The Product Guru: Investing In Water

It seems like water is everywhere suddenly.

Not the salty kind that covers 70% of the earth, but the media attention on the water problem facing the planet.

There are a lot of reasons for that, but consider just one: The mutual funds dedicated to this area returned 45% for the 12 months ending March 31. (The 12-month period before that, it was down 38%.)

A few week ago, we mentioned the “water-diamond paradox,” which gave economists fits in Adam Smith’s day because they couldn’t codify a reason why diamonds were so valuable when they add essentially nothing to life, while water, so necessary, had no real economic value.

Later thinkers realized it was because of supply. They called it diminishing marginal utility, but it boiled down to supply - Water was abundant and diamonds were not. End of story.

Fast forward to today and water is not as abundant. And now, that lack of usable water is just one issue that’s driving this newfound value for investors.

Consider that 97% of the world’s water is the salty variety; another 2% is frozen in the ice caps; and of the remaining 1%, the vast majority is currently underground. This means that there is a lot of potential investment opportunities in exploring, digging, purifying and transporting water; not to mention building, installing and repairing pipes and valves; plus there are the utilities that deliver water to homes on a regulated basis.

To be sure, this issue is not entirely new. The Congressional Budget Office issued a report on investing in drinking water and wastewater infrastructure as far back as 2002. But more recently, there have been a handful of mutual funds and ETFs that have been introduced to cover this investment area. Lipper tracks 17 funds in this space, the majority of which are relatively small.

Two ETFs from Invesco Powershares make up about 90% of the investments in this space, according to Lipper. Ben Fulton, managing director of global ETF business at Invesco, said it launched its water-focused ETFs, PowerShares Global Water Portfolio and PowerShares Water Resources Portfolio, because the sector represented an area where the necessary technology already existed to solve a major problem.

Other investment themes that have become popular in recent years under a broad category of sustainability, such as clean energy, represent longer-term issues, he said. But the problem of a lack of clean water had the solutions ready to go.

“The problems had been solved, they just needed to be implemented,” he said.

This is especially true in emerging markets, Fulton said, which have an attractive combination (for investors) of a dire need for clean water and rising wealth levels in general. “The first thing you’re going to do [with new wealth] is get clean water in your home.” he said.

"We believe this is an investment theme that predominantly appeals to retail investors," Fulton said.

One of the best-known actively managed names in this space is Calvert. Its global water fund is managed by Jens Peers from KBC Asset Management. He said in addition to a lack of supply, there is also a sharp increase in demand globally (the ultimate one-two punch for higher prices).

Indeed, as standards of living have increased across the globe, that means there are more golf courses to tend to in the United States, while more beef is raised in China, which requires more water than, say, chickens. All told, water usage has accelerated twice as fast as population growth.

Peers said that under-investment in the current infrastructure is another factor driving value. At the current pace of repairs, it would take 900 years to replace the current infrastructure in just the U.S., he says. Moreover, there is a drastic need in China and India for infrastructure, particularly wastewater treatment facilities, he said.

One final driver Peers noted is regulation. Investors often decry regulation, but in this case it helps. Every time the Environmental Protection Agency sets a new standard on contaminants, it sets in motion a chain reaction from chemical companies to meet the new challenge; and those chemical companies are part of the water-investment universe.

All told, there are about $400 billion in Peers’ investable, water-focused universe. And he said that he views them as a low-risk, steady performing area for an investor’s portfolio.

One final factor driving value for water investors stems from demographic patterns. People seem to be inclined to move where there isn’t enough water. In the U.S., there has been a major move to the Southwest; indeed, Phoenix is the sixth-biggest U.S. city now. Well guess what? Those homes would be worthless if water wasn’t brought in from somewhere else.

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