Asset Allocation
How Water Scarcity Is Shifting the Investment Landscape
Understanding the cost of water, like other business inputs, is ‘critical’ to the investment process across different sectors and asset classes.
Reported by Danielle Walker
Art by Philip Lindeman
As concerns about global water scarcity grow, investors must make sure the land, real estate and companies they own will have sufficient long-term access to water for operational needs, while not over- consuming or polluting the natural resource.
“One of the themes we’ve been focused on for 20 years, has been the rising value of water,” says Jay Aston, a managing director and portfolio manager in Neuberger Berman’s asset management division, said in an interview. “We don’t believe the world is running out of water, but it’s about not having enough water in the right places. What happens is: You have to move it and treat it to solve these imbalances.”
Aston, who is part of the portfolio management team for Neuberger’s “Global Equity Megatrends” strategy, says that, while his team does not invest in farmland, it does invest in businesses for which understanding the costs of water and other climate change issues is critical to the investment process.
“Our focus has been on finding businesses that we believe are enablers in the movement or treatment of water,” Aston says. “Certainly, climate change ends up having an impact on [this]. Some places have too much water, with flooding issues, and some have decreasing water due to climate change.”
When investing in real estate, institutional investors should “understand the hydrodynamics of where you want to build.” That might also include investigating “what sort of preventative measures you need to put in place, if you are building in an area that is more flood prone,” he says.
If investing in a sector such as pharmaceuticals, in which companies must use ultrapure water in the drug-making process, Aston recommends asset owners investigate whether portfolio companies are working with third-party consultants that specialize in environmental issues, including water security, like such as Tetra Tech Inc.
Significant Water Risk
CDP, a not-for-profit charity (formerly known as the Carbon Disclosure Project) that focuses on environmental issues, found in 2020 that the financial impact of water risks to companies was as high as $301 billion for the year, a figure much greater than the $55 billion needed to address water security issues.
Anni Coonan, a consulting analyst at law firm Bradley Arant Boult Cummings LLP, wrote in an October 2023 report on water scarcity that, “A shortage of water is increasingly putting business operations at risk, as water necessary for manufacturing, heavy industries, construction, and the tech sector runs low.”
“While some sectors are especially vulnerable—food, energy and apparel are the most exposed—the risk is indiscriminate,” Coonan wrote. She added that companies could take several steps to proactively lessen these risks, including: modernizing their equipment, tracking water use, reducing water waste and using recycled water when possible.
Last summer, concerns about water scarcity led Arizona officials to block some new housing construction in the metropolitan Phoenix area due to droughts and groundwater overuse, according to an AP report. Developers have pushed back against the restrictions in reaction to the state’s refusal to approve new construction permits in certain subdivisions.
A report from Arizona Governor Katie Hobbs’ administration last year showed that groundwater in areas around Phoenix is not sufficient to meet projected demand over the next 100 years. In October 2023, Hobbs terminated the ground leases of a company that grows alfalfa in Arizona to feed Saudi Arabia’s cattle because the company used groundwater that could instead be used to supply water to the state’s growing urban areas.
A Montana judge in February stopped a new housing development because a state environmental review about of the new homes’ water usage and its impact on existing homes’ water supply was “abjectly deficient” and “astonishing,” the New York Times reported.
Research from BlackRock Investment Institute predicts that nearly the entire Southwest region of the U.S., including parts of Arizona, California, New Mexico and Utah, will face “extreme water stress issues” by the year 2030.
Water Use Disclosure Is Essential
Michelle Dunstan, chief responsibility officer at Janus Henderson Investors, wrote in an email to CIO that, “Accelerating water scarcity poses a material risk to companies in a number of water-intensive sectors.”
“We are looking for companies to effectively assess and disclose their exposure to areas of high water-stress, and evaluate future impacts of water risk on their operations, production output and costs,” Dunstan wrote. “Similarly to how we would consider any sustainability risk with the potential to impact a company’s performance, we want to see that they are taking steps to effectively address the issue.”
Because water risk is determined by multiple factors, from supply issues determined by rainfall and river basin exposure to demand on shared water resources, investors need in-depth research and engagement to understand how each company’s operations would be impacted by water availability, she explained.
“A key area that we look for is location-based water use disclosures,” Dunstan wrote. “A best practice would include reporting to CDP Water, a reporting initiative that provides investors with valuable granular data on a company’s water use. It enables us to compare river basin exposure, site-level withdrawal volumes, water-related capex, and other data points. We can use this data to drive deeper discussions with companies on water risk mitigation.”
While setting targets around water use can be seen as a “positive” for companies, Dunstan said that Janus Henderson wants to see those targets accompanied by “tangible initiatives” or new technologies that will help firms consume less water and improve their water efficiency.
“Most importantly, water is a resource shared among a number of industry and community actors. Addressing water risk therefore requires collective action. We are interested in how companies are working with the community and their involvement in industry partnerships for watershed management.”
More Expensive to Invest
Aston says Neuberger Berman has had to choose its portfolio of water industry-focused companies more carefully in recent years, as water scarcity and security have become growing issues.
Valuations of firms that provide high-end water filtration and other water treatment or infrastructure needs have significantly increased due to the growing need for their services, Aston explains.
“In the last 10 years or so, there’s been a significant amount of new capital coming into publicly-listed companies looking at solving water issues,” Aston says. “You’ve had this dramatic increase in valuations, which makes it more difficult to invest. It’s become much more expensive [to buy into these companies].”
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