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It all boils down to water
SUSTAINABILITY is emerging as a key concern among investors and asset management firms are beefing up their offerings. We speak to Paul Milon, BNP Paribas Asset Management’s ESG Investment Specialist, about Parvest Aqua, a fund investing in water, dubbed “blue gold”, with a track record of more than 10 years.
What is the rationale behind water as an investment theme for the short and long term?
Globally, clean water supply and demand imbalances persist and the long-term drivers discussed below support the superior growth of water companies. An ever-increasing gap between supply and demand, exacerbated by climate disruptions and extreme weather events, is set to require substantial capital investments in water treatment technologies and distribution infrastructure. This opens the door to investment opportunities in many new technologies and services to conserve, treat and distribute water.
i) Population and urbanisation: The global demand for water will continue to grow rapidly. While improving technologies are leading to more efficient water management, rising populations are putting the world’s freshwater resources under considerable strain.
According to the UN, the global population is expected to increase from around seven billion to an estimated nine billion by 2050. Over six billion of this is expected to be concentrated in urban areas. Meanwhile, the global volume of fresh water remains static. Just 2.5 per cent of the total 336 million cubic miles of water on earth is considered “fresh” and only 0.025 per cent is accessible surface water.
ii) Living standards: Increased urbanisation, coupled with greater affluence in developing countries, are changing consumption patterns. Higher standards of living are associated with a rapidly rising demand for clothing and personal products, and a higher protein diet, which all increase the pressures on water supply. Many items taken for granted by modern urban dwellers require significant amounts of water to produce. For example, a hamburger takes 460 gallons (2,090 litres) of water to make; a cotton t-shirt requires 650 gallons (2,950 litres); and one egg takes 50 gallons (227 litres). Major water infrastructure development is needed to service this rapid growth.
iii) Infrastructure: There is an estimated US$7.5 trillion to be spent globally over the next 15 years on water infrastructure. In developed nations there has been significant under-investment in repairs and upgrades, especially to urban infrastructure, much of which was built in the late 19th and early 20th centuries. The useful life of these systems is considered to be around 60 to 80 years.
Water leakage is a major problem in many cities – 15–25 per cent of water is lost every day in the US from pipe leaks, while London loses 180 million gallons (818 litres) per day from ageing water infrastructure. Authorities are working to solve this problem. For example, Thames Water has proposed a long-term objective to reduce leakage by approximately 50 per cent by 2035. In the US, the Environmental Protection Agency conducted a study that identified an investment requirement of US$298 billion for the upgrading and maintenance of the US waste water and storm water infrastructure network.
iv) Regulation: Governments and regulations play an important role in driving water supply and demand patterns and can dictate the quality of water, service, and water pricing. Water infrastructure, and particularly water treatment, has moved sharply up national and local governments’ agendas in recent years as a result of the
influence of regulations over water governance. Investment opportunities require careful due diligence of regulations and how they may develop in future.
v) Changing weather patterns: The increased incidence of extreme weather events and climate change are exacerbating the strains on global fresh water supply. Rising temperatures fuelled by global warming are accelerating glacial ice melt. The depletion of this freshwater source could have catastrophic effects on ecosystems and freshwater supplies.
What is the value chain that the fund can potentially invest in (how large is the investible universe)?
i) Water infrastructure: Pumps, pipes and valves manufacturers: These are relatively commoditised products, with some early cyclical exposures to the construction and the general industrial capital expenditure cycles.
Global growth rates for infrastructure projects are generally accepted to be considerably higher than the rate of growth of other global infrastructure spending. However, emerging market growth expectations are often quoted in the 12-18 per cent range. In particular, attractive Asian opportunities exist given government commitments to invest heavily in water infrastructure.
ii) Water treatment and efficiency: Solutions to using water more efficiently span industrial sectors as diverse as cement, semi-conductors, biotechnology and food processing. Water treatment companies typically supply products such as membranes and filters to these projects, often on a repeat purchase model so the buyer is tied to buying replacements from the equipment supplier. The equipment has predictable replacement cycles and provides manufacturers with relatively stable earnings profiles. This is also the case for suppliers of mission critical water chemicals which could not be more crucial from a process and safety standpoint.
Global growth rates for filtration of around 5 per cent are widely expected, whereas domestic water treatment in China is expected to grow by more than 30 per cent by 2020.
iii) Water utilities: Regional regulatory regimes are key to understanding global water utilities. For example, the US system sees utilities invest and subsequently request a region-specific cost of capital from the regulator to enable competitive returns. China operates on a cost-plus model, set and approved by local governments to allow a return on equity of 8-10 per cent. Tariffs are expected to rise in the coming years in order to facilitate the substantial growth expected in the country.
Please describe the approach to picking stocks and exposures for the fund
Investments are made in stocks of companies that generate >20 per cent of their underlying revenues through products and services that address a number of long-term water related macro-economic themes. The investment approach is GARP (growth at a reasonable price) focused. Exposures relating to GICS sectors, water sub-sectors, countries, market capitalisations and currencies are relatively stable over time. The fund is mid-cap oriented – selected from stocks from a list of 80 circa investable stocks.
What risks should investors be mindful of in a thematic fund like Aqua?
Besides the usual risks of investing in equity markets, investing in a thematic fund means your investment universe – while diversified – will be narrower than when investing across all sectors without a thematic filter. Therefore, relative performance versus conventional benchmarks such as MSCI World may experience larger differences (outperformance or underperformance) compared to conventional funds investing across all sectors. We believe, however, that the growth opportunities represented by a theme such as water could lead to superior returns over the long term. W