.
“What the blue bonds does is actually not only sanitation water, or what you would say would go to SDG 6, giving clean water to households, but it’s more like saving oceans programs,” Linden says.
“We’re not able to do things for charity, because we are managing pensioners’ money, so we’re not allowed to give money away. We need to get an investment return that equals what we would have been given otherwise.”
Linden says a “big advantage with green bonds from the start” is that the risk for investors is considerably lower than for equity investors. For a fund like AP7 that is restricted in the credit rating of the bonds it can buy, investing only in the highest-rated securities, it might otherwise be precluded from taking part in such projects because of the associated risks.
“We have big development banks that come in and take the risk that we would not be able to bear in cleaning up an ocean in a [location outside Sweden], because we only have to be very low risk,” she says.
“We have this development bank, like the Asian Development Bank or World Bank, to go in and take the risk.”
Linden says the motivation for investing in blue green bonds is as much environmental as it is financial – but with the important caveat that the returns must be competitive.
“That’s a purpose with it, when it’s from the fixed income part, that you actually have some environmental benefit from it, because otherwise you can get that investment return elsewhere,” Linden says.
“So when you’re a fixed income investor, it’s kind of that you get to do these good things, but not lose money on the way, and then you’re very happy if you get to do this project, but still have the same return as if you were investing in something that didn’t do anything for the ocean or for the sea.”
One of the major issues faced by fixed income investors is the credit risk of the bond issuer, but Linden says this is mitigated to a significant degree by the involvement of the World Bank or the ADB. Provided the bond is held to maturity, the capital risk is minimised.
Private infrastructure
For investors such as pension funds with very long-time investment horizons and risk appetites to match, “there are interesting private infrastructure assets, for example, that are out there”, Carnegie says.
“When you get down into infrastructure assets, a lot of them are unlisted, but they tend to be lower growth, low volatility, lower returns,” he saus.
“It’s just a slightly different profile.”
Investing in clean water distribution and sanitation might seem like it would be a bigger issue in developing economies than in developed economies, but Carnegie says investment in water management is required right around the world.
“Even in the developed world we still see a lot of interesting opportunities, in particular where you’re seeing significant urbanisation,” he says.
“Even in an advanced economy, we’re seeing urban population growth at almost 2 per cent annually, and obviously that creates a lot of pressure on the urban drinking water and wastewater systems. There, we see the need to invest incrementally.”
Carnegie says substantial investment is also needed to upgrade existing infrastructure, because in places such as the east coast of the US and in Europe a lot of the water network was built a century or longer ago, “which will provide a lot of opportunity to the water utility supply chain, and also the utilities themselves, as they make that investment with a guaranteed return through their water rates”.
There’s also the issue of polluted waterways and complying with growing regulatory demands to clean them up and maintain safe drinking water.
“The EU in 2020 dialled-up its requirements on water quality through the Drinking Water Directive, and they set a requirement on member states to comply by 2026,” Carnegie says.
“In the US, we’ve recently seen a pretty seismic ruling by the Environmental Protection Agency, setting an incredibly strict minimum contaminant limit on what’s called ‘forever chemicals’, and that’s going to drive tens of billions of dollars of investment over the coming five or six years, as water utility companies are forced to comply with this.”
