Options to invest in innovative technologies that address water shortages are limited

There are only four exchange-traded funds and two mutual funds specifically dedicated to investing in water-related industries

Apr 19, 2015 @ 12:01 am

By Jeff Benjamin

It only takes a single image of cracked and dusty ground somewhere in California to appreciate the reality of water as a limited resource. Given that, you might expect the greatest minds in technology, engineering, innovation and government to be working frantically to try and resolve the problem and manage the state's worst drought on record.

Yet the biggest response so far has been a call from Gov. Jerry Brown to voluntarily reduce water usage by 25%.

“California is a case study of how not to deal with this kind of situation,” said Charles Fishman, author of “The Big Thirst: The Secret Life and Turbulent Future of Water” (Free Press, 2010).

“They're in year four of a drought and they just decided to tell people to cut back on their water usage,” he added. “They obviously need to take shorter showers, but they're clearly not yet looking at it as a crisis. What are they going to do if the drought lasts six more years?”

On Wednesday, the 45th anniversary of Earth Day, the world will be flooded with all manner of data about water usage, disposal, runoff, leakage, waste and evaporation.

But so far, innovation to address the need for more and better access to fresh water has not reached any kind of turning point in terms of investment ideas. For proof, just look at the piecemeal focus on water-related industries packaged as investment products and strategies.

While there are multiple examples of individual companies doing creative things to address the global need for more fresh water, there are only four exchange-traded funds and two mutual funds specifically dedicated to investing in water-related industries.

“People have been talking about investing in water for 30 years, but the problem is there are still no pure plays that don't correlate to the broad equity markets,” said Paul Schatz, president of Heritage Capital.

“I don't think the problem is urgent enough yet, and when it does become a high priority, the governments will get involved,” he added. “I also don't believe this drought in California is a long-term issue. In five years, they might be dealing with some kind of flooding issue.”

Beyond California, there is no dearth of examples of water shortages.

In China, for example, fresh water is so sparse it is estimated that if each of its 1.4 billion people took just three showers a week, the country would deplete its supply of fresh water in one year.

And fully half of the 1.3 billion people in India don't have access to drinking water on a daily basis, while 70% of the patients in Indian hospitals are there for water-borne illnesses. Half the people in India equals twice the population of the United States. Some financial advisers are more enthusiastic than others about tapping into the water industry for investment purposes. That is being aided somewhat by a growing trend of reporting water usage at the corporate level. For example, Google Inc. has estimated that every Google search uses about two tablespoons of water.

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TWater pipeline in California: While California is suffering a drought, countries like China and India also face water shortages.

Companies such as Ford Motor Co., General Electric Co., and International Business Machines Corp. have developed water divisions just to help manage their use of the commodity.

“From an investing standpoint in general, we believe there are significant unpriced externalities in terms of fossil fuel and water usage for our companies,” said J.D. Bruce, president of Abacus Wealth Partners in Santa Monica, Calif. “Water is likely to get more expensive and the rules are likely to change significantly around water. The companies that are conserving water or pricing their water usage in right now won't be hurt in their stock price when water is at a much higher cost, compared to companies that are ignoring the issue.”

From a pure performance perspective, the handful of water-related ETFs and mutual funds available today don't really stand out. The largest ETF in the category, the $853 million PowerShares Water Resources ETF (PHO) has fallen 4% over the last 12 months. Of the two mutual funds dedicated to water, the $327 million AllianzGI Global Water Fund (AWTAX) is up 1.4% over the past 12 months and the Calvert Global Water Fund (CFWAX) is down 2.8% over the same period.

Meanwhile, the MSCI World Index is up 10.3% over the past 12 months through April 13.

With that kind of performance, it's no wonder more asset managers aren't jumping on the water bandwagon with creative products of their own.

That means advisers have to be truly dedicated to find ways to invest in water that make sense as an investment and not just as an idea that's in line with efforts to help the cause.

“I definitely believe water is an area of opportunity for investment, and I've actually done a seminar on it, but I didn't have very good attendance,” said Allan Moskowitz, principal of Affirmative Wealth Advisors in El Cerrito, Calif.

In addition to the aforementioned water-related funds, Mr. Moskowitz also invests in the $28 million Shelton Green Alpha Fund (NEXTX), which has gained 7.2% over the past 12 months, compared with the 17.6% gain in the S&P 500 Index.

“Water is definitely a good investing theme because you have to have it, supply is limited and demand is increasing,” he said. “I don't see anything that's going to change that dynamic, so that's a pretty good formula for investing success.”

As Mr. Fishman explains, on paper, water represents an incredible investment opportunity.

Considering that the entire country relies on water systems that are between 40 and 90 years old, maintenance and upgrades alone should represent an investment bonanza.

“Even if you put aside all the issues related to climate change, population growth, water scarcity, and economic growth that causes people to use more water, we do not take care of our water systems in this country,” Mr. Fishman said.

Water is definitely a good investing theme because you have to have it, supply is limited and demand is increasing.— Allan Moskowitz,  principal of Affirmative Wealth Advisors

According to his research, the nation's dilapidated water systems lose about a day's worth of water every seven days due to leaks. Meanwhile, there are shining examples of successful efforts to address the water shortage issue.

Exhibit A: Orange County, Fla. In 1986, the county opened a treatment plant that gets water to a level just below potable, known as tertiary, as opposed to the secondary level of cleaned sewage water. All new development in the county, which includes Orlando, since 1986 has been double-plumbed with potable water and what is called purple pipe water for needs like watering lawns, washing cars and flushing toilets.

“Twenty-nine years later, the population of Orange County has doubled, and they don't use any more potable water than they did in 1986,” said Mr. Fishman. “They've also raiseD a generation of people who appreciate that it's crazy to wash your car with potable drinking water.”

Long-term trend

Adam Patti, chief executive of IndexIQ, describes water-related investing as a “very robust and long-term trend.”

For that reason, he has included water among the eight natural resource categories making up the IQ Global Resources ETF (GRES). The $80 million fund, which was launched in 2009, allocates among the eight categories based on price momentum and valuation. Right now water is at the maximum weight of 22.5%.

The GRES fund has declined by 9.8% over the past 12 months.

“We see the water sector as undervalued based on its own history,” Mr. Patti said.

No less a mega-player than Merrill Lynch also has jumped on the water-investing platform by encouraging its more than 14,000 reps to start allocating to the space.

“It's not a traditional commodity that can be traded,” said Mary Ann Bartels, chief investment officer of portfolio solutions for U.S. wealth management at Merrill.

“It's not just about buying the underlying commodity, water, it's about buying the companies that clean the water, that build the infrastructure,” she added. “Why this area is growing for us, particularly with the younger generation, the millennials are demanding that it be expressed within their investments.”

Even if the space isn't taking off as an investment theme just yet, the potential appears to be there.

Michael Underhill, chief investment officer at Capital Innovations, estimates the overall water industry — including water utilities, infrastructure companies and reclamation companies — at $360 billion in revenues with an annual growth rate of 4% to 6%.

Mr. Underhill, who's the author of “The Handbook of Infrastructure Investing”(Wiley, 2010), and manager of the CI Global Infrastructure, Timber & AgriBusiness Fund (INNAX), said investors can invest in water through the developed network of businesses building water infrastructure or through companies that deliver water to emerging economies around the world.

If you talk about the U.S. market alone, there are over 200,000 water systems. It has traditionally been only about maintenance and repair. — Simon Gottelier,  senior portfolio manager at Impax Asset Management Group

“Everyone is trying to crack the desalination conundrum,” he said. “When it comes to water, the commodity remains constant, but the demand side is more humans consuming more water.”

Simon Gottelier, senior portfolio manager at Impax Asset Management Group, looks at water a bit differently, by focusing on annual capital expenditures related to water that total more than $600 billion and are growing by about 8% annually.

As subadviser to the $226 million Pax World Global Environmental Markets Fund (PGINX), Mr. Gottelier concentrates on four secular water-related themes: population growth that drives infrastructure development, refurbishment of existing infrastructure, improved government oversight and increased government spending to adapt to changing weather patterns.

“If you talk about the U.S. market alone, there are over 200,000 water systems,” he said. “It has traditionally been only about maintenance and repair.”

No Standouts

— Trevor Hunnicutt contributed to this article.

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