Water Shortages: Investment Opportunities?

The new oil may be water. According to Global Water Intelligence, a U.K. consultancy, by December total assets under management in water funds could hit a record $20 billion this year, a 53 percent increase from 12 months earlier. No wonder: since 2001, shares in glob-al water companies have gone up 150 percent, according to Thomson Financial. That compares with a 50 percent rise in international blue chips.

The reason is simple: there is profit in scarcity. Buffeted by constant news of dying rivers, droughts and water shortages from China to Mexico, investors are increasingly aware that water is a threatened resource. With more and more governments handing public water systems over to the big multinationals like the U.K.'s Veolia Environnement and Thames Water, profits are rising. One of the top companies, France's Suez, saw global sales from its water unit increase 11.7 percent, helped by a 20.3 percent rise in revenue from China. These days, savvy asset-management companies have turned water-shortage anxieties into a burgeoning investment-fund business. Like the rest of the market, water stocks have fallen recently, but a lot less than, say, U.S. equities. While the Standard & Poor's index plunged by a tenth in the last few weeks, shares in global water companies are down only about 3 percent, helped by international business exposure and the view that cash-generating utilities businesses are a good defense in a downturn.

This year, much of the new money pouring into water funds is coming from Asia, where ethical investing is very new. It may also simply be that Asia is the only developing region that has a combination of remarkably acute water crises and particularly rapid growth, creating a new crop of investors who are intimately familiar with the water threat. Only seven months into 2007, there are now 27 international water funds, more than double the number compared with 2006. Of the 15 new products, nine target Asian investors in Hong Kong, Seoul, Tokyo and Sydney. Since April, when Société Générale's Lyxor Asset Management unit began inundating Hong Kong with ads touting its new water fund, it has raised $320 million from mom-and-pop investors alone, well beyond its expectations.

The price of any company's stock reflects its estimated future earnings, and the potential to make money fixing water problems is huge. In developing markets where affluence is growing, and hundreds of millions of people are set to move from rural to urban areas, water resources are under assault. The Chinese government estimates that demand will increase by 120 percent in the next 25 years, while in India, urban water needs will rise 100 percent in the coming two decades. "We see a combination of exploding demand for water per capita, growing scarcity of supply and massive pollution,'' says Anthony Wilkinson, co-principal of the CLSA Clean Water Asia Fund, which started in May, and invests most of its money in Asia-listed companies.

For major water-treatment specialists, the biggest new projects are in China. Some 1,000 wastewater plants are to be built over the next five years, as the government has pledged more than $125 billion to address the natural-resource shortage. Hundreds of billions more are expected to come from the private sector. A recent report from Macquarie, the investment bank, pegged earnings growth for Singapore-listed water-treatment companies like Epure and Hyflux, which target the China market, at between 37 and 40 percent over the next three years.

The hottest investment bets include companies engaged in desalination, recycling or infrastructure, which have the highest margins and potential profit growth. Utilities are less attractive, because water prices anywhere are usually regulated by the government and not subject to market conditions. Dieter Küffer, a senior portfolio manager with Sustainable Asset Management in Zurich—which has the second biggest water fund in the world, worth $1.6 billion—says: "We think earnings growth in water stocks overall will be 14 percent over the next five years, and Asian water-stock growth will be 50 to 100 percent.''

Investors pouring money into water funds may find, as they say in China, double happiness. The stocks themselves have had a good run. But investing in sustainability may have a larger payoff. Many economists now see environmental issues as the biggest stumbling block to continued fast growth in Asia. Already, Beijing estimates economic losses due to water shortages at $25 billion a year. Investors buying into liquid assets could help secure Asia's larger economic future.