As Fresh Water Grows Scarcer, It Could Become a Good Investment
Yet the prospect of shortages in the years ahead could make water a precious commodity. That represents an opportunity for investors. A small group of traditional mutual funds and exchange-traded funds already invest in it, mainly in companies that contribute to the delivery, testing and cleaning of potable water. Those companies stand to grow as governments around the globe strive to stem the expected water shortfalls. Water scarcity is a global phenomenon, said Andreas M. Fruschki, portfolio manager of the . And its most pronounced in regions with the highest population growth, like the Indian subcontinent and the Middle East. Population growth, climate change and pollution are disrupting the worlds freshwater supplies. The United Nations Environment Program has predicted that half the globes population could face severe water stress by 2030. Annual expenditures of $200 billion, up from a historical average of about $40 billion to $45 billion, are needed now to keep spigots running, the U.N. said in a . Even developed countries face rising costs to deliver water, because water is heavy and hard to move long distances. Rain in New York doesnt help Southern California, Mr. Fruschki said. On top of this, much of the water infrastructure in the developed world is antiquated and overdue to be replaced, he said. Thats leading to water-main breaks across the United States and the loss of two trillion gallons a year of drinking water, according to the American Society of Civil Engineers . The 35 companies held by the AllianzGI fund provide products or services to help overcome water scarcity and remedy infrastructure shortcomings, Mr. Fruschki said. The funds largest holding, American Water Works, is a utility that operates in 16 states, including New York and New Jersey. Another top holding, Xylem, supplies a spate of water technologies as diverse as pumps and smart meters. A quirk of this sector is that, though water is a commodity, it cant be bought directly in the way many other commodities can be. Its not a tradable good like oil, Mr. Fruschki said. Australia has a water market, called . But in the United States, betting on the price of water requires buying land that has water rights associated with it. Harvard Universitys endowment, for example, has and thus acquired control of their water rights. Created in 2008, the AllianzGI fund returned an annual average of 9.83 percent over the 10 years that ended in June, compared with 5.37 percent for its average Morningstar peer. The fund is unusual in this niche in that its actively managed. The bulk of the water mutual funds and E.T.F.s available to retail investors track indexes and are not actively managed. Take the . Its built upon an index that the funds sponsor, Calvert Research and Management, created to include not just companies that help supply potable water but also big users with exemplary practices, said , a vice president and environmental, social and governance portfolio manager for Calvert. While the fund owns American Water Works and Xylem, it also counts Taiwan Semiconductor Manufacturing among its 111 holdings. Taiwan is a water-scarce area, so Taiwan Semiconductor has developed innovative practices, Ms. Huang said. They recapture, refilter and reuse their water three times. Semiconductor plants gulp down huge quantities of water, and, though Taiwan receives plenty of rainfall, it has little ability to store it. Ms. Huang said Calvert views smart water handling as prudent risk management for chip-makers like Taiwan Semiconductor. It puts them in a better position competitively, and theyre a market leader in the semiconductor space. The companies in the Calvert index are divided into four subgroups utilities, infrastructure outfits, technology providers and efficient users like Taiwan Semiconductor. Each group accounts for a quarter of the funds assets, Ms. Huang said. The fund returned an annual average of 8.56 percent over the 10 years that ended in June. For water E.T.F.s, Invesco is the dominant player, with three offerings. Two of its funds and are constructed around Nasdaq indexes. The holdings of the former are focused on the United States, while those of the latter are spread around the world, though companies listed in the United States account for about half its assets. The former fund returned an annual average of 9.89 percent over the decade that ended in June, while the latter returned an annual average of 8.1 percent. Invesco acquired its third offering, the , when it bought Guggenheims line of E.T.F.s last year. Like Water Resources, this fund also invests mainly in the United States, but the two arent twins, said J. Jason Bloom, senior director of Global Macro E.T.F. Strategy at Invesco. Water Resources has more focus on companies developing technology around delivering clean water, while the S&P index fund leans more toward utilities, which make up about half of its assets, he said. The S&P Global Water Index fund returned an annual average of 11.05 percent for the decade that ended in June. Two other aqueous E.T.F.s are the and the . One way water investments differ from those in some other sectors is their greater exposure to regulatory and political risk. In the developed world, water supplies are often closely regulated, and in the United States, governments are both big customers and potential competitors. Thats why a funds diversification, especially its country diversification, matters, Mr. Bloom said. Even if the United States were to tighten water regulation, other countries wouldnt necessarily follow. Matthew C. Sheldon, senior portfolio manager for water strategy at KBI Global Investors in Boston, said, Different investors come to water from different angles. Some are looking to dilute their other natural-resource exposures. Others are looking for an infrastructure play. Some have a strong interest in environmental, social and governance investing. Some just want a diversifier. An internal found that adding a water E.T.F. to an already diverse portfolio both increased its overall return and reduced its risk. But water wagers create ethical quandaries for some investors, said Monika J. Freyman, director for investor engagement, water, at Ceres, a Boston nonprofit. Waters needed for life itself, she said. So if youre jacking up rates, you are going to run into social justice issues. Do you turn off a poor familys water? Some investors shy from the sector because a lot of people see publicly traded water utilities as water privatizers, said Julie K. Gorte, senior vice president for sustainable investing at Impax Asset Management. Water, in this view, should be publicly owned and controlled to ensure that everyone has access to it. In reality, municipalities often contract with water utilities and regulate their service provision, Ms. Gorte said. Robert Glennon, a water-law expert at the University of Arizonas Rogers College of Law, said some of the distrust of private-sector control of water supplies may stem from misunderstandings of what customers pay for and where most fresh water goes. Water may be a gift from God, but God doesnt give us pipes, and pipes are expensive, he said. Household water accounts for only a small portion of water consumption in the United States, about 7 percent, Professor Glennon said. The rest is used by farms and industry. And they have little incentive to use it prudently because nearly everyone in the United States pays little for water, he said. Our water supply is like a giant milkshake, and each diversion is a straw in the glass. People have a sense of our water supply as infinite, but in reality, its finite and exhaustible, he said. Economists, starting with Adam Smith, have long pondered the diamond-water paradox. Simply put, its the puzzle that fresh water is essential for life but cheap, while diamonds are a mere ornament but costly. The difference, of course, was waters abundance. Today, Mr. Smith might still be flummoxed by the price of diamonds, but investment possibilities of water he might attribute to his favorite market forces: supply and demand.