Water sustainability: Why private investment in water assets is becoming increasingly popular.

As the most consumed resource on the planet, water is the backbone of the United States and global economy with virtually every sector of the financial system directly fueled by water inputs or impacted by the sectors that are. The three primary pillars of the global economy, energy production, water supply, and food production are becoming exceedingly dependent on freshwater resources, infrastructure, and technologies as secular trends drive up demand for the declining and finite resource.

This existing and ongoing importance of water dependence and sustainability falls within a broader backdrop of investor focus on environmental, social, and governance (“ESG”) initiatives as climate change mitigation and environmental sustainability remain at the forefront of investor agendas.

As ESG investment grows, a heightened focus on environmental sustainability as it relates to corporate responsibility is leading investors to aggressively pursue products and technologies that address key environmental issues.

Water sustainability remains a focus area within ESG throughout the United States and globally. With a growing number of funds geared towards clean water infrastructure, filtration technologies, and conservation methods, investors are bullish on the importance of these businesses in the long term but maintain their stance on the importance of economic viability.

Many investors are introducing water resources, infrastructure, and technologies into their portfolios with an understanding that a majority of the United States is exposed to some type of water related risk. Holdings that enable the economy to become more resilient to climate related threats including water stress (situations where water demand exceeds supply in either the short or long term) may command a premium at exit as the world transitions to a sustainable economy. Examples of these assets include:

• Water rights – Water right investment from both public and private sources via real estate, farmland, or direct sale of rights is gaining traction as resources become scarce and existing rights consistently appreciate faster than other real asset classes.
• Water transportation infrastructure – As municipalities search for alternative sources of water, transmission and distribution infrastructure is expected to require the most investment over the next two decades to sustain current population growth. It is estimated that approximately $300bn of drinking water transportation infrastructure will be required over the next 20 years in the United States.
• Water storage infrastructure – As water stress rises and the delta between the finite water resources available each year and the expanding demand becomes increasingly harder to manage, many Western states are investing in storage infrastructure in order to conserve water for instances of droughts and other disruptions of availability. It is estimated that approximately $50bn of investment in drinking water storage infrastructure will be required over the next 20 years in the United States.

Backed by strong secular tailwinds, water resources, rights, and / or infrastructure as part of private equity and family office portfolios allow funds to hedge against cyclical assets while simultaneously benefiting from long term appreciation.

Uncorrelated assets – Water resources, rights, and infrastructure diverge from typical cycle expectations because they are uncorrelated with other asset classes providing an opportunity for portfolio diversification.

Sustainable appreciation – Although dependent on factors such as location, quality, and availability, water assets have demonstrated year over year appreciation in value particularly in the Western United States. This is primarily due to diminishing reserves and increased water demand from population growth and economic expansion.

• In the Western United States, population growth is a key demand driver for water resources and infrastructure. Over $150bn of infrastructure investment is expected to be required to sustain this region over the next 20 years.

Diversified end use – In addition to residential and commercial applications, water resources are essential for industrial users in many high growth markets across the United States and therefore play a crucial role in the economic development and growth of many sectors / regions.

Although the outlook for these assets is strong, investment headwinds can include:

Social concerns – Changes to water resources can greatly impact the existing users in a region. In areas where longstanding farms and Native American reservations are prominent, operations with less senior rights can be disrupted and rights can be disputed. Additionally, private ownership of municipally used assets can result in increased political concerns from the community, delaying project and transaction timelines.

Long lead times – Transactions involving water rights and resources, specifically involving municipal entities, can have long gestation periods due to factors such as rigorous due diligence requirements, extended project approval periods, and stringent regulatory constraints.

Even considering the drawbacks, holding water assets in a portfolio can provide long term, steady returns that are uncorrelated from other sectors. Furthermore, for private equity firms that do not intend on investing in hard assets, water technologies that enable long term sustainability can also balance a portfolio and fulfill the ESG mandates set forth by many investors.

With population growth, climate change, and pollution disrupting the world’s freshwater supply, valuations of companies that focus on water sustainability products and technologies such as filtration, smart metering, and conservation technology have continued to rise.

Valuations – As the importance of water sustainability heightens and freshwater sources dwindle, valuations of water technology companies have increased approximately 60% over the past decade.

As a whole, the private sector’s ESG commitments coupled with the strong secular tailwinds and financial advantages of water related assets is leading an increasing number of funds to consider water resources, infrastructure, products, and technologies as integral parts of their portfolios. Recent examples include:

At Industria Partners we work closely with both entrepreneurs and investors on ESG, natural resource, and decarbonization projects. We consider our team as strategic advisors, first and foremost, in our approach to finding and creating solutions to our client's challenges at every point in the business cycle. We can assist you and your business in growth capital planning and raising, buy-side and sell-side M&A advisory, and capital stack optimization initiatives.

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