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‘Undervalued, underappreciated and ignored’: why investors are lagging behind on water and how it is changing

RI looks at how investors are stepping up to protect the vital resource

Thomas Schumann has been working in the water risk space for 10 years and, for him “water net zero is just as important as carbon”. However, he feels it is generally “undervalued, underappreciated, ignored” by investors.

“It hasn't to date been properly promoted as a responsible and impact investment case. There needs to be more attractive and performing responsible investing products out there, more transformative investment opportunities.” 

The manager of Thomas Schumann Capital’s call to action is not unfounded. Every year since 2012 water has appeared in the top five risks in the World Economic Forum’s Global Risks Report. Within the next decade demand is expected to exceed supply by 56%.

For investors, this will – if not already – have significant financially material impacts across their portfolios. For instance, water stress could lead to corporations facing supply chain disruptions and increased operating costs. The links between water and climate change are increasingly being addressed by investors, too. Andre Bertolotti, Head of Sustainable Portfolio Strategies, Blackrock Sustainable Investing, says: “Water stress is like a canary in the coal mine […] it is alerting us that the impacts of climate change are visible now.”

“We have a clear framework for carbon prices, but we don't have the same for the price of water”

Regulators are also set to step up. For example, a recent European Central Bank report included water stress among the physical climate risks it may require financial institutions to manage and disclose. 

“Investors exposed to companies who are reliant on the current regulatory practice and don't have a plan for what may happen should that change, present a very significant risk to the orderly transition and their company value,” says Mary Delahunty, Head of Impact at HESTA.

Despite the evident risks, water has received much less investor attention than, for example, climate. Piet Klop, Head of Responsible Investment, PGGM, recently said he is “concerned by ignorance amongst investors on the importance of addressing water risk”.

So what’s holding investors back from addressing water and investing to protect the valuable resource? To alter an often quoted phrase, “you can’t manage what you can’t value”, the ability to quantify a price of the resource is a fundamental hurdle. 

“We have a clear framework for carbon prices, but we don't have the same for the price of water,” says Francesco Curto, Global Head of Research at DWS Group. Targets like the 1.5 degree scenario for climate are also needed so investors have a “north star” explains Kirsten James, Ceres’ Programme Director for Water. 

The difficulty in valuing water can explain why some investor reception to the first water futures index, which tracks the price of water rights leases and sales transactions in five Californian regions and launched in December on the Chicago Mercantile Exchange, was lukewarm. In a note Jade Huang, Portfolio Manager at Calvert Research and Management, wrote: “We remain cautious with such types of financial instruments and its implications because it only reflects a small fraction of the true value of water. Global water challenges involve many environmental and social issues across spatial and temporal scales, with significant regional differences, and are much broader and more complicated than just water scarcity.”

For Schumann, investors must learn to be water stewards as opposed to water investors. “Water was always portrayed and narrated in a context of commodities, but water cannot be compared to these, water is a precious resource.” 

“What we have out there are water indices and funds that portray themselves as clean water investment opportunities, but they really only invest in a subset of equities which are companies that are involved in water utilities, water technology, waste management. Although these are important in the global water industry, they don't drive any transformative investment.” 

Some investors are starting to broaden out their investments beyond these types of companies. Huang said in a note that while it invests in water utilities, infrastructure and technology companies that serve on the supply side, it also invests in “companies in water-intensive industries that are leading in their water stewardship and water efficiency. Each of these companies is part of the solution to global water issues.”

Another investor barrier is that water needs to be looked at on a facility by facility basis. However, “while it is a very local issue there are certain industrial practices that are prevalent globally, and there are impacts that are systemic in nature,” says James.

Delahunty echoes this: “We think about it as a systemic risk through the lens of a universal owner. When you agree with the premise that there is a systemic risk, then there is really no way to mitigate that risk away by simply excluding things from the portfolio. In fact, even if you don't have exposure in the portfolio, the broader economy does, and you're invested in the economy.”

Investors also need to understand double materiality related to water. For Curto, corporate reporting is “all about scarcity of water and how it may impact the financial return of investors. While this is important, there is not so much attention on the inside out approach – how do a company’s operations impact water.”

“Water is life, water is biodiversity, and most importantly it's number one responsible investment opportunity”

There are signs that investors are trying to improve the way they analyse and tackle water risk. At the end of last year DWS Research Institute published an article detailing the need for a “transformational framework for water risk” for investors. 

Within this, it called on investors to have portfolio companies sign a Water Charter on their exposures and measures to act on water risk. “If companies have a clear set of principles and guidelines to follow then we have a good chance of addressing the more extreme water challenges that lie ahead. This will mean companies start to think about water as a scarce resource, provide information on it, and move towards a more sustainable framework. It may sound like utopia, but our very survival will most likely depend on it”, explains Curto.

Moving forward with the framework, Curto explains it is focusing on refining the areas where it can have an impact. The next stage will also involve collaborating with a range of stakeholders to find solutions for addressing water risks. Ultimately, the objective is to “become a reference point for understanding how our investments impact water issues and improve it in our investments”. 

BlackRock is also broadening its analytical toolset, via Aladdin Climate, to address climate change, and within this water stress, across all sectors of the global economy. They have launched the first component covering collateralized mortgage backed securities, residential mortgage backed, municipal bonds, and REITs – the latter was the subject of its Troubled Water Report  on water risks last year.  

BlackRock hopes later this year to include the granular analysis of companies in its analytics. “This is a bigger challenge given the need to locate all the operating locations of companies,” says Bertolotti.

Taking the engagement approach is the Valuing Water Finance Task Force, launched by Ceres last year in partnership with the Dutch Government and investors, including, the New York State Common Retirement Fund, CalSTRS, AP7, SEB, the Government Employees Pension Fund of South Africa, and the UK Local Authority Pension Fund Forum. 

James says the project aims to launch their corporate expectations – “so investors can all be singing from the same hymn sheet” – next year. Alongside this, the coalition hopes to also launch next year an engagement initiative akin to a Climate Action 100+ for water. Other investor networks, including, FAIRR, PRI, and the Dutch Engagement Network have run or are running water focused programmes.

 Looking ahead, Delahunty says the water conversation needs to go beyond focusing on agriculture and industrial sectors. “We must be aware of the way in which water risk aligns with health objectives, similar to the way in which health objectives align with economic objectives.”

Towards the end of our conversation, Schumann muses: “Humans are just by nature ignorant, unless you don't have any water or air, you don't realise the value of it. We cannot afford that any longer, water is life, water is biodiversity, and most importantly it's number one responsible investment opportunity.”