Making waves: opportunities and challenges in water

Water investment is challenging and while there is opportunity, innovation and more efficient markets are necessary to create scalable investment strategies.

Water investment is in vogue. In 2014 the S&P Water Index beat bellwether gold and energy indices over the previous ten years and over the same period, indices and funds with water as a pivotal strategy have bubbled up around the world.

Take Liontrust, whose latest water and agriculture fund was launched in January. The fund is indexed, so it shows the sheer variety of investments possible under the umbrella title of water, from salmon farms on the coast of Chile to milk production, shipping and Whirlpool washing machines.

But there is one thing an index or general fund might find it harder to directly invest in, and that is water itself – water as an asset class or natural resource capable of being explicitly owned, traded and managed for profit. At the moment, there are two main water markets in this sense: Australia and the US.

The separation of water and land titles Down Under since 2007 has made it possible for asset manager Kilter Rural to set up the Murray-Darling Basin Balanced Water Fund, in Australia, a vehicle targeting A$100 million dedicated to water entitlements and irrigation, with a conservation element.

General manager for water at Kilter Euan Friday told me launching a pure water fund has been part of a longer journey of learning and innovation. Although managers have technically been able to trade in allocations since 2007, Kilter has developed irrigation supply contracts such as leases, share farming and credit deals that free up capital for farmers, to create more stable returns. Friday added investor education has sometimes been “a hard yard”, because it is so new. Water titles are also the subject of some controversy, which can affect investment interest. Even though the latest full water fund has a credit backer in the charity Nature Conservancy, and promises to return water to wetlands in years when supply is plentiful, the fund has so far barred its doors to non-Australian investors.

Successful strategies do exist, but their scalability and repeatability can be limited geographically, technologically, legally and politically.

Dave Chen, chief executive at US firm Equilibrium, has been studying and researching water investment strategies over the last few months, and it is exactly this “scalability” and “repeatability” which he thinks needs to be tackled head on. Chen said investing in water is far more complicated than it appears on the surface, but its potential means investor interest is growing.

In the US, as Chen again points out, mitigation banking has been the stronger investment model to date. Government regulation and support for it has been growing. This year, private investors have pledged $2 billion towards forestry conservation and wetland restoration at a US government roundtable. In February, Ecosystem Investment Partners, a firm that invests in US wetland areas that qualify for revenue-generating environmental offset projects in the US, reached a final close on $303 million for its third fund. Its investors include institutions like the New Mexico Education Review Board.

Chen said that while specialist mitigation funds have “shown the way […] now you could be potentially any ag fund beginning to use that as part of your returns arsenal.” That means mitigation banking could become more widespread as an additional revenue stream for combined land and water investment than in specialist funds.

Kilter’s dedicated water fund was made conceivable by the efficient water markets developed in Australia, said Friday, who added their strategy is now repeatable and scalable. Internationally, there are expectations that efficient water markets will develop in the US and other geographies. But experience also shows that as opportunity opens, investment in water has demanded continuous innovation, flexibility and education, making for a challenging environment.

We will be taking a deeper look at water for a feature next week. Email your thoughts on investment in water rights to clare.p@peimedia.com