By Matt Sheldon
Water is a very big business. According to a McKinsey study, $11.7trn will be spent in water between 2013 and 2030. This is one of the largest infrastructure categories, similar in size to telecoms and power. But while investors have a large exposure to power and telecoms, most are underexposed to water.
It is easy to see where the trillions will be spent. In general, the supply of clean, fresh, local water has already been allocated globally such that the incremental supply is coming from further away or from a starting point of wastewater, seawater, or brackish groundwater. This requires a significant investment in water treatment technologies. The other main driver of growth is that the water infrastructure already in place is breaking at an increasing rate. When something breaks, it has to be fixed. This provides a large, economy-independent demand for companies providing equipment and services to maintain existing infrastructure. On top of this, there are cyclical growth opportunities related to construction, capital spending, and specific regulations that can be material to earnings growth.
Addressing this market is a diverse collection of global companies. While the investing strategy is niche, it is certainly not narrow. Their solutions range from increasing supply and access; decreasing demand and waste; improving and assuring the quality; and building and maintaining the infrastructure. Some have predictable and protected business models like that of a regulated utility while others are quite cyclical, like a pump manufacturer, providing the ability for the investment approach to participate in both risk-on and risk-off market environments.
Identifying the exciting opportunity, Kleinwort Benson Investors began investing in water equities nearly 15 years ago. While the original thesis for the strategy has not changed since inception, it’s arguably more relevant now. The near-term drivers look attractive too. Our companies are exposed to certain cycles that are early in their recovery, specifically non-residential building construction and municipal water projects. These will drive growth in storm water, fire systems, plumbing, engineering, and analytical and water treatment technologies. Also, regulations and policies that have recently come into force, or will soon, will push investment in water efficiency and reuse to address California and Brazil droughts as well as the treatment of oil sands water and the shipping industry’s ballast water. China is rolling out its water pollution prevention and control targets that feature aggressive spending and highlighting enforcement to ensure targets are met. This will grow investments into sludge and industrial water treatment and a retrofit of existing urban wastewater plants to higher technology specifications. Finally, after a brief hiatus, we believe M&A is returning to water – about 8% of our portfolio received takeover bids in each of 2011, 2012 and 2013.
So why do most investors lack exposure? Oftentimes it is a result of not knowing about or misunderstanding the opportunity. Many water companies are small and under-the-radar. The overlap of our portfolio with the MSCI World is less than 1%, and the market cap of the whole universe of global water companies in aggregate is smaller than the market cap of Apple. The favourable tailwinds and under-owned stocks provide an attractive combination for investing. For example, while most UK investors may be familiar with United Utilities, they might be unaware that another UK water utility, Bristol Water, is owned by a small cap Canadian company, Capstone Infrastructure, currently with a dividend yield of nearly 10%.
Another reason for under-exposure is that water investing does not have an obvious asset allocation box. Does it go into the global equities allocation? Or natural resources? Or liquid real assets? Or thematic/sustainable/ESG? The fact that water “ticks a lot of boxes” is both a blessing and curse. We have various investors that have placed it in each of the above (we tend to lean towards global equities when asked), but others can’t find the box and therefore forgo the opportunity altogether.
Looking ahead, we continue to be optimistic about water investing and see it increasingly taking a role in portfolios as a way to capture the multi-decade increase in spend on water infrastructure and technologies.
Matt Sheldon is a portfolio manager, environmental strategies at Kleinwort Benson Investors