Water is a sustainable investing opportunity, but underinvested

Despite global investors stepping up their commitments to sustainability, some are raising the point that water remains underinvested as the global population grows and water infrastructure decays.

Prompted by macroeconomic and environmental trends surrounding the subject of water-based infrastructure, Alex Loucopoulos and his team at Sciens Capital Management LLC decided to launch a water-focused subsidiary in 2015 to answer the question of how to deploy capital into decaying water infrastructure.

"There's no surprise in the U.S. that the infrastructure is aging," Mr. Loucopoulos, a New York-based partner at Sciens Water, said in an interview.

"The water infrastructure is even more aging because fewer people, especially politicians, have paid as much attention to water infrastructure because oftentimes you can't see it … It's not a bridge (or) airport. Its underground pipes and sewage."

Water mains also needing an upgrade. According to the United States Environmental Protection Agency, U.S. utilities will need to spend up to $200 billion dollars on water systems over the next 20 years to upgrade transmission and distribution systems.

Sciens Water founded the Sciens Water Opportunities Fund in 2018 with the goal of making "investments in private companies that address the big problems facing U.S. water infrastructure today, with a focus on utilities, transmission and distribution, and wastewater treatment and recycling."

The fund has assets in excess of $850 million, the vast majority of which come from institutional investors.

Mr. Loucopoulos declined to name which institutions were invested, but did say that some large pension funds are interested in an allocation toward the water industry.

But institutional investors dedicated to solving this issue are coalescing. The Valuing Water Finance Initiative represents 64 institutional investors with a total of $9.8 trillion in assets under management with the goal of getting the world's biggest corporate water users to consider water as a financial risk. Participants include the $456.7 billion California Public Employees' Retirement System, $306 billion California State Teachers Retirement System, and U.K.-based £4.5 billion ($5.6 billion) Environment Agency Pension Fund.

"All signatories of the Valuing Water Finance Initiative have committed to engage with companies with a high water footprint to value and act on water as a financial risk and make the large-scale changes needed to protect water supplies," said Kirsten James, a Santa Monica, Calif.-based senior program director for water at Ceres, in an email.

"For many years Ceres has also worked with investors on increasing water risk integration into investment decision-making and developed resources such as the Investor Water Toolkit for investors to better understand water risk within their portfolios," she said.

Ceres' investor water toolkit is a comprehensive tool for institutional investors to evaluate water-related risks in portfolios through databases, case studies and other resources.

Ms. James said that the toolkit outlines numerous water-related policies and goals set by investors, though she added it is out of date and in the process of being updated.

"Through Ceres' Valuing Water Finance Initiative, investors are driving companies to prioritize water risk and act as responsible stewards in their operations and supply chains," she said. "Investors support companies' efforts to mitigate their water impacts in key focus areas, including water quality, water quantity, ecosystem protection, access to water and sanitation, board oversight, and public policy engagement."

Investors have several more options when it comes to tracking the water investment opportunities — such as the Dow Jones U.S. Water index, the ISE Clean Edge Water index, The S&P 1500 Water Utilities index (though the index only tracks the stocks of two water companies) and the S&P Global Water index. Internationally, the MSCI Global Water Index provides a broader perspective.

The sectors of the economy that could suffer the most from water-related risk are mining, fossil fuels, food, beverages, manufacturing and semiconductor technologies.

Water strategies are not uncommon among larger firms, with Switzerland-based Pictet Asset Management having founded its own water-based strategy in 2000. The strategy focuses on sustaining the global water supply through investments into water infrastructure, technology and waste management.

Louis Veilleux, co-lead manager of the Pictet-Water Fund, said in an email that the companies they invest in serve an estimated $1.1 trillion market, which is growing about 5% annually.

"The overarching goal of our water strategy is to back the companies that stand to benefit from the global need to improve the efficiency, quality and resilience of our global water networks," he said. "These water challenges include the (roughly) 2.2 billion people without access to safe drinking water today, the rapid rise in urbanization bringing 1.5 million people into urban areas each week and straining municipal water supply, and the alarming rise in contaminants such as micro-plastics within our existing water systems. These will all require massive investment to overcome and should — we believe — drive an addressable market opportunity that will grow well ahead of GDP for decades to come. We believe this is a theme that warrants attention and exposure from all investors."

Some common misconceptions hold investors back: they confuse a water strategy with investing in a commodity, the same way an investor would with oil, or confuse water with a utilities strategy. Pictet's fund invests in companies across the water value chain across sectors like industrials, health care, consumer and information technology sectors, he said.

Pictet's water strategy's AUM stands at $10.6 billion, while returns in U.S. dollars over the past five years as of March 15 have been 6.6% vs. an annualized 6.1% achieved by the MSCI World Net Total Return index over the same period. On a year-to-date basis through March 15, the water strategy is down 0.29% while the index is up by 1.68%.

Other firms that have set up water strategies express the sentiment that water still lacks adequate investment.

"It's effectively the most important commodity; it's an essential resource that has very limited supply," said Rene Reyna, head thematic ETF strategist at Invesco Ltd., based out of Munster, Ind., in an interview. Invesco has also established its own water ETFs, two being focused on the domestic U.S. and another globally.

"You've seen some of this data (that show) if we look at the amount of water that's on the planet, 97% of it is undrinkable. Only 3% of water is freshwater and of that, it's very hard to access or in some cases, we have such a strong dependency for humanity's livelihood when it comes to water," he said.

Mr. Reyna's claims are backed up by the World Wildlife Fund's own research, which also shows that two-thirds of the world's fresh water is tucked away in glaciers and otherwise unavailable for human consumption.

The Invesco Global Water ETF and Invesco Water Resources ETF focus on companies listed on global exchanges that aid in purifying homes, businesses and industries, though the latter is concentrated on U.S. equities. The two ETFs have total assets under management of $271 million and $1.7 billion, respectively.

The firm's S&P Global Water Index ETF focuses on developed market securities that include water utilities, infrastructure, equipment, instruments and materials with AUM of $939 million. These figures are as of March 21.

Scott Arnell, founding partner at Geneva Capital SA, said in an email the ambiguity surrounding factors taken into consideration when institutions invest capital could be potentially scaring off large allocations toward water-related entities.

"Water-related risks and opportunities can be difficult to quantify and standardize since there's a true lack of consistent and comparable data on water-related metrics," Mr. Arnell said. Geneva Capital is an independent adviser for alternative investments based in Geneva, Switzerland, that specializes in advising institutional investors on socially responsible investment.

"That scares a lot of investors," he said. "As it stands right now, our water infrastructure is being managed by thousands of different public and private entities across the country. This can make it difficult to identify investment opportunities — or to scale up existing investments."

Aanand Venkatramanan, London-based head of ETFs at Legal & General Investment Management, said in an interview that public entities have made efforts to foster investment in water.

Mr. Venkatramanan pointed to COP27, at which the United Nations presented 50 projects to highlight opportunities for climate financiers; six of those concerned water. He also mentioned the World Bank's Public-Private Infrastructure Advisory Facility almost doubling its funding allocation to water to 17% in 2022. In addition, the European Commission proposed a revamp of its Urban Wastewater Treatment directive, which is more than 30 years old, he said.

"From these examples, it is evident that public institutions are trying to generate further investments into the water industry," he said.

Alina Donets, a London-based portfolio manager at Lombard Odier Investment Managers, said in an email that many of the water-related challenges are caused by the private sector, mostly industrial and agricultural use. While governments may attempt to resolve these issues by regulating utility networks, she said the real solution is change of behavior at the point of use.

"This means better treatment during industrial processes, reuse of water by large users, closed-loop systems and the likes," she said. "Achieving this, therefore, requires capital directed to the private sector players that bring the solutions. It is also the private sector that is better positioned to innovate, due to motivation founded on financial returns and growth."