Investing in Water – A Clear View on this Investable Theme

Simon Gottelier: So, I suppose there are a few characteristics that I would use to describe the investible universe for water. It's global, it's highly diversified, so you have a range of business models and different types of company, from industrial exposed businesses, to companies supplying irrigation equipment to farmers, to waste management businesses, pollution testing companies, and of course, you know, utilities and concessions businesses providing drinking water and sanitation. But it's also a very defensive, growth-oriented opportunity set. It's global. It is a very elegant way to get exposure to sustainable investment themes and underlying business models. And I think I would characterize it as having a very high active share relative to a typical global equity benchmark. So there are a lot of long-term growth drivers that underlie the sector, that give us optimism that for the next 20, 30, 40 years, this is gonna be a very exciting place to invest.

Simon Gottelier: It's typically more of a hardy perennial, I'd say, I mean, we do have a sort of direct inflation hedge through the utility businesses, which are able to pass inflation straight through to their customers. We have companies in the opportunity set with mission critical products, and therefore typically very strong pricing power who are able to weather a difficult market, perhaps better than some other stocks. I think if you look at the performance of the water sector over the last 20 years or so, it's performed extremely well, particularly again, relative to a global equity opportunity set.

Darren Pilbeam: First of all is that lower beta profile, which is very attractive alongside the defensive growth mindset as well. I think that does come as a bit of a surprise. Secondly, in terms of its performance over the past few years, good, relative risk adjusted performance, which in a bull market sometimes gets overlooked.

Simon Gottelier: I think, we've historically seen growth in the sector of around five to 7% per annum. We are today seeing some very interesting new technologies come into this space. The idea of smart and connected devices, the idea of the consumer having interfaces with various water products through their phone, we're seeing federal stimulus dollars hitting the water market, we think that will have a substantial benefit to the space in the second half of this year. And I think one of the key areas of growth that we're seeing is PFAS. So these forever chemicals that come from for example, firefighting foams and military bases, those sorts of things, which are providing or presenting a huge environmental problem. And it's very often the water companies and some of the waste management companies out there that are providing the solutions and technologies to get rid of these nasty chemicals. We think that that's gonna add potentially up to 100 basis points of growth to the sector in the coming 12, 24 months.

Simon Gottelier: So, clearly you need to be very macro aware when you are investing in thematic equities but ultimately we're looking for individual stocks and uncorrelated returns. So I would describe water investing as very much bottom up. You are looking for competent management teams, you're looking for very strong business models, you are looking for sustainability criteria to be sort of ticked off the list, so to speak. And you're also looking for liquidity and tradeability. So I think when you have all of those things, the analysis that we perform is very much bottom up, conviction driven, setting a target price, and then trading positions around that target price.

Darren Pilbeam: Having the ability and the expertise to cut through a lot of the noise in some of these more nichier themes is a powerful, powerful trait to have. And we are speaking to wholesale clients and we have been for a number of years, who are always looking for new ideas, new themes, new trends. But more interestingly now we're seeing institutional clients are looking at this as an asset class and identifying the positive diversification benefits as well as the defensive mindset that some of these themes can add to some of their portfolios.

Simon Gottelier: Well, I think, within the thematic boundaries that we set, we go out and look at the entirety of global equities, look for companies that are exposed to the theme of water, whether it be through a technology or a service provided to an end user, a company, an individual, or we look for global market leadership in that particular niche market.

Simon Gottelier: So, no, I mean, it is a great question. I mean, the simple answer is no. So typically, we're looking for the companies that are supplying the technologies that treat, cleanup, move water for the broader industrial economy. In other words, there are businesses that are very, very good in terms of reducing their water consumption, et cetera. We're not, per se, interested in those companies, we're interested in the technologies that they're using and the companies that supply those technologies to achieve the water efficiency.

Darren Pilbeam: Yeah, I mean, ultimately, we listen to our clients and we try to provide solutions to some of their problems. And the beauty of the model at Natixis is that we have various affiliates that can cover a wide variety of themes, one of those being Thematics Asset Management, which although only formed in 2018, are now up to over 3 billion in terms of assets under management, covering a wide variety of channels from retail, wholesale, and more recently, institutional.

Simon Gottelier: Well, I think we've touched on a lot of this, I think, defensive growth, low beta, high active share, a strong track record of outperforming global equities over a sustained period of time, all of these things are resonating with both retail and wholesale as well as increasingly institutional clients. I mean, I would add to one of Darren's comments that the pendulum has very much sort of begun to shift more towards institutional investments. Historically, probably around 80% of the book of clients for a typical water strategy would've been retail and wholesale. I think we're seeing now that number shift increasingly towards having a little bit more institutional interest. So perhaps, 30 to 40% and 60 retail/wholesale will be the direction of travel from here.
Darren Pilbeam: I would just add to that I think typically when we've been speaking to potential clients in recent times, they've always looked at water as maybe a satellite position within their broader equity allocation. We see no reason why that shouldn't become more core, particularly as the trend as you've identified, is essential for life, it's gonna be around for a very, very long time. And we see that trend continuing, as we increase allocations with satellite, we certainly see it becoming more core.

Darren Pilbeam: Yeah, I think, we've mentioned the phrase long term quite a bit today and this is a long term theme. And through some of those globalization, the digital, the climate issues that we're all talking about all the time, this has given them the opportunity to invest and do good for certain sectors and adding in the water theme alongside various other themes, can add those greater diversification benefits to a client's overall portfolio.

Simon Gottelier: I think the theme as a whole has this sort of slightly slow growth, slow and steady characteristic associated with it. I think we are going to see more technology coming into the space, more smart and connected devices across the value chain. I do think we're gonna see more growth coming out of Asian markets. We might perhaps not see as many IPOs as we have been hoping for over the last 10, 20 years. And there are clearly sort of, you know, there continue to be legacy governance concerns around, for example, some of the emerging economies in the East. But I do think that there are tremendous growth opportunities in those markets for developed economy businesses. So for example, you could look at larger US and larger European businesses that are very well established, that are able to capitalize on the growth coming out of a market like China or India, for example.

Darren Pilbeam: The beauty of our model is that we have a wide range of affiliates underneath the Natixis Investment Managers banner that we can discuss with our clients. And ultimately, it does depend on what the client is looking for. And with Thematics, they have a wide range of themes that clients can invest in. And as we're starting to see, particularly in the institutional world, they're really opening their eyes to these new opportunities, given all the benefits that we've discussed around diversification, low beta profiles, and ultimately, high active share investing, which is something that they seem to be really keen on.

Simon Gottelier: I think a uniquely experienced management team with a very strong track record of investing in the sector over a number of years. But I think equally today, people are very conscious of where they're putting their money, they want to be able to draw a line between their capital and the underlying companies that they're investing in. And I think that a water strategy with underlying stories and tangible examples of a responsible benefit that the companies are bringing, it is a very elegant way to do that.