Value in every drop

- compiled from information supplied by UBS

Water is essential to sustain life. Water scarcity is growing more acute in many regions and pollution remains a constant threat to supplies. Huge investments have been made to maintain and improve water supply and sanitation globally but even more spending will be needed in future.

Severely challenged water resources

If you have had a shower, flushed a toilet or taken a healthy sip of water from a tap today, you are among the fortunate. For much of the world’s population, these activities are an inaccessible luxury. More than a billion people have no access to clean drinking water and about two-and-a-half billion lack access to adequate sanitation. The demand for clean water is mounting. The UN estimates that human water usage grew at twice the rate of population growth in the 20th century.

Water is essential for sustainable development

Properly managed water resources are crucial for social and economic development and for the conservation of the natural environment. Freshwater is a critical factor for a sustainable development, comparable with energy or food security. However, unlike oil, there is no alternative to clean water. More and more regions face water shortages, where demand exceeds available supply or where poor water quality restricts its use.
Water is closely related to other global challenges. Its supply is affected by environmental pollution or the consequences of climate change. Demand for clean water is increasing at an alarming rate, along with population growth, increasing wealth and dietary changes. In some regions, aquifers are heavily depleted,their decline clearly outpacing the natural replacement rate. Groundwater quality in China, for instance, has deteriorated significantly in recent years.

There are several ways to increase the supply of usable water: reduce leakage in the distribution infrastructure, recycle wastewater, expand the infrastructure (dams and reservoirs), or produce fresh water by desalination or by condensation from the air. The high energy needs of the latter two should be met by renewable energies to allow for a sustainable solution. Public-private partnerships or privatization could facilitate the upgrading of aging water infrastructure and contribute to more efficient use. We think it is crucial that the government supervises the water supply and sets a strict framework for commercial enterprises, but governments should also assure full cost recovery for commercial operators.

Water pricing is the subject of ongoing debate. One view argues that free water is a basic human right. Indeed, it is widely agreed that people should have access to a basic amount of water, such as the 20 litres defined by the WHO as a minimum daily requirement. However, we believe that unless water is adequately priced, incentives for its efficient use are lacking. This is also playing an important part in the overexploitation of water resources, most notably in agriculture.

Water sector outlook

Governments are increasingly aware of the paramount role of adequate water supply and its efficient management play in sustainable development. Particularly in emerging markets, there is an urgent demand to improve the irrigation, drinking and wastewater infrastructures. However, unlike the strong governmental support for energy effciency and renewable energies, found in many recent stimulus packages, investments in the water sector, have so far been largely neglected. The US intends to spend an additional USD 6bn over the next 10 years, whereas the Chinese government earmarked an additional USD 51bn over the next two years for urban ard industrial wastewater treatment, according to Global Water Intelligence.

Given the size of the economic stimulus packages, these figures are modest (1-10%) and, in our view, ignore the urgency of the needed improvement. However, in light of the global recession, we think it unlikely that a great deal of additional money will be spent by governments on water-related issues in the near future. However. we are convinced that the need to step up the investments will only increase in the coming years in view of the pressing water challenges. This should be a long-term catalyst for the water sector.

Water-related investments

Investment strategies for water have become increasingly popular in recent years. Thus, there are now many products available, via funds, ETFs, or via individual stocks.

A wide variety of companies in various industries are involved in the water sector. With water demand increasing and supplies under stress, we prefer companies that provide sustainable solutions to efficient water use along the whole water value chair  - exploitation, treatment, distributon, use and discharge.
Given that there are not many large-scale pure-play water companies, the revenues of many large-cap stocks in the water sector are driven by factors other than water. Therefore, investors should take a close look at the investment policy and specific composition of a pooled vehicle when considering an investment
While also suffering from the recent financial turmoil, water-related investments have significantly outperformed the MSCI World Index in the last few years. We also note that the retum/nsk proflie for the representative S&P Global Water Index appears favorable relative to the MSCI World Index and the MSCI sector indices.

Issues for SRI investors

Areas in which some water companies are typically active - infrastructure or construction - are often susceptible to corruption. Some infrastructure projects, for example, large dams, are controversial. With the expansion of these activities in emerging markets, these risks are unlikely to diminish.
Companies involved in bottled water often meet criticism: bottled water is seen to have an unnecessary critical environmental impact related to packaging and transportation. International companies are sometimes blamed for lowering local groundwater levels. Moreover, bottled water is also relatively expensive, and thus cannot be afforded by many people in emerging markets.

Seven water-related investment areas

Utilities: Drinking water and wastewater, utilities are usually monopolies because their network infrastructure is very expensive to build and maintain. Therefore they are often public, or. if privately-held, heavily regulated.
Bottled water: Despite the impressive growth rates of global sales for bottled water of about 10% in recent years, we remain cautious regarding the social and environmental impacts. On the positive side, in some regions with bad tap water conditions, bottled water can be a viable alternative as a safe drink for consumers.

Pipes, pumps and valves: Pipes, pumps and valves are vital to the distribution    networks for drinking and wastewater. Many networks need to be built and many existing networks are in dire need of renewal or replacement.

Water treatment: Water quality and energy have become a major focus and therefore innovation in improved treatment technologies (reverse osmosis membranes, nano, ultra, and micro-filtration) and efficient solutions are paramount to compete in this field. We expect increasing demand for filtration and desalination technologies.

Metering and testing: Increasing pressure to manage water more efficiently should create strong and ongoing demand for measuring devices for water quantity and quality.

Appliances: Proper water pricing, subsidies on efficient appliances, or regulation may encourage early replacement of less efficient appliances. As agriculture consumes the largest amount of water globally (70%), the impact of reducing water use in agriculture could be immense. Drip irrigation practices could reduce water usage by up to 80%.

Dams and reservoirs: Given the growing demand and changing precipitation patterns, storage of water will become an important water management tool. Given the controversy surrounding large dams, we expect to see more small-scale projects that serve local and regional rather than national interests.