Different Ways to Make Water Plays

May 18, 2015 at 01:24 AM
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California move to require further water-use restrictions highlights both a problem and an investment opportunity. In parts of the U.S. and other countries, water supplies are tight.

It's not just a supply question, though: Deteriorating infrastructures, such as leaky municipal pipes, and increased demand compound the problem.

Those conditions create domestic and global investment opportunities that range from the acquisition of water rights to desalinization technologies, experts say.

The premise of investing in water is fairly simple, according to Matt Sheldon, CFA, co-manager of the Calvert Global Water Fund (CFWAX) in Dublin, Ireland. A significant amount of money will be spent in the water space over the coming decades, he says, and that spending will "act as a very nice tail wind for the companies that are providing solutions in it."

He cites two primary reasons for the high spending levels. The water infrastructure in many areas is breaking down at an increasing rate and must be repaired quickly.

Widespread droughts are the second impetus – namely the need for "clean, local, fresh water (that) has essentially been already has been used up globally," Sheldon explains.

Statistics support that contention. Guggenheim Investments, sponsors of the Guggenheim S&P Global Water Index ETF (CGW), notes that the global water supply is limited: 97.5% is salt water vs. 2.5% fresh water.

Seventy percent of the freshwater is frozen in the polar ice caps with just 30% available for consumption. By 2030, roughly half the world's population–primarily in underdeveloped countries–will be living in areas of "high water stress."

Active Management

The actively managed Calvert Global Water Fund divides water-related stocks into three main categories: infrastructure, technology and utilities. That approach provides a diversified mix of geographies, business drivers and models, Sheldon says.

The fund invests in publicly traded companies within these categories but does have some exposure to water rights-ownership businesses. The water rights model differs from the other categories, he notes.

"It's a different investment proposition because generally you can own these assets for a long time before they are monetized …," Sheldon explains. "But, generally, we don't spend a lot of time in water rights, because there are not a lot of opportunities; and it is very transaction oriented."

Stocks in the three categories exhibit different investment profiles. Water infrastructure is the most cyclical, with betas (movement compared with that of the stock-market average) of typically 1.3-1.4.

These companies provide pumps, pipes and plumbing, engineering and construction services, and irrigation equipment. Their stocks perform well when the cycle is in their favor. But "when the cycle is on the downside, it could be quite problematic for the stocks," says Sheldon.

Water technology companies provide measurement equipment and water-treatment chemicals, as well as  treatment, disinfection and separation equipment, along with infrastructure diagnostics, he explains. Cyclicality varies by company, and the firms tend to produce higher margins.

Water utilities are defensive and the regulatory environment often drives their results more than the economy.

How does Sheldon see the fund's role in investors' portfolios? "Most of or many of our investors allocate it as a unique alpha-generator within their equity bucket," he explains.

"There are others that have separate allocations for natural resources or ESG (environmental, social and governance) sustainability themes. There are others that are interested in liquid real assets or liquid infrastructure that water fits quite nicely into. But, again, at the end of the day these are global equities and most of our investors would allocate them as such," Sheldon states.

Passive Management

The Guggenheim S&P Global Water Index Fund ETF (CGW) tracks the performance of the underlying S&P Global Water NR Index, which consists of roughly 50 equities. These stocks can include water utilities, infrastructure, equipment, instruments and materials.

A ranking methodology determines a stock's weight in the index, according to William Belden, managing director for product development with Guggenheim Investments in Chicago. Companies with greater participation in and benefit from water-related operations receive higher scores.

As of March 31, industrial companies comprised the fund's largest holdings with a 52% weighting followed by utilities (39%), and information technology (3.6%). The Swiss company Geberit AG, a maker of sanitation equipment, is the fund's largest holding at just over 8% of assets.

Belden agrees that the water industry is poised to "capture significant levels of investment going forward." As to the fund's potential portfolio role, he sees it as buy-and-hold allocation vs. a tactical trading allocation, such as a solar ETF.

"Typically we've seen those companies (in the index) not be overly tactical in terms of the way in which their performance is delivered," Belden says. "So, you're not going to invest today to sell tomorrow or next week or next month for that matter. This is more of a thematic approach that can serve in a complimentary fashion to a core portfolio type of allocation."

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