November 9, 2020

By Jeremy Stroud

Benjamin Franklin famously asserted, “When the well’s dry, we will know the worth of water.” A timely aphorism considering the current circumstances. As groundwater and river systems face increased stress, impact investors look to the water sector as an opportunity to drive environmental, social, and governance (ESG) metrics along with consistent, uncorrelated returns.

Impact investors are looking to every industry, commodity, and asset in pursuit of returns outsized risk-adjusted returns that also meet sustainability goals. This dual mandate is easier said than done, particularly in an environment marked by the uncertainty and volatility of the COVID-19 pandemic. The United Nations Principles of Responsible Investing (UNPRI) group considers water a multi-impact investment due to its interconnection with climate change, the agri-food value chain, industrial productivity, healthcare, renewable energy, ecosystem services, and biodiversity.(1)  In achieving the UN’s Sustainable Development Goals, water scarcity has resurfaced as an issue that requires more attention from the private sector and perhaps more flexibility from the public sector. 

Water management and infrastructure are among the oldest and least defined spaces for investment. They have long been funded by government funds from the advent of gravity-led surface irrigation in Egypt over five thousand years ago(2) to the complexity of Imperial Rome’s aqueduct systems several thousand years later. The central focus of water management has remained relatively consistent from the dawn of irrigated agriculture through to the first hydro-political mega projects of the twentieth century. It is what economists call the hydraulic mission: a function of finding and exploiting as much freshwater as needed to meet growing demands from individuals, businesses, and farmers.(3) We are now faced with a paradigm shift where water scarcity is becoming increasingly relevant to the majority of countries, and additional dimensions are arising – namely water-use efficiency, governance, ownership rights, technology, and health. 

Even so, why has impact investor interest in the water management space piqued recently? How can private investors attain exposure to a sector that has historically been publicly funded? 

The answers to these questions are explained through analyzing several factors. Let’s first explore the predominant theories of water scarcity and investment.

~ We will then assess how this investment thesis has been implemented in the past and present by intergovernmental organizations, index funds, and active asset managers.

~ Lastly we will share a few examples detailing the recent innovations and successes of water investors and companies that may offer us a glimpse at the future of the industry and its capital flows. 

The Water Sector Investment Thesis

While water appears to be globally abundant, it is estimated that less than 0.1 percent of total supplies have the low levels of salinity, acidity, and pollution needed for human consumption.(4) Investing in water management and its underlying industries does not generally classify as a traditional sector. Rather it is a complex intersection between agriculture, technology, real estate, commodity rights, infrastructure and other divisions of a national economy. We see a significant discrepancy between long-term freshwater supply versus its growing demand in many parts of the world. To accelerate the issue further, rising temperatures, misdirected market signals, increased climatic variability, growing withdrawals, and a history of resource mismanagement are placing strain on water resources.

In addition to the issue of water resource availability, quality is another area of concern. Waste management, sanitation, flooding, and nutrient management are all key sectors which play a part in providing the world with the clean water that may be taken for granted. A distinction should be made between freshwater scarcity and clean freshwater scarcity. Regions like Flint, Michigan, near the Great Lakes of North America, for example, may have abundant freshwater access, but lack access to drinkable water.  

On the demand side, water use is increasing annually, and in some regions, at a pace that surpasses replenishment.(5) While significant water resources exist in several of the world’s less arable zones, the geographic distribution of fresh water naturally lends itself to scarcity in arid regions across the globe. In other words, rain in London will not help those in Dubai, and unlike oil, water does not make financial sense to ship and trade directly. From a macro-perspective, humans have increased their water use by 1 percent each year since 1983.(6)  Agriculture comprises about 70 percent of freshwater withdrawals globally, and the trend of increased demand is expected to continue as a growing middle-class demands more water-intensive meat, fruit, and nut products.(7)

In considering the projected water supply/demand dynamics, investors tend to believe that:

~ Companies with the mission to alleviate water scarcity and increase efficiency will see disproportionate growth over the next several decades.  

~ Increasing water efficiency requires investment in water infrastructure (ie. pipelines, storage, pumping and distribution), treatment, and research for technological innovation.

~ Agricultural land with an abundance of water and the conduciveness for high-value crop production will grow significantly in value due to a trend of increasing demand and scarcity.

~ Other industries which withdraw significant quantities of water and create wastewater are expected to face water-related operational risks in the long-term. Investing in water technology, treatment, and infrastructure systems which work to alleviate scarcity or benefit from increased water-efficiency, may provide a mechanism for institutional investors to hedge that risk.

With these assumptions in mind, several impact investors seek to fund infrastructure projects, innovations, utilities, and agricultural firms to increase water efficiency, particularly in water-stressed regions, and allocate water resources towards their highest and best uses.

Investable Opportunities in Water

Two opportunities become abundantly clear to impact investors in the current hydrological and infrastructural environment. First, more investment is needed in research and development for water technologies that improve resource-use efficiency and prevent pollution or salination from occurring. Next, significant additional capital will need to be allocated towards water infrastructure and management projects; not only to bridge the current US$560 billion investment gap,(8) but also to implement efficiency technologies. The World Bank aims to fund some of this gap through its Water Resources 2030 initiative that seeks to align Public-Private Partnerships (PPP’s) in developing nations with strategic lending, technical expertise, and relationships in the water management space.(9) Water-related lending now accounts for US$24.5 billion, about 11 percent of The World Bank Group’s total lending program.(10)

Positive exposure to water scarcity is in high demand and finding attractive, investable, liquid opportunities can be challenging for the unspecialized asset manager. Some investors have taken a wrong approach by exploiting water-rights and hoarding supplies. These are among the most negative outcomes of an increase in sector demand and are now cautionary tales of what can go wrong when investing in the space. One example is the purchase of exclusive water rights in Turkey for hundreds of rivers for a hydropower plant that has left several communities environmentally compromised.(11)

Most impact investments today may be found through sizable portfolios of sustainably irrigated or rain-fed farmland, PPP’s, a limited selection of publicly traded water utility and tech companies, or venture-backed water tech startups. While it has historically been difficult to attain diversified exposure to water as a retail investor, institutional investors, who tend to have a greater appetite for illiquid investments, have allocated significant capital towards water-connected assets.

There are now several ETF’s and indices focused on water, such as the Invesco S&P Global Water Index ETF (CGW), the First Trust ISE Clean Edge Water Index ETF (FIW), and the MSCI Global Sustainable Water Index. The latter MSCI portfolio, which invests in developed and emerging market companies with at least 50 percent of revenues derived from sustainable water, has generated 12.9 percent annualized returns since 2015 and 10 percent annualized returns since inception.(12)  Additionally, Impax Asset Management, a London-based impact investment firm, leads a global equity water strategy for institutional investors with over US$5 billion in AUM.(13) In a similar vein, the Harvard University endowment fund has made water investments an explicit theme of their real asset strategy.(14)

Private Equity & Innovative Water Firms

In the private equity space, firms such as Cimbria Capital in the U.S. and XPV Water Partners in Canada focus on water technology and services companies with a need for growth capital. XPV announced a strategic partnership with KKR in 2019 to establish a platform to invest in companies solving water-quality issues.(15)  Cimbria Capital, which also invests in agriculture and renewable energy, has funded data-solutions firms, sustainable drilling companies, and engineering consultancies, each connected to water.(16) Brian Iverson, founder and managing partner of Cimbria, has noted the many complexities that exist for water-focused investors, saying, “There are many venture capitalists financing start-ups and large players covering established companies on each end of the sector, opportunity exists for mid-sized growth-equity firms to fill the gap and finance those in-between.” Once considered a forgotten industry, Iverson now sees significant additional capital flowing into water projects; a trend that may bring along a long-term normalization of equity valuations. He adds, “The water space naturally lends itself to ESG outcomes with alternative exposures to traditional equity returns. This has driven increased interest for alternative investors in water.”

In another example of water-related finance, Equilibrium Capital invests in climate-controlled agriculture throughout the United States with high-efficiency water systems. Their portfolio assets can produce vegetables and high-quality agricultural goods with far greater efficiency than conventionally irrigated farms. The firm has also opened two wastewater opportunity funds which are focused on building facilities to process agri-food and municipal wastewater.(17)

Venture Capitalists see the tailwinds associated with water-tech as well. Switzerland’s Emerald Technology Ventures recently closed a US$100 million ‘Water Innovation Impact Fund’ with investment backing from Microsoft and Singapore-based Temasek Holding’s.(18) The fund’s mission is to fund early-stage water-tech companies with solutions that fit the UN’s Sustainable Development Goals.

Investors can also purchase publicly traded equities with exposure to water infrastructure, utility or technology, such as American Water Works (AWK), Xylem Inc. (XYL), or Danaher Corp (DHR).  The latter of the three, a utilities conglomerate that owns several firms throughout the water solution value chain, has experienced significant investor attention during the COVID-19 pandemic. Its stock price has increased by 23 percent since its pre-COVID highs in February, and by 68 percent since its lows in March. Carefully chosen stocks can strengthen and create diversity for an impact investment portfolio.(19)

Several investment vehicles are available in developed countries, emerging markets remain the regions where water investment is needed the most. While some publicly traded water companies generate revenues in emerging markets, there are few apparent investable firms and assets which directly deliver sustainable water sources to the individuals who experience the greatest degree of water scarcity and contamination. This is a complex issue that is largely a product of greater geo-political, socio-cultural, environmental and economic forces at play. It may, however, serve as an opportunity for the next frontier of water-focused investment funds.

Conclusion

A spotlight will be placed on the water sector and its prevailing issues for decades to come. Significant investment is needed to support our economic transition towards a healthier water system with more efficient withdrawals and more resilient infrastructure. Several opportunities are available for impact investors; however, the sector is nascent and poised for additional investment vehicles with further varied geographic offerings along the risk curve. Responsible and ESG-focused investment in water treatment, infrastructure, and technology could prove to benefit not only investor returns, but society for generations to come. It is a rare case where such an exciting financial trend may also provide significant benefit for the world.

Notes:
1. UNPRI, 2018
2. Angelakis et al., 2020
3.Wester et al., 2009
4. Grantham, 2018
5. Ray, McInnes & Sanderson, 2018
6. FAO AQUASTAT, 2017
7. Diaz et al., 2019
8. OECD, 2018
9. Water Resources Group, 2020
10. Water Resources Group, 2020
11. Franco et al., 2014
12. MSCI, 2020
13. Impax Asset Management, 2020
14. Gold, 2019
15. Private Equity News, 2019
16. Cimbria Capital, 2020
17. Agri Investor, 2018
18. SWF Institute, 2020
19. Google Finance, 2020

ABOUT THE AUTHOR:

Jeremy Stroud offers insights on global agri-food and water investments, helping businesses integrate their core value propositions through marketing and thought-leadership. He is currently an investment consultant and graduate student at the University of Oxford. His diverse experience in supporting boutique investment firms, consumer packaged goods companies, and sector-focused media outlets uniquely positions him to service a spectrum of companies. With experience in sustainable farmland investing at an institutional scale, Stroud places a long-term lens on projects relating to agriculture, water, and the environment.

All views, data, opinions and declarations expressed are solely those of the author(s) and not of Global AgInvesting, GAI News, GAI Gazette, or parent company HighQuest Group.