Why Invest in Water?

When the well’s dry, we know the worth of water.” – Benjamin Franklin

If you read “The State of the Water Industry” and the “Introduction to Water Investing 2008” reports on the Summit Global Management’s website, you might go away feeling depressed about the current or future state of our water.

If you think the report is quite doomsday in its predictions, the guys from the UN issued similar warnings about the state of water. You can check out “The 3rd United Nations World Water Development Report: Water in a Changing World (WWDR-3)” just released by the UN in Mar 2009.

I’ll briefly highlight “recent trends and highlights” from the report:
1. Water investments gain attention as economy falters
2. Renewed focus on the environment
3. The intertwining aspects of water and global food production
4. Water to make oil, oil to make water
5. Growing concerns about global climate change
6. The bottled water craze cools off
7. New policies and new ways of thinking about water
8. Public versus private ownership

The key drivers behind the water business:
1. Water quality and scarcity problems are reaching crisis proportions
2. Public awareness and understanding of water problems is increasing
3. Regulation and enforcement will continue to intensify
4. Huge economic and human capital investments are required in the water industry

Industry trends and key issues:
1. Increasing regulation and government oversight
2. Our dilapidated infrastructure
3. Conservation and efficiency
4. Focus on recycling and re-use
5. Better measurement and monitoring
6. Technological solutions
7. Residential water consumption
8. A surge of investment in the industry

One of the amazing item on the report is that it shows the high returns of US water utilities compared to major indices like DJIA, S&P500 and Nasdaq, achieving 104.4% returns over 5 year period and 383.06% returns over 10 year period. See the picture below.
US Water Utilities Outperform
In the report, it claims “a striking and very illustrative fact is that in any randomly examined 5-year period in the last 25 years (1982-87, 1993-98, 1979-84, etc), water utilities topped the list of the best performing industry groups in the US stock market on a total return basis. Why? The simple answer again is that water utilities have always done very well in good times and bad.” Now, if only I could get the latest data to 2009 (since the data above was until 2006 at near the height of the bubble)…

I’m trying to reconcile two facts here: on one hand, these utilities are cash-rich and gives out dividends regularly, and on the other hand, water is underpriced and underinvested as well as it costs a lot to maintain and upgrade the dilapidating infrastructure. So where’s the money coming from and why the extremely high returns?

Nevertheless, with the water crisis looming, there are unique attributes specific to water investing, as described in the report:
1. There is no substitute for water and users cannot postpone purchases; price-inelastic demand
2. Conveyance and resource assets create a natural monopoly with huge barriers to entry
3. Demand is unaffected by inflation, recession, interest rates, changing preferences, or inventory loss
4. A history of strong and consistent growth under all market or economic conditions
5. Price of water does not yet reflect real economic value: huge room/need exists for asset price expansion