How to Invest in Water
Water, as a commodity might seem a bit unusual for retail traders as an investment opportunity but given the facts, some savvy investors have already taken up speculative positions betting that the water crisis will only worsen. Water is perhaps one of the few natural resources that are required to sustain life on the planet, making it one of the most important commodities. In the arid regions of the earth, water has been the cause for wars and civil unrest.
There has already been known conflicts between Turkey and Syria over the Euphrates River. The World Bank estimates that water is now a multitrillion dollar industry due to its importance and of course the shortages of the commodity alongside climate change.
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Wall street is yet to fully come to terms with investing in water, but to draw a parallel, water could be the next 'Crude Oil' commodity for the investing and perhaps speculative community. Still, having said that investing in water is slowly growing in popularity and it would only be a matter of time before the main street catches on to it.
Over 71% of the earth's surface is covered with water. Oceans hold about 96.5% of all the earth's water and all of it is saline or salty, making it unusable for drinking or farming purposes. It is estimated that over nine and half out of ten liters of water is salty. The remaining half a liter of fresh water is used in farming, industry and household consumption. Only 4% of all water is fresh water, with 70% of fresh water frozen as ice, leaving the world with just 1% of the water as fresh water.
In many advanced and even in some developing economies, water is already metered and billed, although not many people realize this. For example, an initiative in the UK around 2014 saw a public initiative campaign educating the masses about using water meters to save up on water. In places such as Australia for example which is considered to be the driest continent on the planet, water restrictions are already in place to avert chronic water shortages and droughts. Depending on the region, there are restrictions on using water for certain purposes such as watering lawns, sprinkler systems, refilling swimming pools and so on, most of the things that some parts of the world take for granted. Besides restrictions, there are also taxes on water usage.
For the moment, the restrictions on water are largely imbalanced. Water was free and considered a right in Ireland but in 2014 new taxes on water was implemented. In other parts of the world such as Denmark, Germany and the U.S. a fee of around $1 - $4 on average is levied for consumption of 1 cubic meter of fresh water.
Estimates already show that by the next quarter century, clean and drinkable water could become scarce on account of climate change and population growth which makes it a matter of "when" and not "if" water becomes a tradable commodity putting it next to the likes of other commodities such as gold, other base metals and crude oil.
Water as a commodity is vital to both life and industry due to its vast uses and according to academicians and researchers, peak water suggests that we are nearing the limits of using this finite resource.
Some industry experts such as Richard Sandor expect full scale trading of water (commodity futures) within the next five to ten years. Sandor worked as an economist with the CME Group and was behind the creation of the interest rate futures. According to him, there are quite a few obstacles currently in regards to trading water which he believes will be resolved over a period of time.
In fact, there are some exchanges that focus on water trading already. Waterfind, is an Australian based online market that offers forward contracts among other trading instruments focusing on water but concentrated to the Australian markets alone. Still, Waterfind’s forward contracts on water offer a glimpse into what water futures trading might look like in the near term.
Different ways you can invest in water
While trading water futures might still take time and even after that, traders will need to wait until it picks up in popularity to have the required trading volumes to make water futures liquid enough (pun intended) to trade, retail investors can look to investing in water via purchasing stocks of the various industries related to water. Some of these include:
- Public utility companies
- Bottling companies
- Water research and development companies
- Water desalination & reclamation companies
When investing or trading water, an important distinction to make is that unlike gold or crude oil or other commodities where you can directly invest in the price of the commodity, you cannot do the same with water. In other words, speculators cannot bet on whether the price of water will rise or fall and thus eliminates any possibility of cornering the water market (at least for now). The next best way to invest in water is to invest in companies that deal with water. Among the different sectors, you can either purchase stocks that have exposure to water or trade ETF’s or even create your own water based motifs.
The chart below shows some of the top water based motifs as an example. As you can see, even with water being the central theme, there are different ways to play it. A motif such as water shortage deals with companies that are involved in supply drinkable water. This motif as an example already recorded a one year return of 41.8%. Then there are utility based motifs with exposure to water bills. Such motif (basket of stocks) has a one year return of 27.7%.
While motifs and investing in stocks involved with water might require a bit of active investing, you can also opt for water equities ETF's and there are many. According to ETFdb, there are about five exchange traded funds under the water equities category. These ETF's have an average of 0.68% expense ratio. Some of the ETF names include Powershares Water Resources Portfolio ETF among other similar funds. Most of the water based ETFs were founded around early 2000 so they are still new compared to other sectors.
Comparing the top three ETFs (PHO, CGW, FIW) to the S&P500 one can find that all the three ETF’s have performed above average compared to the S&P500 index.
Water ETFs offer a better way to invest in water as they are cost effective way for a retail investor. Not all ETFs are created equally. For example First Trust ISE Water ETF (FIW) and PowerShares Water Resources Portfolio (PHO) ETFs track the companies whose revenues are based on water conservation and purification. On the other hand, Guggenheim S&P Global Water Fund (CGW) and PowerShares Global Water Portfolio (PIO) focus on companies dealing with water utilities, infrastructure, equipment and materials.
You can see that although all the above four mentioned ETF's deal with water, the way the ETF is structured around the stocks dealing with different aspects of the water industry offers different levels of exposure.
What are the risks of investing in water?
For a commodity/natural resource that has so much going in its favor, one might be pardoned to think that investing in water might be less risky. That is a mistake. A quick look at some of the water ETFs will show that even this sector of ETFs went through corrections especially during the 2008 - 2009 financial crises. Thus it suffices to say that investing in water based financial products such as ETFs might be a safe bet that doesn't make them immune to financial crisis.
Besides the above, another risk to bear in mind is government regulations which can change. Do not rule out the fact that governments can effectively seize private property especially if it has to do with abundance of fresh water in a specific region or area.
Climate change is one of the reasons for water scarcity and it could very well be the reason for volatility as well. Seasonal patterns can often bring about changes which could see seasonal shifts in demand for the natural resource.
However, for good or bad, with the exception of the financial crisis, due to the different way stocks are structured around water, the level of risk might differ. For example increase in water supply might hit stocks that are involved in bottling fresh water, but it wouldn’t quite affect water utility companies. Likewise regulation might hit a stock that is dealing with water purification or supply from a fresh water resource but it will not affect utility stocks or bottling companies.
Therefore, there is no straightforward way to play when it comes to investing in water but this means that the level of exposure can vary.
Investors also need to know that investing in water is a long term play and you cannot expect to see big returns overnight. Sure, the ETF returns seem to outperform the benchmark index but that is because of certain market conditions. Water based financial products (Stocks and ETFs) might offer a better play compared to blue chip stocks which are more risky in comparison.
On a macro level, analyzing water ETF's might offer a good way to hedge against the market declines and could form part of a defensive portfolio. This means that water ETFs or stocks could underperform during a strong bull market which is when investors flock to high growth sectors.
Demand for water is only set to increase over the coming years. A recent report by the U.N. suggested that driving demand for water will be the consumption from the Agriculture sector which is expected to grow by 20% globally by the year 2050. Water for energy purposes is expected to increase by a third by 2035 with most of the demand coming from OECD countries.
The water stressed zones such as the African continent, South and Central Asia could see additional demand with population expected to expand by an additional 2.3 billion. The U.N. report also paints a grim picture in highlighting that climate change could impact the surface water with further divergence seen in key parts of the world. Water’s importance goes beyond the traditional commodities as its effects can be immediately felt, the economic impact being the least of the concerns.
While the statistics might be grim, for an investing/speculative purpose taking an early leap into water based stocks and other trading instruments such as ETF's can potentially reap benefits for the retail investor in the long term. You do not necessarily need to go and buy a bunch of water based stocks or ETF’s but you could start looking at slowly allocating some part of your equity towards the water based stocks or ETFs which can offer a level of safety compared to the high risk growth portfolio.
The World Energy Council puts a figure of 100 billion cubic meters as expected demand for water by 2050 with most of the challenges coming from Asia as it struggles to meet the demands of growing population. China alone is estimated to increase its water demand rise 15% in the next 40 years.
Given the circumstances, it quite likely that water based stocks, motifs, ETFs will only gain in popularity over the coming years as the water crisis starts to gain the attention of the mainstream media. While other financial products such as futures for water are still yet to take shape, the fact that such derivatives are being already considered is evidence enough that investors should seriously consider evaluating the water sector as a viable investment opportunity.