More investors thirst for most liquid asset

Water is the new carbon for institutional investors and money management firms across the globe, as risks and opportunities arising from water scarcity climb up the risk agenda.

The United Nations estimates almost half the world's population will live in areas of high water stress by 2030, with a 40% shortfall between water supply and demand. Changing demographics, a developing middle and working class, and aging infrastructure are all contributing to water stress, said sources.

“This is a very significant issue for all investors,” said Fiona Reynolds, managing director at the U.N. Principles for Responsible Investment, based in London. “Water is central to pretty much everything that we invest in,” with food, beverage, apparel, retail and agriculture sectors the biggest users. “That is why, now that investors (have) really started to accept climate change as a risk — and that is still relatively new for (many) — we are seeing the increased focus on water. And I cannot see that going away.” Ms. Reynolds added that demographics and waste due to aging infrastructure are also issues.

The PRI partnered with the World Wildlife Fund and PricewaterhouseCoopers Germany to launch an investor-led effort focused on the water risks that companies face in their agricultural supply chains. It will publish its results in October.

Doug Morrow, Toronto-based associate director of thematic research at ratings and analysis provider Sustainalytics BV, said the market as a whole is increasingly aware of water risks and opportunities. “It is becoming clear that water scarcity can impact the productive capacity of companies and thus shareholder returns.”

Sustainability advocate Ceres is seeing increased maturity in the understanding of water risks, with a “real evolution in investor awareness and understanding,” said Monika Freyman, director, investor initiative, water program, in Vancouver. She said the “1.0” was asking questions around volumetric water usage by companies. “The 2.0 was also looking at water risks” around wastewater, and also considered social issues related to water. “In 3.0 we are seeing scenario analysis as being important to understanding water risks,” and focus on sector-specific risks.

Institutional interest

The topic is gaining traction with institutional investors. The U.K.'s £1.3 billion ($1.6 billion) National Employment Savings Trust, London, will this year turn its attention to water as part of its continued focus on climate change.

Executives are in the “knowledge acquisition phase” right now, said Paul Todd, London-based director of investment development and delivery at the plan. In their work around climate change, executives kept coming across the issue of water usage. While they are still trying to distill the different areas of water risk on which to focus, Mr. Todd said focus is coming from three angles.

“Most of the large carbon and greenhouse gas emitters are also pretty heavily involved in the amount of water they use,” he said. “So their approach and the impact of how they use water and the price they are paying — and what happens after they have used it — seems from our analysis to be quite a significant factor.”

The second element is water scarcity, moving up the agenda in general. “Traditionally water was seen as a kind of free asset,” but, as with carbon, this will not be the same going forward, said Mr. Todd.

And the third point is related to policy and regulation. Executives are approaching this by asking a series of questions of institutions and experts. He said one of the key issues is transparency and reporting. “It is difficult to make decisions about portfolio construction and where you engage with different companies when you haven't got the actual data on their water usage.”

Plan executives want to understand the role water plays in setting the price of securities in which NEST invests.

“Water clearly has a price and a value, and the way we use it will have an impact on the price and sustainability (of a company.) We are not convinced it is being accurately represented, particularly in the short term,” Mr. Todd said. “We are trying to understand what that means for our portfolios going forward — we see that as a responsibility. We think it would be remiss if we weren't doing that kind of work.”

That doesn't mean NEST will immediately start investing in water projects, “but making that decision of what should and shouldn't (be investments) should come from a position of knowledge and information, not because it is a fad,” said Mr. Todd.

Tapping opportunity

NEST is not the only plan focusing on water from a risk point of view.

“We are having multiple discussions, predominantly with asset owners, who are aiming to identify and mitigate the impact of water risk at (the) corporate and supply chain management level and/or are looking at building better resilience through effective water usage and efficiencies management strategies,” said Martina MacPherson, global head of sustainability indexes, product management, at S&P Dow Jones Indices in London.

Others started on the water journey earlier. Norges Bank Investment Management, which runs the assets of the 7.5 trillion Norwegian kroner ($912 billion) Government Pension Fund - Global, has been assessing companies exposed to water risk since 2010, said a Norgesspokesman. Water is one of three focus areas that deals directly with environmental and social issues. The other two are children's rights and climate change.

“How companies manage water risks and capitalize on opportunities, that may drive long-term returns for us as a shareholder. Externalities from unsustainable water use may in itself present a risk to the portfolio's long-term value,” the spokesman said. The firm expects companies to incorporate potential water risks into their strategic planning, risk management and reporting.

And the 297.5 billion Swedish kronor ($33.9 billion) AP1, Stockholm, found an opportunity to invest just as it had set its internal policy on environmental, social and governance factors.

“As many investors, we have been challenged by how to approach ESG from the perspective that there is no way anyone can do everything,” said Mikael Angberg, chief investment officer at the fund. Executives wanted to formulate a strategy that was meaningful, captured sufficient ESG factors, and was manageable — and at the same time could be communicated to its board and externally.

They came across the term “resource efficiency,” and focused on three pillars: climate, water and waste.

Then in July 2016, Resonance Asset Management announced AP1 was one of six investors committing a total $300 million to what it said was the first institutional strategy exclusively focused on financing industrial water infrastructure projects in Europe, southeast Asia, China, Australia and New Zealand.

“Resonance is so far our only dedicated water investment, and I emphasize dedicated, as other strategies have elements” of water focus, said Mr. Angberg. And while executives want to “expand within water specifically ... it is really hard to find investment opportunities. We don't want to compromise on the quality of the counterpart, and the risk/return perspective.”

But Mr. Angberg is hopeful this will change. “It is supply and demand at the end of the day — the fact that many more institutions are picking up on the water issue, and resource efficiency more broadly, will help deal flow. And will bring more investment and transactions and opportunities online.”

Matt Sheldon, Boston-based senior portfolio manager at KBI Global Investors Ltd., and a manager on the firm's e500 million ($539 million) water strategy, said the firm has seen investors looking at water from a risk perspective, and starting to shift focus to opportunities.

He said European investors are “undoubtedly in the lead” when it comes to focusing on water risk and opportunity, and while U.S. investors are generally behind the curve they are asking the right questions.