Business | Investment
Water stocks generate positive returns
Water is "the oil of this century", Andrew Liveris, chairman and chief executive of Dow Chemical, claimed at last month's gathering of the World Economic Forum at Davos.
- By Steve Johnson, Financial Times
- Published: 01:04 February 9, 2008
Water is "the oil of this century", Andrew Liveris, chairman and chief executive of Dow Chemical, claimed at last month's gathering of the World Economic Forum at Davos.
In the same session, Ban Ki-Moon, secretary-general of the United Nations, warned of a looming water crisis, highlighting "water stress" as a common denominator between disease, rising food prices and crises such as the Darfur conflict.
Given the growing economic and social importance of clean water, and the potential oil-like riches to be made from supplying it, it will come as no surprise that asset managers have created vehicles for those eager to surf this trend. But is there any reason to believe the sector should produce rich rewards? "We believe water stocks should outperform. The theme has outperformed over a five-year period and we've generated alpha through positive stock selection," says Jean Ryan, investment specialist for KBC Asset Management's water fund, launched in 2000.
Ryan's view is derived from hard-headed economics. "Demand is going to continue to rise due to rapidly increasing population and increased industrialisation in the developing world, as well as a benign economic background in the developed world.
"On the supply side the world's supply of water is finite. You can recycle or desalinate it, but however you shake it you have got a finite level of supply." Philippe Rohner, senior investment manager at Pictet Asset Management, another early entrant that launched a water fund in January 2000, also believes the sector has some innate advantages, given the presence of growth-oriented water technology and engineering companies alongside more prosaic water supply and treatment outfits.
"We have a defensive core in utilities and we have the industrial sector," he says. "That gives us growth at a reasonable price and it's well balanced geographically and by sector. The growth element is slowly being recognised and rewarded.
"If you look at the water theme as we define it and compare it to the MSCI world equities, there is not one sub-component that comes close to such a good risk/return profile."
What is more, Pictet points to estimates that the 707 million people served by private water or sewerage services globally in 2007 will jump to 1.15 billion by 2015.
Perhaps unsurprisingly, these arguments have their disciples. Pictet has already taken the decision to soft close its water fund, which now stands at four billion euros ($6 billion), plus "a little north" of 500 million euros in mirror funds.
"In the last 18 months [inflows were] probably excessive in terms of what the universe we define as accessible to us was able to absorb. A barrage of water came upon us. We did not feel it would be in our fiduciary responsibility to inflate asset prices. We felt it would be in the interests of our clients to soft close," explains Rohner.
New entrants are also descending on the sector, with Barclays Global Investors and PowerShares having launched water-focused exchange traded funds.
Simultaneously returns appear to be dipping. Pictet's water fund fell 11.7 per cent in the year to January 25, underperforming the MSCI World index, after five straight years of outperformance. KBC's 1.1 billion euros water fund also fell alongside the wider market in the final quarter of 2007, ending years of outperformance.
After five strong years, even the water utilities sector is trading on a higher historic earnings multiple than global equities; 18.9 versus 15.7, pointing to potential overvaluation.
Ryan demurs. With KBC forecasting earnings growth of 16 per cent for its portfolio, against 11 per cent for equities as a whole, it sees water stocks trading at a lower p/e-growth ratio than the broad market. "I wouldn't regard valuations as being overstretched," she says, pointing to the likelihood of renewed merger and acquisition activity when the current spike in risk aversion abates.
Rohner also finds valuations "reasonable, on average".
Ryan sees scope for further growth, driven by the rise of emerging markets and higher environmental standards in the west.
"We have got very significant spending on water infrastructure in China and India and the developing world. In the US there is new EPA [Environmental Protection Agency] regulation, in Europe there is a water directive that quality has to be improved.
"In water-stressed regions such as Spain and the UAE desalination is coming on stream. This is all creating an ongoing demand for water that cannot be satisfied without significant improvements in infrastructure."
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