The Smart are Lapping Up the Chance to Invest in Water

Most opportunities for investment in the water sector are available in companies — and the funds that invest in them — concentrated in developed countries. 

Water stocks typically divide into three groups. Utility companies, responsible for the infrastructure of supplying water. Industrial and water-technology companies, that manufacture the components on which the infrastructure relies, such as pipes. And the racier business of environmental technology, which includes purification and treatment innovations that help to shore up future supply.

Specialist funds typically combine the three in varying proportions. The Pictet Water fund, for example, splits its investments in each sector 50 per cent, 40 per cent and 10 per cent respectively. The co-manager Simon Gottelier says that the fund invests in “higher-growth markets such as China and Brazil”, as well as steadier developed ones.

Water utilities:  income-rich,  defensive bet
Utilities are bankable, defensive stocks. Most are based in developed countries, where demand for water is constant, meaning they can produce steady cash flows. “These are long-term regulated earnings and their commitments raise their dividends above the rate of RPI [retail price index] inflation, meaning that the shares are more attractive than index-linked bonds,” says Garry White, the chief investment commentator at Charles Stanley.

The dividends that these cash flows generate have turned them into investor favourites, especially after the Brexit vote. By the end of June, according to the ratings agency Fitch Ratings, the total stock of government bonds globally with negative yields had reached $11.7 trillion. So, utility-style yields are compelling at a time when yield has become, as water soon will, a sought-after resource.

The Hoover Dam provides power for US utility companies that are a good bet for investorsETHAN MILLER/GETTY IMAGES

Heavy buying after Brexit has pushed prices higher, but Mr White and Rob Burgeman, of Brewin Dolphin, still favour Pennon. One of three water companies listed on the UK stock market, the company owns South West Water and Bournemouth Water. Recently it reiterated its aim of growing dividends at 4 per cent above RPI inflation through to 2020 (it yields 3.7 per cent at present). The company is based in the UK, so there is no currency risk to UK investors, a relief after sterling’s recent slump.

Water industrials: capital growth
Industrial companies are a key part of this sector, supplying the pumps and pipework to keep water running.

The sector, says Mr White, can be at the whim of public policy and government budgets, making cash flows less predictable than those of water companies, “but they offer the potential for capital gains over time”.

He recommends New York-listed Danaher Corporation, which provides instrumentation and disinfection systems to treat and manage water, one of which treats 2.24 billion gallons of drinking water a day for New York City.

Water consumption is only one dimension. At Pictet, Mr Gottelier also invests in companies supporting agricultural and industrial or construction markets, which have different cycles and so can be less correlated with water utilities. In this category he likes “companies supplying the healthy US construction market, such as the UK group Wolseley”.

Mr Burgeman says a cheap fund route is the iShares Global Water ETF (exchange-traded fund), which charges 0.65 per cent. It tracks the performance of S&P Global Water Index, containing 50 of the largest publicly traded companies in water-related businesses.

This means holdings are diversified beyond companies that supply only to the large water companies; one of its largest holdings is Geberit, the Swiss producer of sanitary systems. It has a relatively modest yield — 1.6 per cent — but has provided extremely strong five-year returns of 80 per cent.

Environmental funds: the racier end
Funds that focus on water treatment typically invest in related sectors such as biofuels, solar energy, carbon-trading and pollution control. One such fund recommended by Mr Burgeman is Impax Environmental Markets, which selects 60 to 80 small and mid-sized stocks worldwide. Between 15 and 45 per cent will be in water treatment; the other sectors are alternative energy and pollution control. The fee on the unit trust retail units is 0.8 per cent.

A pure play on the theme of future water scarcity, however, is tricky. The thesis that water will become scarce or expensive will not play out in utilities (they are highly regulated) or industrial companies (whose prices do not track water prices closely), says Shaun Port, of Nutmeg, the online investor.

Where stocks do provide pure exposure, they are not for the faint-hearted. “Water tech is very interesting, but a bit like buying oil-exploration companies — it’s incredibly hard to pick winners,” he says.

Source: The Times

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