Strategic Insights | Splashing Out On Water Stocks

Strategic Insights | Splashing Out On Water Stocks

Published November 30, 2020
“Thousands have lived without love, not one without water.” — W. H. Auden

The choppy waters ahead

Once we’ve wrapped up Brexit and seen off Covid, we won’t quite be able to put our feet up and relax: don’t forget that we’ll still have climate change, population growth and the depletion of the planet’s natural resources to deal with.
The optimists among us would point out that – in comparative terms – we are well on our way to phasing out our dependency on fossil fuels. Similarly, sociologists and students of demographic change might point out that industrialisation combined with upward mobility together constitute a “population killer”: in other words, the more literate, educated and middle-class we become as a species, the fewer children we are likely to have. This means that the world population may possibly peak at around 11.2 billion before actually declining. And we are constantly developing new technologies that leverage the potential of different minerals and elements: today’s batteries use lithium (a finite resource), but the energy storage solutions of the future will be based on hydrogen fuel cells, and there is no shortage of that in the universe. And by the time we have run out of absolutely everything, it’s just possible that Elon Musk will have found us all a nice new home beyond the stars.
But there is one natural resource for which there really is no substitute. Water. And some of the statistics really are… well, eye-watering. A mere 0.014% of all water on Earth is both fresh and easily accessible. Of the remaining water, 97% is saline and a little less than 3% is difficult to access. Technically, there is a sufficient amount of freshwater on a global scale. However, because of its unequal distribution (exacerbated by climate change) resulting in some very wet and some very dry geographic locations – plus a sharp rise in global freshwater demand in recent decades driven by industry – humanity is facing a water crisis. If current trends continue, then demand is expected to outstrip supply by 40% in 2030. And, according to the United Nations FAO, by as early as 2025, at least two thirds of the world population may already be in a state of “water stress”.

A dryer world and a thirstier population

Global water scarcity is essentially the geographic and temporal disconnect between freshwater demand and its availability. Global population growth, improving living standards, changing consumption patterns and the development of irrigated agriculture are the main factors driving rising global demand for water. Climate change, such as altered weather-patterns (including droughts or floods), deforestation, increased pollution, greenhouse gases and wasteful use of water are all factors which affect its supply. At global level, there is actually enough freshwater available to meet such demand, but spatial and temporal variations in water demand and availability are huge. The result is water scarcity in several parts of the world at specific times of the year. Water scarcity varies naturally over time due to natural phenomena. But prevailing economic policy, planning and management patterns all cause even greater variation. Fundamentally, water scarcity is a corollary of most forms of economic development. But if sensitively managed, many of its causes can be anticipated, avoided or at least attenuated.

Investors are wetting their lips

In view of its scarcity, investors and traders naturally see water stocks and ETFs as interesting investment opportunities. Indeed, it is precisely because it is the world’s most precious natural resource – and one that is increasingly limited – that it represents such a promising investment.
Water may be essential for everyone, but not every country throughout the world manages it in the same way. Historically, water companies were publicly owned, and governments ensured that people had affordable access to it. However, in many countries, water management boards have gradually been privatised.
Some countries have embraced the private sector model more than others. The entire UK water market was privatised 30 years ago, whereas other governments still manage most of their water resources. Some countries prefer to let private companies manage the entire network, while others favour public-private partnerships. Understanding that each country follows a different regulatory system is as important as understanding the investment profile of individual stocks.

Investing in water

The opportunities to ease these stresses in the water market are captured by several different types of business.
Technology and digital: from desalination to disinfection, innovative companies are developing ways to make water more readily available and safer.
Utilities: as well as their legacy business of providing and managing water supplies, utilities are at the forefront of the ‘Internet of Things’ as they deploy sensors and automation to run the world’s water infrastructure more efficiently.
Engineering: water is a vital input when creating everything from chemicals to fabrics, so engineering companies have deep expertise in conserving this natural resource.
Energy: shale oil and gas, for example, cannot be accessed without vast quantities of water, often long distances from water sources, so energy groups are pioneering solutions for water transport and onsite recycling.
There are numerous ways to invest in water.
Although the market offers a variety of water utility stocks from all over the world, IQ will obviously conduct thorough research before it invests in drinking water stocks. By their very nature, water companies are subject to periods of financial debt, meaning that very close attention should be paid to interest rates. At IQ, we prefer to invest in companies that are able to demonstrate higher levels of stability. Our core portfolio does not currently have a focus on water, but this could change as the investment case becomes more convincing. Higher-risk strategies mean higher levels of volatility, so would probably not be appropriate for low-risk or short-term investors.
Water utilities are particularly attractive to long-term investors and position traders: they tend to be part of a stable sector – one that is exposed to significantly lower levels of volatility than, say, the oil sector. At IQ, we are already investing in water stocks indirectly by purchasing shares in tech companies that produce water-related equipment (such as pumps, meters and filters), or companies involved in cleaning, purifying or distributing water.
Investing in water ETFs is a convenient way to start investing in water via a single fund. Water ETFs hold shares in companies involved in the above – water purification, pipeline, construction, and other related services and infrastructure. Investing in water ETFs has numerous benefits, such as diversification and passive management… and expenses are low.
IQ’s investment team is just putting the finishing touches on its new Sustainability Strategy. The due diligence that we conduct before opting for one ETF over another involves giving consideration to the carbon emissions of the underlying holdings. Any negatives have to be carefully weighed against the positives – for example, a given company might not have a stellar ESG rating, but it might be firmly committed to increasing the share of renewables in the power mix and helping to deliver the energy transition.
One of the ETFs that we are currently looking into as a candidate for inclusion is the L&G Clean Water UCITS ETF, which seeks to offer investors a liquid, cost-effective and transparent vehicle providing exposure to a diverse basket of stocks (around 65) integral to the world’s management of its water.
The L&G fund does not include companies which synthesise speciality chemicals or biocides, for example, or companies which operate in ethically unsound areas. Nor does it include companies whose general ethos is in breach of one or more of the UN Global Compact principles. Its underlying approach is very much geared towards sustainability and safeguarding the planet’s natural resources – making the whole fund generally more “investable” for eco-conscious investors.
A more sustainable global water system is in the interests of consumers, businesses, and governments. IQ believes that companies that can contribute to solving the plethora of challenges in meeting the planet’s insatiable thirst for clean, affordable water will become indispensable in the economy of the future.