A SEVERE DROUGHT that has afflicted California for the past four years and prompted Governor Jerry Brown to declare a state of emergency has led to mandatory water restrictions, with Brown citing the need to "prepare the state for an uncertain future."
It was partly actions like this that have prompted us to identify water as an investment theme. It goes beyond water acquisition to include systems and technologies for cleaning, storage and transportation. We expect innovation in the use of water to become increasingly valuable and companies that provide relevant solutions to be in demand.
Over the next 20 years, the U.S. alone will need more than $650 billion in investment to maintain and improve public water systems.
In California, a $1 billion drought package authorizes critical water infrastructure projects, following a $7.5 billion water bond issued in 2014 for water infrastructure. In addition, a government grant program will enable farmers to improve agricultural and irrigation efficiencies. These new measures call for private enterprise to step in and assist.
Texas and Oklahoma also face water scarcity. Outside the U.S., there is a dire water shortage in Brazil; in the city of São Paulo, many strategic reserves are at historic lows. Taiwan is also facing its worst drought in nearly 70 years.
According to Sarbjit Nahal, head of Thematic Investing at BofA Merrill Lynch (BofAML) Global Research, 50% of the world's population will live in conditions of "water stress" by 2030. Generally, as emerging markets develop they will require more water as they shift from agricultural to increasingly industrialized economies. Growing middle-class populations will require more water as food preferences shift to meat and dairy items that require more water to produce. As pollution increases and water scarcity grows, global demand for water is projected to exceed supply by 40% over the next 20 years.
Public and private solutions on deck
Solutions to deal with water scarcity start with water conservation or management, continue with treatment, and finally require building and maintaining infrastructure. Corporations and individuals have a part to play, and efforts to conserve water offer a range of opportunities for investment while also making a difference.
Water management means optimizing use and is especially pertinent to agriculture, which accounts for 70% of global water consumption. It includes developing drought-resistant seeds and crops, irrigation, smart metering and household water efficiency.
Water treatment, which includes wastewater processing, industrial treatment and desalination, helps make water acceptable for drinking or agriculture. After all, freshwater accounts for only 2.5% of the total global supply.
Water infrastructure and supply solutions involve building and maintaining infrastructure for storing and transporting water, along with sewage treatment facilities. Over the next 20 years, the U.S. alone will need more than $650 billion in investment to maintain and improve public water systems, Nahal says. We expect to see the private sector play an increasingly significant role.
Past performance is not a guarantee of future results.
An important theme poised for growth
Investing in a theme such as water seeks to leverage a focused trend that is expected to outperform the broad market over the long term. Already the S&P Global Water Index has outperformed global equities over the past 10 years. Water is a necessity, and innovative companies are positioned to benefit from the structural shifts occurring across economies, sectors and demographic groups. The need for water and related products and solutions will continue to grow along with the global population and levels of consumption.
As pollution increases and water scarcity grows, global demand for water is projected to exceed supply by 40% over the next 20 years.
With long-term investment themes such as water, it is prudent to gradually phase into portfolio positions. There are opportunities in individual equities across water-themed subsectors. However, it may be difficult to link exposure to water and stock price performance in the near term, according to Nahal. He sees water as a thematic long-term megatrend with the potential to outperform the overall market. When dealing with exchange-traded funds (ETFs) or other passive vehicles, we suggest focusing on diversification and avoiding significant concentrations in any country or sector.
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Investments focused in a certain industry or sector may pose additional risks due to lack of diversification, industry volatility, economic turmoil, susceptibility to economic, political or regulatory risks and other sector concentration risks.