june 2024
Testing the water
While data is still limited, fund managers’ engagement on water risk is evolving
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Can water scarcity be quenched? BNP Paribas Asset Management
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Water is a basic human right and of systemic importance to the planet and the economy, and the investment industry is embracing this. A notable number of funds have launched that invest specifically in water companies or where businesses are dedicated to improving water quality and scarcity. On wider sustainable products, water and waste are often a top theme to be prioritised over the next few years. In our first digital magazine under the PA Future brand, we have focused on water. We explore the investment industry’s evolving engagement in our cover feature, the trajectory of blue bonds in the video interview with Nuveen and Square Mile shares water fund picks. LGIM discusses the desalination market and we also delve into an OECD report on the blue economy. Finally, there is commentary from LGT Wealth Management, giving the fund selector’s view on this topic, and EdenTree examines how partnerships are improving water quality. We hope you enjoy this issue. Please send any thoughts or feedback to natalie.kenway@markallengroup.com
Spotlight
COVER feature
Water quality and scarcity is finally getting much-needed coverage. After all, water is a basic human right and yet still out of reach for billions of people. And while data is still limited, fund managers’ engagement on water risk is evolving. Natalie Kenway reports
Also in this issue ...
Continued investor engagement is vital in keeping pressure on the water companies to clean up our rivers, says Carlota Esguevillas
Turning the tide on water quality
Achieving a closed water cycle promises unlimited volumes of freshwater, but investment is required to recognise its full potential, writes LGT’s Phoebe Stone
Stress relief
Holly Downes speaks to LGIM’s Rob Martin about the importance of investing in the desalination market in helping increase water security in all regions
From sea to tap
ED’s letter
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Natalie Kenway Contributing editor, PA Future
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Q&A
Natalie Kenway speaks to Steve Liberatore, lead portfolio manager for Nuveen’s fixed-income strategies that incorporate ESG and impact criteria, about the landscape and outlook for blue bonds, as well as targeted engagement conversations with issuers
Blue bond trajectory
video interview
The sustainable segment of the global equity market continues to outshine its traditional counterparts. Louis Selby, Investment research analyst at Square Mile Investment Consulting and Research, shares products with water exposure that are making an impact
A bigger splash
sector review
BNP Paribas Asset Managment asks, why is this vital resource not being managed effectively?
Can water scarcity be quenched?
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The blue economy could reach $3trn by 2030 but what are the risks fund managers need to consider as they allocate much-needed capital to this asset class?
Blue economy barriers
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While data is still limited, fund managers’ engagement on water risk is evolving. Natalie Kenway reports
Water has been making headlines. Whether it’s the cancellation of test events for water sports at the upcoming Paris Olympics or an outbreak of cryptosporidium cases in the southwest of the UK, water quality and water scarcity is getting much-needed coverage. After all, water is a basic human right that is still out of reach for billions of people. The United Nations reports 2.2 billion people lacked safely managed drinking water in 2022, while 3.5 billion people lacked safely managed sanitation, as part of its research on progress towards Sustainable Development Goal (SDG) 6 – to ‘ensure availability and sustainable management of water and sanitation for all’. Meanwhile, global water utilities generate a sizeable amount of greenhouse gas emissions with wastewater treatment accounting for much of this – which is why it is key to engage with companies on this for the net-zero transition, highlights Barney Timson, assistant investment analyst at Castlefield. Fund managers of sustainable products are making progress on this and have been assessing water risks, as they understand it is an increasingly financial material issue for businesses. Furthermore, investors are becoming more focused on water – at a recent Greenbank Investor Day, a poll of attendees found global concerns centred around water impacts related to climate change, such as flooding, rising sea levels and rising water temperatures, followed by water-related conflict and geopolitical risk. Some 31% said sewage released into waterways was the most concerning water issue facing the UK, followed by loss of habitats and impact on land, water and marine biodiversity (28%). As a result, engagement in this area is evolving. “Generally, many companies are still early in their journey on managing and reporting on water risk, but there are companies that have invested significant thought and effort into their policies and procedures,” says Olivia Gull, responsible investment and governance analyst at Janus Henderson. Véronique Chapplow, investment specialist focused on ESG capabilities in the equity division at T Rowe Price, highlights, however, that water risks are often under-appreciated and inadequately priced in, and as we routinely hear on climate change issues, efforts need to pick up pace. “So far, companies have taken a reactive rather than a proactive approach to managing costs related to water impact, which may need to change as a higher frequency of extreme weather events and increasing regulatory scrutiny bring more water-related risks under the spotlight. In addition, corporate water stewardship has traditionally been narrowly focused on mitigating water risks to direct operations. “However, for many industries, water risks lie upstream in the supply chain or downstream during the use of end products. Recognising that water dependencies and impact can occur anywhere across a value chain, water stewardship activities and materiality frameworks are evolving into more comprehensive and contextualised strategies that are inclusive of upstream (primarily) and downstream business activities and locations.”
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Companies have taken a reactive approach to water impact, which may need to change’
Véronique Chapplow, investment specialist, T Rowe Price
Source United Nations
Sector nuances Of course, with companies at varying stages when it comes to thinking about water risk, engagement with companies can differ quite significantly, especially when taking into consideration the differences in exposure across sectors. “For example, when engaging with brewery and spirits companies, the discussion is quite advanced as there is good disclosure and data, reflecting the longstanding recognition that water is critical to continued business growth,” says Janus Henderson’s Gull. “Engagements here focused on how companies are working with their agriculture supply chain (managing their vast ‘Scope 3 water footprint’), trialling more climate-resilient crops and managing flexible procurement strategies to pivot if certain suppliers are hit by a drought.” She adds the mining sector is also quite advanced in how it thinks about water risk, and is a sector the team has been engaging with. “The demand for metals needed to drive the energy transition is dramatically increasing, and therefore so is the amount of water needed to process them. The added issue is that, for various geological reasons, ore deposits are concentrated in areas of high water stress. “For this reason we have been engaging with this sector, which is the second-most water-intensive industry after utilities, on how they are thinking about water efficiency, recycling and feasibility of solutions such as desalination plants.” Despite fund managers needing to consider the nuances of different sectors when engaging on water, the engagement process tends to follow the same principles as the rest of a company’s engagement, and they are not afraid to escalate engagement if the conversations so far have not created change. “When we find that water management is an area of financial concern in a portfolio, we make these concerns known to the management of the company exposed,” says T Rowe Price’s Chapplow. “Most of our water engagements take the form of a constructive dialogue at company level, to provide our view on best practices with regards to water management. Water risk is inherently location specific and requires an extensive knowledge of a company’s specific exposure to areas with water stress. “When a company does not deliver on our expectations, we may decide to escalate the water-related engagement. On these occasions, we request an in-depth exchange with a company management or the board. The objective is to share our perspective about what we view as a significant impediment to our ability to meet our investment goals and to explore ways to work constructively with the issuer to address the concern.” Encouraging disclosure One of the main barriers to analysing water risk is data but fund managers expect this to be tackled as companies increasingly adopt the Taskforce for Nature-related Financial Disclosures, of which two are required indicators for water: withdrawal and consumption from areas of high-water scarcity and wastewater discharged. “Disclosure is an engagement priority as companies do not currently report consistent water data,” says Chapplow. Companies are also being encouraged to disclose to the Carbon Disclosure Project (CDP)’s Water Survey. “This is the first step to understanding how companies are managing water relative to industry peers,” explains Gull, while Castlefield’s Timson adds: “We predominantly engage companies on the topic of water through CDP. We find this really helpful as investors because greater data availability allows us to have more informed conversations with our investee companies and means we can ask better questions. “Disclosing is beneficial for companies because it allows them to identify any potential risks across the business, such as operating in areas of water scarcity or areas of increased physical risk through flooding. This data can be tracked over a period of years and compared more easily against competitors.” Economic activity It is clear engagement on water risks is gaining momentum and not just focused on the main issues we see in the headlines. Water is essential for the production of food and for sanitation, but is also extensively used in all forms of economic activity such as industrial manufacturing, textile, energy production and materials extraction. “A simple way of thinking about it is – there is no economy without water,” states Saurabh Sharma, manager of Regnan’s Sustainable Water and Waste fund. Water’s systemic importance should be embedded into investment processes and engagement priorities – it is pleasing to see the investment industry is making progress.
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A simple way of thinking about it is – there is no economy without water’
Saurabh Sharma, fund manager, Regnan
Water is a basic human right but still out of reach for billions of people
In 2022, 2.2 billion people lacked safely managed drinking water
Safely managed sanitation is unavailable for 3.5 billion people
Click to read about Castlefield’s water engagement
“As part of the most recent Carbon Disclosure Project (CDP) campaign, we engaged with Spectris, a high-tech instruments and equipment provider, which had not previously submitted water security data to CDP. The campaign seeks to only engage companies on material themes, and following our engagement we were pleased to see Spectris had disclosed. This year, there are plans for us to once again be the lead investor for several of our investee companies on water. “Another case study from the recent past is Pennon. Following concerns regarding persistent environmental underperformance, we engaged with Pennon, a water utility company that owns South West Water. We believed their response and planned remedial action was not sufficient and, as a result, we made the decision to divest.” Barney Timson, assistant investment analyst, Castlefield
How Castlefield is leading on water engagement
Physical water risk, or the exposure to changes in water quantity (such as droughts or floods), will impact sectors that rely on physical assets, such as real estate and infrastructure. Other sectors like textiles, fashion, food, pharmaceuticals and semiconductors are more sensitive to water quality. Agriculture is very sensitive to water scarcity. Regulatory risk is not always intuitive and there is not always a link between regulatory and physical water risk. For example, the semiconductor sector typically enjoys favorable regulatory tailwinds when it comes to water access. Many of the world’s largest semiconductor plants are located in water-stressed regions. Finally, reputational risk, often illustrated by community backlash, can have material impacts on corporate operational risks. Source: T Rowe Price
Different types of water risk
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So far, companies have taken a reactive approach to water impact, which may need to change’
Fund managers of sustainable products are making progress on this and have been assessing water risks, as they understand it is an increasingly financial material issue for businesses. Furthermore, investors are becoming more focused on water – at a recent Greenbank Investor Day, a poll of attendees found global concerns centred around water impacts related to climate change, such as flooding, rising sea levels and rising water temperatures, followed by water-related conflict and geopolitical risk. Some 31% said sewage released into waterways was the most concerning water issue facing the UK, followed by loss of habitats and impact on land, water and marine biodiversity (28%). As a result, engagement in this area is evolving. “Generally, many companies are still early in their journey on managing and reporting on water risk, but there are companies that have invested significant thought and effort into their policies and procedures,” says Olivia Gull, responsible investment and governance analyst at Janus Henderson. Véronique Chapplow, investment specialist focused on ESG capabilities in the equity division at T Rowe Price, highlights, however, that water risks are often under-appreciated and inadequately priced in, and as we routinely hear on climate change issues, efforts need to pick up pace. “So far, companies have taken a reactive rather than a proactive approach to managing costs related to water impact, which may need to change as a higher frequency of extreme weather events and increasing regulatory scrutiny bring more water-related risks under the spotlight. In addition, corporate water stewardship has traditionally been narrowly focused on mitigating water risks to direct operations. “However, for many industries, water risks lie upstream in the supply chain or downstream during the use of end products. Recognising that water dependencies and impact can occur anywhere across a value chain, water stewardship activities and materiality frameworks are evolving into more comprehensive and contextualised strategies that are inclusive of upstream (primarily) and downstream business activities and locations.”
“When a company does not deliver on our expectations, we may decide to escalate the water-related engagement. On these occasions, we request an in-depth exchange with a company management or the board. The objective is to share our perspective about what we view as a significant impediment to our ability to meet our investment goals and to explore ways to work constructively with the issuer to address the concern.” Encouraging disclosure One of the main barriers to analysing water risk is data but fund managers expect this to be tackled as companies increasingly adopt the Taskforce for Nature-related Financial Disclosures, of which two are required indicators for water: withdrawal and consumption from areas of high-water scarcity and wastewater discharged. “Disclosure is an engagement priority as companies do not currently report consistent water data,” says Chapplow. Companies are also being encouraged to disclose to the Carbon Disclosure Project (CDP)’s Water Survey. “This is the first step to understanding how companies are managing water relative to industry peers,” explains Gull, while Castlefield’s Timson adds: “We predominantly engage companies on the topic of water through CDP. We find this really helpful as investors because greater data availability allows us to have more informed conversations with our investee companies and means we can ask better questions. “Disclosing is beneficial for companies because it allows them to identify any potential risks across the business, such as operating in areas of water scarcity or areas of increased physical risk through flooding. This data can be tracked over a period of years and compared more easily against competitors.” Economic activity It is clear engagement on water risks is gaining momentum and not just focused on the main issues we see in the headlines. Water is essential for the production of food and for sanitation, but is also extensively used in all forms of economic activity such as industrial manufacturing, textile, energy production and materials extraction. “A simple way of thinking about it is – there is no economy without water,” states Saurabh Sharma, manager of Regnan’s Sustainable Water and Waste fund. Water’s systemic importance should be embedded into investment processes and engagement priorities – it is pleasing to see the investment industry is making progress.
Investing in blue bonds exposed to projects such as marine-based, coral reef restoration and waste water treatment can impact many different parts of the economy. In this video interview, Natalie Kenway speaks to Steve Liberatore, lead portfolio manager for Nuveen’s fixed-income strategies that incorporate ESG and impact criteria, about the landscape and outlook for blue bonds, as well as targeted engagement conversations with issuers.
In this video interview, Natalie Kenway speaks to Steve Libatore, lead portfolio manager for Nuveen’s fixed-income strategies that incorporate ESG and impact criteria, about the landscape and outlook for blue bonds, as well as targeted engagement conversations with issuers
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The sustainable segment of the global equity market continues to outshine its traditional counterparts. Square Mile’s Louis Selby shares some products with water exposure that are making an impact
Last year was a testing time for global equity funds. Against the backdrop of geopolitical uncertainty driven in part by the ongoing Russian full-scale invasion of Ukraine and the situation in Gaza, global markets have been affected by both political and economic uncertainty. In addition to geopolitical factors, global equity fund managers have also had to battle against lower-cost passive funds in an environment that has provided strong tailwinds for large-cap indices. The buoyancy of the ‘magnificent seven’, which contributed to around 20% of the MSCI World index performance at the end of the calendar year, has driven this. Additionally, high inflation and subsequent high global interest rates have also contributed to this challenging market over the past 12 months, with growth-oriented companies facing difficulties in purchasing materials and expanding their operations in line with investor expectations. Nevertheless, there is light at the end of the tunnel for a specific subsection of the market. As reported in Morgan Stanley’s Sustainable Reality report, produced by its Institute for Sustainable Investing, sustainable funds have outperformed their traditional competitors within every asset class over 2023. In fact, for equities, sustainable funds achieved a median performance of 16.7% over 2023, whereas traditional equities achieved a median performance of 14.4% over the same period. Delving further, we can see the funds with the highest level of social and environmental impact have struggled to match the rest of the sustainable market’s performance. This is due in part to their tendency to be exposed to a higher level of mid- and small-cap growth-oriented companies that have underperformed when compared with larger companies. Yet, while relative outperformance is still a critical objective of many global equity impact funds, we argue that investors in these strategies are, in general, stipulating the manager generates positive environmental and/or social impact as a primary objective. In the following three examples, we have chosen three global equity funds from the Square Mile’s Academy of Funds that have significant exposure to water. These funds should not only offer the potential for good financial performance but, more importantly, generate material positive impact. Pictet Global Environmental Opportunities
Louis Selby Investment research analyst, Square Mile Investment Consulting and Research
Sustainable funds have outperformed their traditional competitors within every asset class over 2023’
Managed by Jason Goins, this global equity fund seeks to provide long-term returns (income and capital appreciation) while investing in companies that offer sustainable solutions to environmental and social challenges. More specifically, the manager targets investments in companies that improve access to and quality of basic life essentials, reduce inequality and mitigate the effects of climate change. To be included within the portfolio, the manager, in consultation with Wellington’s internal impact committee and ESG research team, will determine whether a prospective company aligns with its three impact criteria: materiality – whether the impact activity in question is central to the company; additionality – the impact case must fulfil unmet social and environmental needs that are unlikely to be addressed by other agents; and measurability – whether key performance indicators can be developed that will help the analysts and managers to understand the nature of the impact and to track progress over time. In keeping with the water theme, we have identified several companies that provide products and/or services that directly or indirectly improve the quality or efficiency of water resources. Again, Stantec, Veralto and Xylem have made an appearance in this portfolio. However, there are other additions, such as Aalberts, a Dutch company with multiple segments that offer a positive impact on a variety of environmental and/or social challenges. As per the Aalberts website, the company attributes about 16% of its revenue to safe water delivery, improving water quality and enabling the efficient use of water within buildings. Wheb Sustainability
Luciano Diana, Gabriel Micheli and Yi Du, the managers of the Pictet Global Environmental Opportunities fund, aim to outperform global equity markets over the long term through investing in businesses that contribute to alleviating nine environmental areas highlighted within a 2009 academic study called the Planetary Boundaries Framework. As part of the team’s environmental impact analysis, only companies that derive greater than 20% of their revenue from one of the following themes are considered eligible for investment: renewable energy; energy efficiency; dematerialised economy; sustainable agriculture and forestry; water supply and technologies; waste management and recycling; and pollution control. The managers are supported by an extensive Pictet outfit, which, alongside a dedicated impact, sustainability research and ESG operations team, also includes all investment professionals that manage 17 thematic strategies ranging from timber and health all the way to robotics and smart cities. These 17 strategies, of which the Global Environmental Opportunities fund is included, are able to leverage 13 thematic advisory boards, who each help to oversee and evolve the group’s environmental and/or social impact themes. A prominent theme within the portfolio is water and waste, which aligns well with the managers’ water supply and technologies environmental theme. This theme is represented in the portfolio by companies such as Xylem, a manufacturer and provider of services for the treatment of water and wastewater, and Stantec, a Canadian engineering company, which works across varied disciplines and industries to develop water and infrastructure projects. Another particularly interesting holding is Veralto, a newly formed US manufacturer of water technologies focused on improving and securing global water quality across industrial and municipal environments. Wellington Global Impact
Wheb Asset Management continues to be at the forefront of impact investing within the global equities space, and its flagship product, Wheb Sustainability, embodies all that the group believes. With nine core sustainability themes, of which water management is one, manager Ted Franks says companies that derive greater than 50% of their revenue from one of their nine themes will ultimately enjoy structural growth and will see relative resilient profitability. While 2023 was a challenging year for the Wheb Sustainability fund due to the portfolio’s mid-cap bias and positive impact mandate limiting exposure to the ‘magnificent seven’, the core sustainable objective of the team continues to be achieved. Under Square Mile’s proprietary 3D assessment, Wheb achieved an impressive 96% portfolio alignment to impact companies in its February 2024 review. One theme consistent throughout the portfolio was positive impact on water resources, either through water and waste services or technologies enabling efficient use of water within industrial processes. Spirax-Sarco Engineering, for example, is a British engineering company that specialises in the use of steam within a variety of sectors, such as food processing, drug manufacturing or beer making. Steam is a versatile source of energy, and for Spirax-Sarco, its systems can be used to cut emissions, energy waste and water use, along with reducing costs and increasing output in each of the targeted sectors. Another company contributing to the fund’s impressive exposure to the theme of water management is Ecolab, a US company that provides services within the fields of water, hygiene and energy. The company is incredibly diverse, and its positive impact on water is far-reaching. However, some specific examples include legionella control, wastewater treatment, corrosion and scale control within pipes and equipment.
Performance in 2023: fund 13.9%; sector 12.5%. Source: Refinitiv Lipper
Performance in 2023: fund 6.9%; sector 12.5%. Source: Refinitiv Lipper
Performance in 2023: fund 4%; sector 12.5%. Source: Refinitiv Lipper
Achieving a closed water cycle promises unlimited volumes of freshwater, but investment is required to recognise its full potential
There is projected to be a 40% gap between water consumption and supply by 2030. Today as a society, we consume more freshwater than is available. At current consumption rates, by 2025 two-thirds of the world’s population will face water shortages, according to Unicef. This trajectory risks displacing large populations, affecting livelihoods and adding to environmental stress. However, we also know the Earth has sufficient water supplies, so long as they are used sensibly and reused or recycled. The global water challenge Access to clean water is one of the most pressing challenges we face. Water scarcity, flooding and inadequate water management impedes social and economic development. Over the past 25 years, the amount of fresh water available worldwide has fallen due to pollution, climate change, increased urbanisation, poor water infrastructure and overuse. At the same time, the demand for water is increasing at an unprecedented rate. There is sufficient fresh water on the planet for everyone to have access to clean and accessible water and yet the reality for millions of people across the globe is water scarcity, poor water quality and inadequate sanitation. Since 1990, 2.1 billion people have gained access to improved water sanitation, according to the United Nations. However, it is projected that by 2050, at least one in four people will be affected by recurring water shortages. Wastewater and seawater have long been considered potential sources of freshwater, with emerging technologies aimed at facilitating reuse and recycling. Humanity is polluting water faster than nature can recycle and purify rivers and lakes. Achieving a closed water cycle promises unlimited volumes of freshwater, but investment is required to recognise its full potential. Investment in water purification technology is essential to ensure access across the developing and developed regions.
Phoebe Stone Partner and head of sustainable investing, LGT Wealth Management
Humanity is polluting water faster than nature can recycle and purify rivers and lakes’
Investing in water sustainability Within our sustainable data tool, we assess water consumption and water usage, as well as the water stress levels in which the company operates. This analysis helps to build a picture of the water stress exposure and the risk management for the underlying businesses. Water stress exposure refers to the ability, or lack thereof, to meet demand for fresh water, including both the access to physical water supplies and the quality of the water available. We also evaluate water risk, meaning the possibility of an entity experiencing a water-related challenge such as droughts and flooding, and the company’s own management of water supplies through water risk management practices. The materials (including metals and mining), utilities and energy sectors are the top three most water intensive sectors, meaning they are most likely to face above-average water availability challenges. Countries currently experiencing the highest level of water stress, and those predicted to do so by 2050, include north African countries such as Egypt, the Middle East and some Asian countries, such as India and Pakistan. Water risk data points are integrated into our in-house sustainability rating tool to evaluate the sustainability profile of investee companies. Additionally, within the sustainable portfolios we manage for our clients, we seek to invest in solutions for water treatment and purification to address water scarcity and improve development standards. As water stress is an issue that is likely to increasingly impact companies and countries globally, the role of these businesses will become more critical.
40%
2/3
Projected gap between water consumption and supply by 2030 Source: Unicef
Share of world’s population that will face water shortages by 2025 Source: Unicef
Louis Selby, investment research analyst, Square Mile Investment Consulting and Research
Holly Downes speaks to LGIM’s Rob Martin about the rapidly growing desalination market
Investors must recognise the importance of investing in the desalination market in helping increase water security in all regions, according to Rob Martin, global head, investment strategy and research at Legal & General Investment Management (LGIM). Figures from the National Institute of Health suggest around four billion people – or 66% of the global population – live in areas affected by severe water scarcity for at least one month of the year. Further, the Global Commission on the Economics of Water predicts that by 2030 global freshwater demand will outstrip supply by 40%, as 700 million people – of which 250 million are in Africa alone – could be displaced due to water scarcity. The sustainable investment community is increasingly aware of water scarcity risk and, as a result, investments in desalination solutions – which turn abundant saltwater into usable fresh water – are gaining traction. How has the desalination market evolved recently? Where are you finding opportunities? The industry has grown quite rapidly. From 2010 to 2019, the amount of capacity has grown by 7% per year, according to Global Water Intelligence. We estimate this growth will accelerate up to around 10% a year, partly because of climate change and the need to reinforce water supply chains. However, to fund this growth, a material capital requirement is needed. We’ve seen some figures that suggest around $35bn (£28bn) could be needed to fund just four years of new desalination capacity. That is a very plausible number when we turn it into a material capital requirement. We’ll certainly see some opportunities to create assets in the developed markets in Europe, the US and Australasia. These opportunities will also appear in developing and emerging markets. The latter will suit investors with a slightly higher risk tolerance because those tend to cope with slightly more complexity around regulatory and political risks. Overall, there will be a spread of returns in this space. How can investing in desalination help transition to a greener economy? Global warming is going to intensify the water cycle and lead to an increase in the frequency of droughts and floods. We are going to see energy security risks more often. It is partly about building resilience to some of the impacts of climate change that are typically felt most severely in some of the less wealthy regions. As stress becomes more common, particularly in emerging economies, desalination plants help lessen the impacts of water scarcity in these regions. Where are the challenges when investing in desalination? The challenges are interconnected: one is the cost; the other is energy intensity. The newer desalination technology called ‘reverse osmosis’, a water purification process that uses a semi-permeable membrane to separate water molecules from other substances, is already four to five times more energy efficient – and eight to 10 times more energy intensive – than traditional water treatment technologies. This makes the technology more energy intensive and more costly. One of ways this challenge is being managed is by blending desalination plants with access to renewable energy. Solar and wind play a big part in this, and in cases where desalination capacity is needed, solar plays a key role. Areas that have this desalination capacity include the west coast of the US and Australia, and it is even more important in China and India where the demand for this capacity is expected to grow. Currently, a wide area of innovation in this space is how to blend intermittent energy sources with desalination, which is in continuous demand. Does desalination align with Sustainable Development Goals (SDGs)? Desalination plants align with SDG 6: Ensure availability and sustainable management of water and sanitation for all. There are two parts to this goal. The first is enabling access to water, and the second is ensuring that access to this water is broadly felt. There is still a significant proportion of the world’s population that doesn’t have access to clean water. The effects of climate change are going to get more severe, and it has wide wider ramifications. Another process is deglobalisation, where water deficits are being linked to an increase in migration and conflict. This is an aggravating factor that creates more geopolitical tension. Overall, the more we can do to create water security, the more you are helping lean against these processes.
As stress becomes more common, particularly in emerging economies, desalination plants help lessen the impacts of water scarcity in these regions’
Rob Martin, global head, investment strategy and research, Legal & General Investment Management
Click here to read Rob Martin’s biography
Rob Martin is global head of investment strategy and research for LGIM Real Assets. He leads the formation of market and thematic views, with an emphasis on long-term drivers including ESG, and supporting their integration into portfolio strategy. He is also responsible for performance assessment and analysis for real assets managed portfolios, driving the selection of objective reference points against which to assess investment performance and extracting value from performance data. Rob joined LGIM in October 2006 from Hammerson, where he held the role of head of research. Prior to that he was an economist with the CBI, and previously spent three years in a consultancy role in the oil and gas industry.
Click to read how LGIM’s Clean Water ETF gains exposure to desalination
The L&G Clean Water Ucits ETF has a greater focus on water technology and digital solution providers, which are expected to play a key role in shaping the future landscape of water and creating the solutions to manage water more efficiently. Our investment process combines active research and actively designed investment strategy, leveraging the expertise of third-party experts to obtain a starting universe across all size levels with a higher purity to the clean water theme. The ETF is comprised of a diverse range of companies engaged in water production, processing and provision of other related services, where the underlying stocks are selected through a fully transparent systematic approach that considers water-related revenues, sectors, specialisms and applications. Desalination is becoming more attractive as it becomes more cost-competitive, technology scales up and fresh water supply dwindles. Advanced desalination techniques such as rainwater harvesting, water reuse systems, smart water management tools and leak detection devices could increase the water supply, reduce water waste and improve efficiency. Further, the seawater and brackish water desalination markets continue to grow. Key markets are the Gulf Cooperation Council, including Saudi Arabia, the UAE, Kuwait and Qatar. Egypt is another growing market as it tries to reduce dependency on the Nile, and California and Texas for brackish and surface water desalination. Saudi Arabia is by far the market with the largest 2018 to 2027 capex. Overall, the desalination market is expected to grow at about a 10% CAGR. Aanand Venkatramanan is head of ETFs at LGIM
‘Desalination is more attractive as it becomes more cost-competitive, technology scales up and fresh water supply dwindles’
The blue economy could reach $3trn by 2030 but what are the risks fund managers need to consider as they allocate much-needed capital to this asset class? Michael Nelson reports
The blue economy – the value of products and services generated with and by our oceans and seas – is set to grow faster than the established economy by 2030, according to estimates from the Organisation for Economic Co-Operation and Development (OECD), and therefore investments into this area are increasingly becoming mainstream. Earlier this year, fund managers predicted a record year for issuance in fixed-income markets for bonds focused on ocean health and water security, while water has been flagged as a key theme for many equity portfolios, with funds solely investing in this area. Indeed, the OECD’s report – The Blue Economy in Cities and Regions – predicts the blue economy could reach $3trn (£2.36trn) by 2030 if barriers to development are addressed. As with any relatively immature asset class, experienced investors understand the opportunity of allocating to this area in its early development. But, and perhaps more pressingly for some, they also understand the urgency. The OECD report – based on the findings of a global survey of more than 80 cities, regions and basins – highlights the damaging effects of climate change on the blue economy and its impact on the cities and regions most exposed, as well as shedding light on the link between the blue economy and water security.
The blue economy is a major driver of urban and regional development, creating millions of local jobs in water-dependent sectors’
Source: OECD
Unlocking potential Despite the risks explored, investment trends indicate a positive outlook and a strong growth pattern for the blue economy – BlueInvest’s Unlocking the Potential of the Blue Economy report shows the sector reached more than €13bn over the five-year period between 2018-23 in the EU alone – up from €900m between 2000-12. With greater emphasis placed on policymaking, coherence and implementation from national and regional governments, as highlighted by the OECD, investors can unlock the benefits derived from conserving biodiversity and ecosystems in a sector where, in the EU, a 10km coastal zone is estimated to generate €400bn worth of services annually.
Climate-related threats From fisheries to shipping and tourism, the report notes the blue economy is a major driver of urban and regional development, creating millions of local jobs in water-dependent sectors. For example, one in nine jobs in California are linked to port-related activities. However, it can also contribute to carbon emissions and ecosystem degradation, while its reliance on freshwater, coastal and marine ecosystems expose it to climate change impacts. Based on survey responses, the most significant climate-related threats to blue economy activities include sea level rise (54%), flooding (41%) and coastal erosion (35%). The DWS Concept ESG Blue Economy fund opened in 2021, and currently holds €300m (£257m) in assets under management. Paul Buchwitz, portfolio manager and analyst for sustainable equities at DWS, says many of the threats identified in the report – particularly the acidification of the ocean, ocean warming and coastal resilience – are at the forefront of minds when it comes to portfolio construction. “In general, we invest in companies that, among other things, offer products and services that address those issues. So, companies in the offshore wind value chain, and engineering companies and geodata companies with a focus on nature-based solutions,” Buchwitz says. “We also invest in companies with a direct link to the blue economy and a potential negative impact on the health of the ocean, engaging with them on climate-related topics like SBTi (Science-based Targets initiative) verification.” Assessment framework Speaking at the UN Ocean Decade Conference in Barcelona in April, Aziza Akhmouch, head of cities at the OECD, stressed the underexplored potential of cities and regions in the blue economy, emphasising “while cities and regions contribute to 69% of significant climate-related public investment in OECD countries, the survey shows less than 10% of respondents have a subnational blue economy strategy”. Further, the report findings showed the primary barrier hindering effective blue economy policies is the lack of financial resources (83%), followed by insufficient data collection and sharing, along with fragmented roles and responsibilities in policymaking (both at 69%). To address this, the OECD has set out an assessment framework designed as a tool for governments to self-evaluate their progress toward a blue economy that is resilient, inclusive, sustainable and circular. The framework is divided into three parts: first, helping local and regional governments with their self-evaluation; second, gauging the level of implementation of the enabling conditions; and third, providing a ‘whole of water’ checklist to local and regional governments that wish to embed water security into their blue economies. Unstable markets For Bryn Jones, head of fixed income at Rathbones, a tailored approach to dealing with blue economy risks can help promote a just transition. However, Jones points out investors need protection, citing a recent scandal involving a debt-for-ocean deal in Gabon. “A Gabon blue bond was issued, and the structure was quite complicated because the idea was that 50% of the proceeds would be used for the blue economy, and the other 50% would be used to refinance the existing government debt. However, one of the major problems with the blue economy is the countries that need that investment are often in emerging markets and regions without a strong financial market or with a lack of stability. “With the Gabon bond, we couldn’t get involved because of the levels of corruption in the country – the same family had run the country since the 1960s and, in fact, the president and his son were arrested only a few weeks after the bond was issued. That’s just one case, but it highlights it can be quite tricky to find the areas that need it most, and also offer some protection for investors. But we are keen to continue to look for the right opportunities.”
Main threats to the blue economy across survey respondents
The value of the ocean economy and related ecosystems
Ocean-based industries $1.5trn/y in global economic value (eg capture fisheries, shipping)
Coastal ecosystems $20.4trn/y in global economic value (eg mangroves, coral reefs, salt marshes)
Inland ecosystems $27trn/y in global economic value (eg rivers, lakes, peatlands, swamps)
Marine ecosystems $27.8trn/y in global economic value (open ocean and continental shelf)
Continued investor engagement is vital in keeping pressure on the water companies to clean up our rivers
For many years now, UK water companies have been under fire for their environmental performance. Much of this is justified – indeed, the Environment Agency’s periodic review into the state of English waters has found just 14% meet ‘good ecological status’, a figure that has not changed since 2009. It is clear the sector needs to evolve. However, there are also reasons to be optimistic about the future of this critical piece of the UK’s infrastructure, and the role investors can play in accelerating change. Partnerships for change It goes without saying the water sector is complex. Water companies face a multitude of challenges that can vary depending on population served, geographical terrain and water scarcity in the region. Like other industries, there is a variance in how companies perform and it is clear some have fallen short due to poor management, historical underinvestment and poor environmental performance. Our engagement with a significant cross section of the industry, however, has revealed a passion for improvement in some areas and instances of good practice that are having an impact. Partnerships with a wide range of interested stakeholders are bearing fruit, and we are seeing signs of improvement from the sector leaders – who are investing more in infrastructure upgrades, technological advancements such as artificial intelligence and nature-based solutions. Continued investor engagement can, and will, accelerate this momentum. However, its important to recognise the industry operates within a regulatory environment that also requires change. The current system, overseen by Ofwat and the Environment Agency, has historically rewarded leading companies while penalising laggards, further widening the gap between best and worst performers. Additionally, budget cuts to the Environment Agency raise concerns about its ability to provide adequate monitoring. Addressing these challenges is key to turning around the performance of the sector. Now is the time to act Our ongoing engagement focuses on driving best practices at water utilities, advocating for investment in infrastructure upgrades and, importantly, engaging with regulators to explore whether the current framework is fit for purpose. Investors have a role to play here in navigating public policy to inform and engage the regulator, the Environment Agency and, of course, water utilities – and this will be a key focus for us in 2024. We are also expanding our engagement to include upstream players whose activities impact water utilities, in recognition of the need to take a holistic view. For example, the chemical sector, whose water usage and ‘forever chemicals’ pose environmental threats, as well as the pharmaceutical sector on antimicrobial resistance. As the next five-year regulatory period approaches, now is the time to recalibrate the investment needed to improve the health of our rivers. Now is the time to act, and investors have a role in pushing for the highest possible level of ambition.
Carlota Esguevillas Head of responsible investment, EdenTree Investment Management
Our engagement with a cross section of the industry has revealed a passion for improvement and instances of good practice are having an impact’
Phoebe Stone, partner and head of sustainable investing, LGT Wealth Management
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Water is the lifeblood of the world, so why is this vital resource not being managed effectively?
Investing across the water value chain In the context of expanding water demand, limited supply and tightening regulations, opportunities for investors can be found across the water value chain. Yet, among the companies that operate water treatment and supply infrastructure, providing clean water, wastewater and sewerage services it pays to be selective. Given the increased regulatory and public scrutiny on the sector, it will be the utility companies demonstrating progressive water stewardship that will face lower regulatory risks in the form of potential fines or loss of social licence to operate and, therefore, present the most compelling investment options. From an infrastructure perspective, the companies supplying the products and services integral to the end-to-end infrastructure in industrial, residential and commercial applications should see demand increase. This ranges from companies that make or distribute network equipment products like specialised pipes, pumps and valves that assist in water transmission, to the providers of groundwater assessments for flood defence planning. Treating water to make it fit for human consumption or refined industrial processes is also a field that is experiencing expansion, involving a breadth of companies that design, manufacture and install technologies or facilities for the treatment, separation and purification of water. Technology to solve water-related challenges And then there are the solutions of tomorrow. Innovative technologies promise to play a critical role in helping address water-related challenges, creating new markets and tapping into structural demand growth. Data and software solutions promise to improve the sophistication of water system management and modelling. ‘Smart irrigation’ techniques have been shown to vastly reduce water consumption in the water-intensive agricultural sector. In addition, nascent technologies are enhancing the reuse and recycling of water in industrial processes to help reduce the costs and operational risks for industries central to the modern economy. It would be surprising to many that semiconductor manufacturing is an area that is driving investment in wastewater treatment and reuse. The industry uses an estimated 1.2m megalitres of water every year,7 much of which is the ultra-pure water needed in the chipmaking process. As well as constructing water recycling plants next to new semiconductor fabrication plants, innovative technologies are being introduced that enable treated wastewater to be used as feedwater for the ultra-pure water systems. Emerging solutions are also improving water treatment processes and the measurement of water quality, including detecting contaminants, such as microplastics. Governments and regulators are paying particular attention to per- and polyfluoroalkyl substances (PFAS), known as forever chemicals, as these have been shown to pose systemic risks to biodiversity and human health. While regulation is restricting their future use, the need to detect forever chemicals, remove them from treated water and safely dispose of them is creating opportunities for companies offering effective products and services, and confronting the issue has been estimated to involve more than $250bn in spending globally.8 Investing in a more sustainable water supply Addressing the unsustainable supply/demand dynamics of the world’s water supply is set to reshape the water value chain in the coming decades and represents an opportunity for investors to realise returns while also helping to address the water challenges faced in society. At BNP Paribas Asset Management, the team behind our Aqua strategy has considerable expertise and experience in this sector, having started to invest in water-related industries over 20 years ago. Their deep understanding of the global industry and its technologies sets them apart, enabling them to carefully build a high-quality portfolio of stocks that is well balanced between economically resilient businesses and firms that are more growth-oriented. As the water industry rapidly evolves and expands, our Aqua strategy seeks to tap into this source of potential growth.
Disclaimer BNP PARIBAS ASSET MANAGEMENT UK Limited, “the investment company”, is authorised and regulated by the Financial Conduct Authority. Registered in England No: 02474627, registered office: 5 Aldermanbury Square, London, England, EC2V 7BP, United Kingdom. This material is issued and has been prepared by the investment company. This material is produced for information purposes only and does not constitute: 1. an offer to buy nor a solicitation to sell, nor shall it form the basis of or be relied upon in connection with any contract or commitment whatsoever or 2. investment advice. Opinions included in this material constitute the judgment of the investment company at the time specified and may be subject to change without notice. The investment company is not obliged to update or alter the information or opinions contained within this material. Investors should consult their own legal and tax advisors in respect of legal, accounting, domicile and tax advice prior to investing in the financial instrument(s) in order to make an independent determination of the suitability and consequences of an investment therein, if permitted. Please note that different types of investments, if contained within this material, involve varying degrees of risk and there can be no assurance that any specific investment may either be suitable, appropriate or profitable for an investor’s investment portfolio. Given the economic and market risks, there can be no assurance that the financial instrument(s) will achieve its/their investment objectives. Returns may be affected by, amongst other things, investment strategies or objectives of the financial instrument(s) and material market and economic conditions, including interest rates, market terms and general market conditions. The different strategies applied to the financial instruments may have a significant effect on the results portrayed in this material. This document is directed only at person(s) who have professional experience in matters relating to investments (“relevant persons”). Any investment or investment activity to which this document relates is available only to and will be engaged in only with Professional Clients as defined in the rules of the Financial Conduct Authority. Any person who is not a relevant person should not act or rely on this document or any of its contents. All information referred to in the present document is available on www.bnpparibas-am.com As at April 2024.
Notes 1UN, 2023: Water – at the center of the climate crisis. 2Our World in Data, 2018: Water Use and Stress. 3Global Commission on the Economics of Water, March 2023: Turning the Tide – A Call to Collective Action. 4NRDC, 2023: Water Pollution: Everything You Need to Know. 5Council on Foreign Relations, 2023: Water Stress: A Global Problem That’s Getting Worse. 6UNCTAD estimates, 2020. 7Sustainalytics, 2017: Waste Not, Want Not – Water Use in the Semiconductor Industry. 8AECOM, June 2023.
In many parts of the world water resources are under severe strain from overconsumption, pollution and the effects of climate change. Water security is not just a challenge for the emerging world, reliable water supplies are also compromised in the developed world. Thankfully, regulatory developments, government support and business innovation are starting to tackle this issue, creating potential investment opportunities. A triple threat to water security Despite being known as the Blue Planet, only 0.5% of water on Earth is usable and available freshwater1 – meaning it can be used for agriculture, industrial and municipal purposes, as well as for consumption. Global demand for freshwater has risen sixfold since the start of the 20th century2 and is likely to outstrip supply by 40% by 2030.3 Three core factors are driving this scarcity of water: higher consumption, pollution and the effects of climate change. Firstly, a growing global population is not only increasing the demand for drinking water, but is also placing other water-dependent processes such as agriculture and industry under strain. Secondly, over 80% of used water flows back into the environment untreated, often containing human waste and toxic industrial byproducts,4 which pollute vital waterways such as rivers. Finally, rising temperatures pose profound challenges to secure, reliable water supplies – for every 1C increase in average global temperatures, the UN projects a 20% drop in renewable water resources.5 Overcoming these challenges and meeting rising demand for water will require vast investment across the water industry’s value chain as well as technological innovation. Upgrading ageing infrastructure While water efficiency solutions are already helping to reduce per capita water withdrawals in advanced economies, ageing water infrastructure requires expanding and upgrading in many parts of the world. In 2020, the UN estimated that an additional $260bn would need to be spent on water-related infrastructure each year to realise its Sustainable Development Goals concerning water by 2030.6 Such infrastructure spending should focus on the expansion of clean and wastewater systems and investment in better drainage solutions that can capture run-off and prevent surface flooding. A tighter regulatory environment can help also address water quality issues throughout the water system, from water testing technologies to wastewater treatment.
Innovative technologies promise to play a critical role in helping address water-related challenges, creating new markets and tapping into structural demand growth’
Global demand for freshwater has risen sixfold since the start of the 20th century and is likely to outstrip supply by 40% by 2030’
water infrastructure capital spending gap (US)
Water infrastructure capital need
2019-2039 cumulative gap: $2.2trn
Water infrastructure capital spending
2019 annual investment gap: $81bn
2019 annual investment gap: $136bn
Source: https://graham.umich.edu/system/files/pubs/Water-Sewer-Infrastructure-Funding-Gap.pdf
