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The ESG Interview: Glass Half Full in Water Scarcity Fight

Martin Conroy, Portfolio Manager, KBI Global Investors, highlights innovation and engagement as key factors in resolving the growing challenge of water scarcity.

We are frequently stopped in our tracks by forecasts about the potentially devastating impact of climate change. But predictions around future availability of drinking water are no less alarming.

The recently published Dasgupta review, commissioned by the UK’s HM Treasury, highlights the imbalance between our use of natural resources and the ability of our planet to replenish them. There are few examples more apposite than water supply and consumption.

Up to 60% of the human adult body is water. Generally, an adult male needs to consume roughly three litres per day, while an adult female needs about 2.2 litres.

If, as predicted, the global population reaches nine billion by 2030, we will need 40% more water than we do today, according to a recent report by the 2030 Water Resources Group. But available fresh water accounts for less than 1% of the planet’s total water supply and is not likely to grow sufficiently in the next decade. This means we’re going to have to use what we have much more carefully.

If anything, that 1% puddle may shrink, or at least shift, in the medium term. Even at two degrees above pre-industrial levels by 2050, climate change will see water scarcity intensify in some areas, with diverse but potentially severe implications for economic output, population mobility and asset prices globally.

“Water scarcity is a huge issue globally,” says Martin Conroy, Portfolio Manager, KBI Global Investors, stressing that its manifestations are diverse. “Some are facing scarcity at certain times of the year, others don’t have a clean water supply to their household, and some don’t have access to basic sanitation services. The numbers can be pretty stark”.

“It’s lot more than just having access to clean water. It’s also about sanitation services and having resilience associated with the water supply. There’s no point having an abundant source of water for six months of the year and then having drought situations from the other six months.”

In 2017, more than two billion people didn’t have access to safe drinking water, and almost double that didn’t have access to basic sanitation services. These can have significant knock-impacts, such as population displacement. Some estimates say 700 million could be displaced by water scarcity by 2030.

Portfolio risks and opportunities

Water-related risks are present in asset owners’ portfolios in a number of respects, most commonly in the failure of investee companies to adequately track, manage and reduce high levels of water usage in line with changes in cost, availability, technology and regulation.

Investors have a number of roles, both in terms of being active owners of the firms involved in managing the supply of water and encouraging change in water usage in end-markets, industrial, commercial, and domestic.

In terms of direct participation in the business of water supply and management, the range of companies involved is diverse and growing, according to Conroy, who manages the KBI Global Investors Water Strategy fund, launched in 2000.

As well as utilities and concession operators, this includes firms across the water infrastructure value chain, which can involve various types of construction and engineering contractor, depending on project, as well as providers of equipment, such as pipes, pumps, valves, and treatment facilities.

Increasingly, it also includes the firms developing new technologies which improve the efficiency of water use, for example identifying leaks and usage levels more accurately. These help to ensure available supplies of water get to those that need them, rather than being spilled and wasted through inefficiency or disrepair.

In developed markets, the primary focus is on ensuring resilience and reliability of supply, which often requires rehabilitation of existing infrastructure, as well as improving water quality. Conroy notes that infrastructure spending is high on the list of bipartisan issues US President Joe Biden hopes to address early in his new administration. This will help to address challenges common in mature and sometimes neglected facilities. “Emerging contaminants is a big issue at the moment in the US,” he says.

Often in emerging markets, water supplies are being established for the first time, meaning efforts centre on developing infrastructure to support new sources of water, as well as remediation work resulting from pollution by overuse.

Demand for new infrastructure is high in many countries and regions globally, including China, Brazil and Africa. India’s government is overseeing an effort, partly funded by the World Bank, to pipe drinking water into every home by 2024, following a campaign pledge which helped Prime Minister Narenda Modi secure a strong mandate for a second term in 2019.

Efficiency through innovation

Water technology is an innovative and wide-ranging area, covering everything from improving energy efficiency associated with pumping technologies to improved reliability and strength from plastic versus lead piping to water metering, leak detection and remote control of water treatment techniques. “Water technologies are constantly evolving,” notes Conroy. “The pandemic will further accelerate adoption of smart water technologies.”

Innovation is already bringing down the cost of managing water supply and reducing consumption levels. Historically, water utilities have implemented multi-year replacement programmes based on digging out pipes of a certain age, whereas new leak detection technologies can identify – or even predict – replacement need more precisely, allowing for a much more targeted spend.

Similarly, the advent of smart metering keeps the consumer better informed of water usage, in real time via an app, which reduces domestic demand significantly.

“Water quality is a very high-profile issue in different parts of the world,” he adds, pointing out that customised domestic water treatment solutions, i.e. water purifiers, are seen as luxury appliances in markets including China and Korea.

It may not be as eye-catching as investing in electric vehicles or renewable energy sources, but investment in water has a proven record, says Conroy, who says KBI Global Investors’ water fund has outperformed global equity indices since inception.

Replacing existing practices

Alongside progress in the home, new technologies and innovative business models are being developed to reduce water use substantially in a wide range of production and manufacturing processes.

This offers hope, but it takes a mix of incentives to change long established practice. Many agricultural and industrial processes are hugely wasteful of water, based on an assumption it is an almost free and limitless resource, suggesting blindness to increasing scarcity.

Around 70% of clean water on earth is used by agriculture at the moment, notes Conroy. Replacement of existing irrigation processes is needed, both from a water efficiency and food security perspective. “Technologies in areas such as drip and central pivot irrigation can reduce water usage by up to 40-50% compared with old-style flood irrigation techniques,” he adds.

As well as water-intensive manufacturing and industrial facilities, the technology sector and its supply chain can also be a large consumer of water, ranging from water-cooled data centres to the manufacture of mobile phones and plasma screens, which require highly purified water.

New solutions to help industrial and manufacturing firms to reduce water usage and operational costs include business models which allow large companies to outsource their water management to specialists via long-term contracts.

One sector to come under the spotlight for water use is apparel. According to a report published by non-profit think tank Planet Tracker in December 2020 into the water-related financial risks in the textiles sector – titled ‘Will Fashion Dye Another Day?’ – practices such as dyeing, heating, bleaching and related treatment processes are adding to the many challenges around water scarcity.

The dyeing and treatment of textiles is estimated to cause 20% of global industrial water pollution by the Natural Resources Defense Council. The Planet Tracker report estimates that 430 litres of water are required to produce 1kg of textile fabric, due largely to wet processing techniques embedded deep in the industry’s supply chain, and often away from investors’ attention.

The report called on investors and lenders to directly engage with publicly listed textile companies involved in wet processing, while also encouraging fashion brands “to develop transition strategies for their supply chains that protect jobs and communities as well as the environment”.

When engaging with either fashion brands or wet processing companies, Planet Tracker urges investors to ask more about their water management processes including how firms assess-water related risks, how they handle wastewater and the chemicals it contains, how often they perform a water audit and what standards they adhere too.

Awareness and action on scarcity

Growing awareness of the impact of established business practice on water scarcity has prompted several high-profile initiatives. US non-profit Ceres has developed its Roadmap 2030 to help firms embed sustainability into their business practices, including protection of water and other natural resources. Signatories must commit to creating net-positive water impacts, supporting human rights to water and strengthening water-related governance and policies.

While Microsoft and Gap have committed to being net-positive by 2030 and 2050 respectively, meaning they replenish all the water they consume, the Ceres roadmap ensures that firms plan out all the specific actions and interim required to achieve those long-term goals.

Signatories of the CEO Water Mandate, including the bosses of Anheuser Busch, Cargill and Dow Chemical, are committed to recognising access to water as a human right and taking steps to improve water stewardship. Ensuring human rights to water involves companies allocating resources and developing policies which increase access to clean water and sanitation for under-services communities.

KBI Global Investors’ Conroy notes that regulatory focus on water scarcity and usage has intensified over the past two decades and he expects this to increase further, adding to the pressure on companies to continually review their processes, practices and disclosures.

“Governments are now getting more involved in terms of managing the available water resources and putting in place regulations to ensure those water resources are, first, not polluted, and second, used more efficiently than has previously been the case,” he says.

Investors have an important role in improving business use of water, says Conroy. To this end, KBI incorporates ESG attributes into valuations of each company in its water fund, including monitoring water footprint. For an industrial firm, this would include tracking levels, efficiency and trajectory of water usage. These potentially negative attributes are balanced against positive attributes, in terms of the contribution their products and services make to the performance of their customers in relation to the supply of clean water and related services.

“No two conversations are the same,” says Conroy. “For an industrial company in a developed market, we might ask about how they are decreasing water usage in the manufacturing facilities. For a water utility in an emerging market, we’d want to engage with them around sustainability of their water sources. It’s no good a water utility having access to lakes, rivers, reservoirs and other sources of clean water, if they’re not managing in a prudent manner. We want to make sure that they’re not overusing water resources to the extent that it impacts the longer-term sustainability of that water supply.”

Forward-looking engagement

As for many investors, the UN’s Sustainable Development Goals is a valuable tool for KBI Global Investors, used to benchmark the negative and positive impact of investee companies, in terms of revenue alignment, largely with reference to SDG 6, which supports clean water and sanitation for all. According to Conroy, more than 70% of portfolio revenues are positively aligned with SDGs, most are neutral, a small amount negatively aligned, which can arise if a company’s revenues are not solely derived from its activities or services related to water supply or management.

Performance monitoring frequently informs engagement activity. KBI Global Investors pursued 20 individual acts of engagement last year in relation to water management, each one resulting in a specific action.

“As investors, we have a role to engage with on these issues. But it’s important not to be backward-looking. Investors need to engage with companies to ensure they have targets in place so that they are leading toward positive societal benefits in the medium to longer term.”

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