Sustainable Investing: Water is plentiful, but ways to invest are scarce — here’s how to make money

This post was originally published on this site

Thanks to climate change, the next forefront for environmental, social and governance investing could be water.

It won’t be easy. Water is a fragmented market and is highly regulated by municipalities, agricultural and environmental interests. In the U.S., land rights and water rights go together, unlike in other countries such as Australia, where investors can buy those separately.

There are few simple ways to invest. Until two years ago, there was no futures market for water, unlike other commodities such as corn, crude oil or gold. And the contract barely trades.

There’s also been little investment incentive. In North America, the cost to extract, clean and deliver water has been quite low for so long, says Matt Howard, vice president of water stewardship for The Water Council, a nonprofit organization that helps companies address water challenges.

“All we’re paying for is the embedded cost of the energy that it takes to extract it, move it around and clean it. So you kind of had this almost unrealistic expectation that water is relatively inexpensive, it’s everywhere when we need it,” he says.

Yet water may finally be getting the attention it deserves. Beyond climate change – and accompanying droughts in some areas and floods in others — there’s heightened awareness of water quality; Flint, Michigan’s lead-contaminated drinking water is a prime example. Crumbling U.S. water infrastructure may see long-term investing following the passage of last year’s infrastructure act, with $55 billion of the $1.2 trillion earmarked to improving water supply.

As a result, says Matthew Diserio, president of Water Asset Management, a water-investing firm, decades of underinvestment in water-related infrastructure may be coming to an end. For ESG investors, improving water quality benefits communities, industry, agriculture and the environment – plus improving water quality is easy to measure.

“Water as an industry, really leapfrogs a lot of the ambiguity around quote, ESG investing because of the very clear, positive metrics that are identifiable around the water,” he says.

Tuesday is World Water Day, a U.N. observation to highlight the importance of fresh water and 2022 is also the 50th anniversary of the Clean Water Act, the U.S. federal law governing water pollution.

Read: What the U.N. climate talks got right and wrong, according to a fund manager and a climate-risk researcher

How to tap water investments

Buying publicly traded companies is the easiest way to own water. Water companies generally fall into two market sectors: utilities, such as American Water Works
AWK,
+0.44%
,
or industrials, such as water technology company Xylem
XYL,
+0.29%
.

Utilities provide drinking water and wastewater treatment. Most are regional, such as York Water Co.
YORW,
+1.97%
,
which services cities in Pennsylvania, and California Water Service
CWT,
-0.31%
,
which operates in California, Washington and New Mexico. American Water Works is the largest publicly traded utility, operating in 46 states.

Industrial companies build pipes, pumps, irrigation equipment, sensors and other technology. Xylem and Evoqua Water Technologies
AQUA,
+0.53%

offers water infrastructure and wastewater treatment products, while Advanced Drainage Systems
WMS,
-1.17%

makes water infrastructure products.

However, there are only a handful of publicly traded companies that are directly in the business of water, says Bobby Blue, a research analyst for Morningstar, who wrote a column looking at water investing. That hasn’t stopped fund managers from flooding the market with more than 60 exchange-traded funds or mutual funds.

Funds have a lot of holdings overlap. In the two biggest U.S.-focused ETFs brimming more than $1 billion in asset under management, First Trust Water
FIW,
+0.30%

and Invesco Water Resources
PHO,
+0.09%
,
eight of the 10 largest holdings are identical.

Some holdings are questionable as water plays, Blue says. Many water funds own life-sciences conglomerate Danaher
DHR,
-0.08%
,
which includes a water-related business unit, but it only makes up about 10% of the firm’s revenues. Another popular name is Roper Technologies
ROP,
+0.40%
,
which makes smart-water meters for utilities, but less than half of its revenues come from its water business.

Read: Can I beat the stock market with ESG investing? How to find the right fund for you

Although water ETFs aren’t pure plays, Gavin Maguire, analyst at Briefing.com, says they can still offer individuals a different way to get industrials exposure, and have offered solid long-term performance. The First Trust Water ETF gained an annualized 15.7% over five years and 14.3% over 10 years, while the Invesco Water Resources ETF is up an annualized 15.5% over five years and annualized 11.3% over 10 years, beating the Industrial Select Sector S&P Fund’s XLI 10.7% five-year annualized return and its 12.3% 10-year annualized return.

Investors wanting pure-play water companies should stick to individual stocks and dig through 10-Ks to look at where the firms get their revenues, Blue says. Maguire agrees, pointing out another popular water fund holding, Essential Utilities
WTRG,
+1.56%
,
owns a natural-gas utility. Irrigation-system companies such as Lindsay
LNN,
+1.19%

and Valmont Industries
VMI,
+0.14%

also manufacture other equipment unrelated to water.

How liquid is water investing’s future?

Ginger Rothrock, senior director at HG Ventures, the corporate venture arm of The Heritage Group, says a number of small start-up companies are starting to address the problem of treating industrial wastewater, especially as the cost of water is likely to increase. There also could be greater monitoring of industrial water use as larger companies’ sustainability mandates demanding more transparency in their supply chain. Another part is interest in a circular economy, where resources are reused instead of disposed, she adds.

She notes a number of the small companies that have gone public have been gobbled up by bigger firms, such as DuPont
DD,
+0.58%

buying desalination company Desalitech in 2019 and Evoqua buying Aquapure, a Cincinnati-area water services and equipment company, in 2020.

ESG investors, instead of buying water-related plays, may put their focus on corporations’ water targets, just as they have done with carbon. But Water Council’s Howard cautions investors to look skeptically at companies’ water goals and targets under the guise of sustainability because most companies haven’t grappled with their water use. Unlike carbon where the impact a ton of carbon has a single metric, water isn’t fungible, since water supplies and demand on aquifers and water systems vary greatly.

Read: Today’s widely adopted ESG ratings and net-zero pledges are mostly worthless, two pioneers of sustainable investing say

The Water Council is working with firms to define good water stewardship, and recently launched a program called WAVE, an enterprise approach for firms to help them understand water uses and impacts.

“There’s maybe 10 to 15 corporations globally that I think truly understand water stewardship and truly have a handle on it in terms of how they operate and the goals and the targets and commitments they’ve set for themselves,” he says. Two of the best on this topic in his view are water-treatment firm Ecolab
ECL,
+0.97%

and food giant General Mills
GIS,
+1.18%
.

Debbie Carlson is a MarketWatch columnist. Follow her on Twitter @DebbieCarlson1.

More from MarketWatch on ESG

Earth-saving promises in ESG fund prospectuses aren’t all that green: report

‘Drill, baby, drill’ is back amid the energy crisis, and that puts ESG efforts on the back burner

‘Want to stop making Putin rich … renewables is the answer’: Does the Russia-Ukraine crisis speed up or slow Europe’s green energy push?

This is what you’re getting wrong about ESG ratings