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VOICES FROM THE INDUSTRY: Investing in liquid assets? Try giving water a good look

September 24, 2007

G e o - p o l i t i c a l events and the media keep our focus on the price of oil, its potential supply interruptions and the need to reduce our country's dependence on foreign oil.

Very little is written or reported about another very strategic resource-water. A top United Nations official addressing the 17th Annual World Water Week in Stockholm last August stated that water is going to be the dominant world issue far into the current century. "The supply of water may threaten the social stability of the world," the U.N. official warned.

An essential asset

Why is water such a strategic resource? First, water is an essential for human life and has no substitute at any price. Second, although water covers nearly 75 percent of the planet and is considered abundant, usable fresh water is less than half of 1 percent of such amount. Further, pollution, climate change, population growth, industrial expansion and urbanization all continue to place unremitting demand on a scarce water supply.

When examining the economics of global water supply as an investment theme, the demand drivers are very attractive from a business perspective. The product is not a luxury item; it is an essential good needed by every person and business, industrial or agricultural. Human demand is constant and largely unaffected by price increases. Business and agricultural demand is steady and continuous, without the cyclical ups an downs experienced by most input commodities.

The water business is generally immune to economic cycles, recessions, interest rate fluctuations, inflation, changing consumer preferences and other common variables affecting global businesses.

Supply issues feed demand

From a supply perspective, most U.S. citizens don't appreciate the scarcity of fresh water. The Great Lakes (combined with other freshwater lakes throughout the world) contain most of the planet's supply of fresh surface water; however, on a global basis, this supply is small and finite. And, in many countries, available fresh water is being polluted at an alarming rate.

Water is not evenly distributed throughout the world. Less than 10 countries have 60 percent of the world's available fresh water. China has 21 percent of the world's population but it possesses only 7 percent of the fresh water. Large migrations from countryside to cities in the developing countries of the world coupled with overall population increases also exacerbate the problem of the location of water sup plies and getting it to the end user.

These themes of noncyclical, increasing demand and declining supply create opportunities for a broad range of public companies, both domestic and international. The global market for waterrelated products and services currently approximates $500 billion per year.

Globally, there are more than 400 waterrelated public companies with a combined market capitalization of almost $1 trillion. These companies provide a broad range of water-related products and services involving water transfer, storage, treatment, monitoring and recycling for residential, commercial, industrial and agricultural users. They are usually divided into two groups: utilities and infrastructure companies (utilities) and water equipment and materials companies (industrials).

Historic stock results

Historically, water utility stocks have been the backbone of water investing in the U.S. The Water Utility Stock index has outperformed the Dow, S&P 500 and NASDAQ over the past five-year and 10-year periods. From Dec. 31, 2001 through Dec. 31, 2006, the Water Utility index returned 15.4 percent per year compared to 6.8 percent for the Dow, 6.2 percent for the S&P 500 and 5 percent for the NASDAQ.

The returns for the 10-year period ended Dec. 31, 2006 are also compelling, with the Water Utility Index returning 8 percent more on an annualized basis than the Dow and S&P 500, and 10 percent more per annum than the NASDAQ.

Water utility stocks will benefit in the future from privatization as the number of investor-owned utilities is expected to rise dramatically. Municipalities with capitalintensive infrastructure needs view waterservice privatization as a resource to generate cash without raising taxes.

Although water utility stocks have been excellent investments, the overall opportunity for growth and investment return in water-related equities is much broader. Further, consolidation is another important force at work in the market.

Investors interested in water-related assets have a number of investment options. There are also a number of investable water indices, such as the Palisades Global Water Index, Palisades Water Index and S&P Global Water Index.

As water scarcity is a worldwide issue, look for water stocks and indices that have global exposure. Although the U.S. has aging water infrastructure that will require large capital outlays in future years, the global economic growth in China and India (which together represent 40 percent of the world's population) combined with their under-developed water delivery systems pose tremendous opportunities for global water companies.



Mersereau is a managing director with KSM Capital Advisors LLC, a registered investment advisor. Views expressed here are the writer's.
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