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TheWall: Investing idea: As liquid as it gets

TheEdge Sun, Jul 14, 2019 11:30am - 1 year ago

Earth’s glaciers and polar caps are melting at an astonishing speed. Taps in South Africa almost ran dry last year while India and Australia recently faced severe droughts — the likes of which has not been experienced in decades.

Water is becoming one of the most coveted resources as global warming, pollution, urbanisation and an increasing population exert pressure on minute global freshwater reserves. To exacerbate the water shortage, millions of people across the world fall sick or die every year from diseases associated with water and sanitation.

This is not lost on investors. In fact, Ireland-headquartered KBI Global Investors Ltd started its water investment strategy way back in 2000 before the melting polar ice caps and dried-up rivers made headline news. The firm invests in companies that specialise in water irrigation, wastewater management and water infrastructure. Meanwhile, the institutional asset manager is majority owned by French-headquartered asset manager Amundi Ltd.

“If you look through satellite images, the earth looks like a planet made of water. While its surface is covered by 71% water, freshwater is only about 2.5% of the planet’s water supply. Two-thirds of that is frozen, locked in permafrost and glaciers — with only 0.3% readily accessible for consumption.

“More importantly, most of the water that is fresh, clean and sourced locally is already allocated. So that incremental drop of water to satisfy demand is coming from further away, which to connect requires a lot of infrastructure. The starting point is storm water, seawater or wastewater, and all of that requires technology to improve the quality to drinking water standards,” says Matt Sheldon, senior portfolio manager at KBI, who is based in the US.

Nearly two decades since KBI began its journey, Sheldon, who joined the team in 2011, says investments into the natural commodity is bound to become more significant as water problems around the world turn dire.

“Historically, it is clear that water systems are under-invested in. But we think that more money will be spent addressing water problems over the coming decade [as governments work on] fixing the infrastructure — which is breaking at an increasing rate — addressing urbanisation, industrialisation and the changing demographics,” he says.

Additionally, climate change is expected to intensify the risks associated with available water supplies and its quality.

According to the United Nations World Water Development report published in April last year, nearly six billion people are likely to live in areas that suffer from water shortages for at least one month a year by 2050.

The report zeroed in on the severity of the global water crisis, which has intensified due to climate change, with wet regions generally becoming wetter and dry regions becoming drier.

“At present, an estimated 3.6 billion people (nearly half the global population) live in areas that are potentially water-scarce at least one month per year, and this population could increase to some 4.8 billion to 5.7 billion by 2050,” warned the UN.

Sheldon adds that the transport and treatment as well as the use of clean and wastewater are significant sources of greenhouse gas emissions.

“In the US, there are major cities and minor cities where people are drinking water that is polluted with lead, which is a neurotoxin that especially affects children. So, policymakers increasingly understand the need to address their water systems and know what they are dealing with.

“All these problems weren’t actually happening in 2000 when we started out, but over the last few years there has been a specific push globally, almost on a synchronised basis, where policymakers, politicians and companies are increasingly allocating funds to address their water systems,” he says.

According to him, an estimated US$7.5 trillion (RM31.07 trillion) will be spent on global water infrastructure by 2030, just improve existing facilities.

Sheldon says in general, investments into the commodity is rising thanks to the Sustainable Development Goals (SDGs), where Goal 6 is aimed at ensuring access to clean water and good sanitation.

As water is considered a multi-impact investment, investments into the commodity also draws impact investors.

This is because water is intrinsically linked to other impact themes as it affects food supply, industrial chain, health, productivity and the environment overall.

“Clean water helps address hunger and clean water helps improve health …  half of the hospital beds around the world are occupied by people who are sick due to water-borne ailments.

“What the SDGs have done is that it encouraged investors to think about what they want to invest in to make a difference. There is no doubt that water does that.

“Two of our largest investors last year — one was a high net-worth family and another was a sovereign wealth fund in northern Europe — were very interested in addressing SDG6, where 70% of the revenue from business activities of the companies in their portfolio helped achieve the underlying targets underneath the SDGs,” he says.


Leaders of the pack

Countries globally are investing in alternative water supply sources. They are also rebuilding pipe networks and advancing technological breakthroughs.

Singapore, which is one of the leading investors in the segment, has been rapidly expanding and improving their water-reuse plants, desalination plants and investing in storm water management to capture water on the west side of island state.

The reason behind the aggressive expansion is mainly the contention on the pricing of water that Singapore draws from the Johor River in Malaysia.

Through the 1962 Water Agreement, which expires in 2061, Singapore is entitled to draw up to 250 million gallons a day (mgd) of water from the river. Singapore pays 3 sen per thousand gallons of raw water and sells treated water back to Johor at 50 sen per thousand gallons.

“The bigger issue for Singapore is that by 2060, they need to be self-sufficient,” he says.

Sheldon says China and India — the two most populous countries in the world — are also making noteworthy breakthroughs in terms of investments in water resources.

“China’s Five-Year Plans [which is in its 13th edition], prioritises water quality and availability. They are on a very aggressive spending spree to upgrade their wastewater treatment facilities in the Tier 1 and Tier 2 cities to improve the quality of water.

“We are invested in a handful of Chinese companies which are building up wastewater treatment plants, upgrading the plants, doing environmental remediation of rivers and river beds. They are growing quite nicely,” he says.

Meanwhile, India — which is among the few countries in the world with poor water infrastructure — is beefing up funding dedicated to water infrastructure.

“They have committed close to US$3 billion to clean up the terribly polluted Ganges River under the ‘Namami Gange’ programme. The government is investing in wastewater treatment for larger cities such as Mumbai. They also have a programme called ‘Housing for All’, which is expected to be completed by 2022. And, as it is with any housing programme, there has to be a significant infrastructure for that,” he says.

Under the Atal Mission for Rejuvenation and Urban Transformation scheme, the Indian government is working towards ensuring round-the-clock water supply, which Sheldon says is rare.

“India is one of the fastest growing markets for water and it is very attractive to us. We are invested in two Indian companies. One does irrigation and another does plant engineering where they design compact wastewater treatment for water desalination,” he adds.

“Even in Malaysia, which is one of the leaders in this space, there are big opportunities for companies to address water leakages.”

While KBI does not have any direct investment in Singapore and Malaysia, the fund house’s portfolio of companies — US-based Mueller Water Products Inc and Xylem Inc — are working with domestic stakeholders to address issues related to leakages, among others. “They are installing equipment on the pipes themselves to listen for leaks in a different way, like vibrations that come through the pipe.”


Positive outlook

These factors are driving opportunities for water companies, says Sheldon. “What we are doing is investing in those water companies that are benefiting [from this trend]. This is a very investable opportunity.

“Historically, the earnings of companies in KBI’s portfolio have grown faster than the broader market by three to four percentage points per year. Everything that we see now makes us believe this will continue into the future, especially now that we see this movement to address global water problems,” he says.

The growth of KBI’s water strategy is benchmarked against the performance of the MSCI All Country World Index (ACWI) from January 2001 to Dec 31, last year.

“[Over the years] We have traded at slightly more than a 20% premium over the MSCI ACWI,” he adds.

The MSCI ACWI captures large and mid-cap companies across 23 developed markets and 26 emerging markets. With 2,852 constituents, the index covers about 85% of the global investable equity opportunity set.

“Over the last five months, we have been trading at that same valuation as the market. I think the immediate opportunity from a risk-rewards perspective is that water stocks are inexpensive. I think the fundamentals for the next three to five years is very strong.

“If you think about what investors would pay a premium for: They [would] pay a premium for growth, for quality and for the believability of future earnings. We believe we have that and yet, you can buy that for the same valuation as the market. That’s the near-term opportunity,” he adds.

At KBI, Sheldon says the companies that they pay close attention to are those that deal with irrigation. “Also, we really like companies that design, build or oversee the building of water infrastructure. These companies have incredibly attractive valuations and yet, over the next two or three years, their earnings growth is going to be a strong double-digit.

“We also invest in futuristic technology, and oftentimes they are part of larger companies. Some of the more interesting technologies are the ones that deal with leak detection, measuring the thickness of pipelines or trying to figure out which pipe is going to break next — so you can fix it before it breaks,” he says.

Seeing the kind of investment that are needed to gain access to high-profile companies, most of KBI’s investors are institutions and family offices. However, Sheldon stresses that their funds are open to sophisticated investors all over the world. To purchase institutional shares, one is required to invest a minimum of US$100,000 while investor shares start at US$10,000.

“It is very difficult to predict the future but everything that we see makes us believe that the future should be equal or better than the past,” he says.

Sheldon recognises that at a portfolio level the amount of allocation to a water strategy may not be on par with energy or transport infrastructure stocks. But it is no doubt that having an exposure to water stocks as a long-term bet is bound to outgrow the market.

Despite the global demand, why are there not more investors betting on the essential commodity as they do with energy and infrastructure?

Sheldon believes this is due to a lack in opportunities if investors were to limit themselves to investing in specific countries or regions.

“If you are going to go passive and just going to own stocks in the Malaysian index or the S&P500, you may completely miss out on the opportunity because the publicly traded water companies tend to be in the small and mid-cap categories.

“So, you almost have to specifically seek out a strategy to get that exposure to everything from water utilities, to companies providing equipment and services, various technologies and chemicals. This tends to be the reason most people are under-invested.”

He adds that KBI is also in the midst of working with “some parties in Malaysia” to potentially put together retail product for local investors. If all goes as planned, investors will be able to invest through a feeder fund by the end this year.

Despite the encouraging returns and future prospects, there are risks that investors need to be aware of.

Unlike energy stocks, which sway in accordance to crude oil prices, water investments are often company-specific.

“Just because a company has a water stock, it does not mean that it is a good idea. This is because the valuation could be wrong ... it is very important to really understand the underlying business model.”

It is also not advisable to be influenced to invest in just about any new technology in the sector, he says.

“Sometimes it is easy to get sucked into the excitement about a new water technology but oftentimes it is very difficult to commercialise such technology because you are selling it to conservative municipal engineers. So, it is important to be seasoned, patient and skeptical — all these tricks help over time,” says Sheldon.

It is also wise to be mindful of country specific risks such as regulatory changes or political interference, he adds.



Other ways of accessing the sector

As water is increasingly regarded as one of the world’s most precious resources, there have been a lot more interest in the commodity beyond just hydrologic outcomes.

Apart from investment in actively managed global funds with water strategies, investors can also gain exposure by investing in exchange-traded funds (ETFs) that group baskets of stocks with exposure to the commodity.

Some of the available ETFs are the Invesco S&P Global Water Index ETF and the Invesco Water Resources ETF.

The Invesco S&P Global Water Index ETF has exposure to developed market securities, including water utilities, infrastructure, equipment, instruments and materials. The ETF, which tracks S&P Global Water Index, has seen a return of 13.7% over a 10-year period. The fund began trading on the New York Stock Exchange Arca on May 2007.

The Invesco Water Resources ETF, on the other hand, invested in listed US companies that create products designed to conserve and purify water for homes, businesses and industries. The ETF, which tracks the Nasdaq OMX Global Water Index since its inception in December 2005, has returned 15.92% (as of March 31) over a 10-year period.

For investors with impact as a priority, WaterEquity Inc — a pioneer impact investment management firm dedicated to ending the global water crisis — raises and deploys capital to water and sanitation enterprises throughout Asia, Africa and Latin America. Founded by activist Gary White and actor Matt Damon, WaterEquity is pioneering market-driven financial solutions to address the global water crisis.

In April, the fund house closed its flagship fund at US$50 million in total commitments from investors, including the Bank of America, the Overseas Private Investment Corporation, Ceniarth LLC, Niagara Cares, as well as the Conrad N. Hilton, Skoll and Osprey Foundations.

For those who prefer investing directly in the local stock market, there is no dearth of listed companies on Bursa Malaysia.

Some of the companies that operate in this segment are Taliworks Corp Bhd, HSS Engineers Bhd, Ranhill Holdings Bhd, PBA Holdings Bhd, Gamuda Bhd, George Kent (Malaysia) Bhd, Engtex Group Bhd, YLI Holdings Bhd, Hiap Teck Venture Bhd, JAKS Resources Bhd and Fitters Diversified Bhd, Kumpulan Perangsang Selangor Bhd and Salcon Engineering Bhd.

Some of these companies have garnered quite a bit of interest of late. In an extensive report released in April, CIMB Equities Research stated that RM77 billion will need to be invested in water infrastructure in the long term to improve and upgrade existing facilities.

The estimated sum was drawn based on figures obtained from industry players like Pengurusan Aset Air Bhd and the National Water Services Commission.

The figure also includes the RM30 billion in capital expenditure needed to improve Selangor’s water services, over a 30-year period beginning this year, for its 9.1 million people.

In Malaysia, investing in water infrastructure is divided mainly into beefing up upstream amenities, such as raw water source and water treatment or production, and downstream facilities like reservoirs, pumping stations and distribution pipeline.

The research institute segregated the Malaysian water sector into three categories: water and infrastructure ownership and management; upstream operations and suppliers; and downstream operations and suppliers.

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