Water risks, opportunities need attention

Institutional investors need to pay more attention to water as an investment risk or opportunity, advocates say.

When sustainability advocacy group Ceres looked at the four main U.S. stock indexes for water risk, it found significant water risks in more than half of the sectors. Most industries face risks tied to water, such as dwindling sources, higher costs, pollution, climate change, more regulation and increasing competition for it, but most companies also are not paying enough attention to manage these risks for themselves or their investors, Ceres maintains.

Those risks could be material for investors, who will have to step up, according to Ceres. "The global water crisis is a global risk. Investors really need to be key players," said Kirsten James, director of Ceres' water program, which is working to mobilize investors and companies to address sustainability risks from water.

To that end, some investors, including the $318.4 billion California State Teachers' Retirement System, West Sacramento, are leading the Valuing Water Finance Task Force formed by Ceres and the Netherlands government to drive corporate action on water-related financial risks, including better disclosure and water risk management throughout supply chains.

CalSTRS; Australia's HESTA, a A$62 billion ($45 billion) superannuation fund in Sydney; Dutch pension manager PGGM, with €266 billion ($311.8 billion) in assets under management; and other investors helped Ceres develop an investor water toolkit for evaluating and acting on water risks in investment portfolios. Those investors also participate in the Ceres Investor Water Hub, an investor resource aimed at increasing consideration of water in portfolios.

Sustainable water investing has been a priority for AP7 — a Swedish pension fund in Stockholm with 722.5 billion Swedish kronor ($83.1 billion) in assets — since it started its green equity mandate in 2018 with Impax Asset Management and KBI Global Investors Ltd.

The $286 million green equity mandate to invest in sustainability solutions also involves a research project to measure impact. AP7's goal is to double green investments by 2025 and increase green mandates in all asset classes.

With a 40% gap between water demand and supply worldwide expected by 2030, "the ramifications are huge, and I think that's beginning to become more and more apparent," said Catherine Cahill, a senior portfolio manager with KBI Global Investors in Dublin. She oversees a water strategy that in the past two years has doubled to $2.8 billion. Along with demand from companies and governments to address water resources, Ms. Cahill said water strategies are showing strong performance, in part because of overall growth in ESG investing.

Investors are starting to realize that "water and climate issues are intricately linked. We have seen more and more institutional investors looking at water in part because they are so interlinked," said Jade Huang, vice president and a portfolio manager for Calvert Research and Management in Washington, with $36 billion under management. The prospect of more corporate and government resources being directed at water infrastructure is also generating more queries, said Ms. Huang, who oversees water risk investing as manager of Calvert Responsible Indexes, a suite of indexes based on ESG data.

Where carbon is easier for investors to manage by avoiding exposure, water has several critical submetrics to consider, including water withdrawal, water saving or treatment and local water conditions, said Lisa Beauvilain, head of sustainability and ESG at Impax Asset Management in London. In its water strategy, which accounts for 18% of £38 billion ($52.2 billion) under management, Impax looks at water solution companies three ways: water infrastructure, treatment and supply.

For AP7, coming at it from a risk perspective, the issues are a company's transparency of water risk exposures, how scarce or polluted water is managed, and the real-life impact of investments, Ms. Beauvilian said.

Industrial sectors at risk of water insecurity run the gamut from mining, chemicals and fossil fuels to food and beverages and manufacturing, particularly defensive and automotive machinery. For water-intensive industries such as semiconductors or apparel, "we are increasingly seeing that risk is elevated," said Ms. Huang at Calvert. For companies that are hard to avoid entirely, "you really want to understand how they are managing their water," she said.

That is a challenge, given that many companies fail to report on the two key water metrics collected by Sustainalytics, water consumption and water withdrawal — the total volume of water a company takes or diverts from other potential users. So far, European countries are leading the effort for reporting on both metrics, driven partly by stricter regional environmental standards and guidelines. For AP7, a key focus of its green equity mandate is developing custom metrics to measure the sustainability impact of water and other resources.

Frameworks for measuring water impact also tend to focus on water quantity over quality, but growing investor focus on the United Nations Sustainable Development Goals, including SDG 6, "clean water and sanitation for all," could lead to better frameworks, advocates say.

Another emerging method for investment analysis is water footprinting to assess high water-risk industries or stocks, by volume of water used, risk by geography, and other parameters.

The environmental disclosure non-profit group CDP in London in August launched a water impact index to measure the potential impact on water quality and quantity of more than 200 industrial activities. CDP also calculates how much companies are investing to combat water scarcity, and how much more is needed.

The good news, according to the Water Resource Institute, is that corporate reporting of water as a material risk is getting better, with growing recognition that water risks like scarcity, floods and droughts can cause operational and supplier disruptions, higher costs and regulatory uncertainty.

In the meantime, advocates say, investors should step up engagement with the companies they hold and the broader business community.

Ceres is working on water stewardship guidelines and preparing to launch a global investor campaign on water in early 2022. Ms. James of Ceres cites the success of Climate Action 100+, an investor initiative to ensure the world's largest corporate greenhouse gas emitters take necessary action on climate change. "We want to do for water what Climate Action 100+ has done for climate," she said.

To start addressing the global water crisis, "it is scale and speed that we need. This is where investors really come in. Pension funds and other investors can take an active role in catalyzing change from the corporate to the global level, which can mitigate risk and enable opportunities and water security," said Kata Molnar, a water issue expert with Sustainalytics in Amsterdam.

As companies realize the need to invest in water security with help from investors, it creates opportunities for new technologies like leak detection, metering and water purification, as well as ways to use less water or reuse it, and the engineering and consulting firms to help them get there.

"Managing water footprint while water demand is increasing creates equally attractive investment opportunities in managing and conserving it as a critical natural resource," including desalinization projects, industrial wastewater treatment, water management/analytics, infrastructure replacement and renewable fuels, said Andrew Ward, founder and managing partner of private equity firm Clearstream Capital LLC in New York

Robeco Institutional Asset Management, with $$232 billion under management, has been focusing on water solutions for more than two decades through a sustainable water equities fund that is seeing increased interest from institutional investors, said portfolio manager Dieter Kuffer in Zurich.

The $3.65 billion fund focuses on companies along the water value chain, with some of the fastest growth coming from wastewater treatment, water analytics and infrastructure.

"They can see the risk-return profile is very strong," Mr. Kuffer said. "They also see the opportunities."

Ms. Beauvilain of Impax agrees that water is a good investment attracting more interest. "It is quite well diversified in terms of the end markets. There is good growth, and relatively low beta. Year after year it has been outperforming the broader markets. I think it reflects the fact that lots of companies are working on solutions," she said.

Many of those solutions will be featured in November at the United Nations Climate Change Conference in Glasgow, where a water and climate pavilion will give water what advocates say is long overdue: equal billing.