Will water slake a thirst for profits?

Investors weigh the ethical question of making money off an essential resource.

For investors who wish their capital could be tackling important global problems while generating handsome returns, water looks quite refreshing.

That's because experts say the stage is set for water-related goods and services to experience strong demand in coming years. In the United States, aging systems for delivering drinking water will require $250 billion to maintain and upgrade over the next 30 years, according to the American Water Works Association, a water utility association in Denver. Worldwide, more than 1.1 billion people lack safe drinking water, according to the United Nations, and needs are sure to increase with a global population on course to reach 8 billion by 2025.

"With climate change issues, and water becoming more scarce in certain areas, [water] is something that all of a sudden is going to be the big issue," says Susan Davis, national water strategist for CARE International, an Atlanta-based nonprofit with water projects in about 45 countries. "And we're going to be caught with our pants down because we haven't really valued it appropriately."

Ethically minded in­­­vestors have reason to like this sector, observers say, both for its humanitarian virtue – its core product is essential – and its rosy growth prospects. But winning at the water game, both in terms of profits and clean conscience, isn't necessarily as simple as buying into a water-focused mutual fund.

For starters, water-focused funds are hard to find. The Sustainable Water Fund from Zurich-based Sustainable Asset Management posted returns in excess of 20 percent in 2005 and 2006, but it's accessible only to investors from certain European countries. American investors seeking water exposure need either to pick from a vast array of water-related stocks or delve into specialized exchange-traded funds (ETFs), which bundle stocks together and then trade like stocks as a single unit on an exchange.

Last month, two new water-resources ETFs made their debut: the Claymore S&P Global Water Index Fund, which takes an international approach, and the First Trust ISE Water Index Fund, which focuses on potable and wastewater industries. Another water-related ETF, PowerShares Water Resources Portfolio, in which 80 percent of the listed companies rank either as utilities or industrials, has the longest track record. It has climbed 17.5 percent since its December 2005 inception.

Ethical investors also need to know more than who's best positioned to turn steady growth into capital returns. They must also weigh the pros and cons of commodifying, and occasionally raising prices for, an essential resource.

Worried about an international trend toward privatizing water-delivery systems, some Christian groups have made a point in recent years to identify water as a public good and a basic human right. At an April conference on "Earth's Water Crisis" at Virginia Theological Seminary in Alexandria, former Episcopal Church Presiding Bishop Frank Griswold defied those angling to profit from water distribution. He championed a view of "water not as a possession, a commodity, a source of economic advantage for some at the expense of others but a gift, an outpouring of divine love."

Some take aim at bottled water

Activists, such as those at Ottawa's Polaris Institute and Boston's Corporate Accountability International, argue it's wrong for large corporations to take control of the general public's water supplies. Polaris this month kicked off what it calls an exposé of the $11 billion bottled-water industry, which the group takes to task for packaging what it calls a "free" resource and depleting underground aquifers, even in such semi-arid places as drought-ravaged Australia. Its chief targets are beverage giants Coca-Cola, PepsiCo, Nestlé, and Danone.

For its part, the International Bottled Water Association contends that bottling accounts for only 0.02 percent of groundwater withdrawals in the United States. "Groundwater supplies are continuously 'recharged' or replenished by precipitation, thus they are considered 'renewable,' " the association said in a November 2006 position statement. Critics' "narrow focus on the bottled-water industry does nothing to protect and sustain groundwater [because] bottled water is one of thousands of products to use water as an ingredient or in production."

Activists also worry about contracts awarded to private firms to operate municipal water systems. They've taken aim at two French water giants, Suez and Veolia Environnement, for alle­gedly taking over local systems and then raising prices, failing to reinvest, or both.

"When you invest in a for-profit enterprise to deliver water to the public, at least in North America, what's happening is that we're having a transfer from public water systems to private water systems," says Verda Cook, water campaign coordinator for Polaris. "You're siphoning off the profits. Those profits ... are not being returned to a community but are going to investors. So you're playing into what we feel is the destruction of a society or a municipality."

Veolia begs to differ: "We're actually able to reduce the overall cost to citizens while simultaneously creating a profit for the company," says Scott Edwards, spokesman for Veolia North America, a division of Veolia Environnement. He says, for instance, that Tampa, Fla., taxpayers saved $80 million by contracting this spring with Veolia to build a water treatment plant.

Suez declined to comment.

Some water experts meanwhile see a different picture. Public water utilities routinely face political pressure to keep prices so low that big users, including farms and industry, have little incentive to conserve, says Rick Rheingans, an economist at Emory University's Center for Global Safe Water in Atlanta. Inadequate pricing means that many utilities in poor nations can't make enough to restore their decaying infrastructures, he says.

What's more, the poorest citizens of developing nations often lack access to municipal water and instead pay three to 10 times as much to have water supplied, for instance, by truck-driving entrepreneurs who mark up the price and can't guarantee safe contents.

Because they aren't on the water grid, the poorest "simply don't benefit from subsidies channeled through utilities," says Gary White, executive director of WaterPartners Inter­­national, a Kansas City, Mo., nonprofit that aims to increase safe water access in developing nations. "Thus, the really poor don't see their water rates go up when a utility is privatized." Indeed, the poor are likely to pay less if they gain access to the grid.

Private firms and their investors can play a role, Mr. Rheingans says, by supplying water to customers who can afford it and reinvesting profits in infrastructure. This may free up public subsidies, he says, to focus on getting the poorest citizens safe water at rates they can afford. Private-­sector investment "is a very important piece of the pie, and it's one that's been remarkably untapped," Rheingans says.

As investors move in, they often look to exploit the very situations that disturb advocates who want to keep water a very inexpensive public resource. For instance, analyst Eric Cinnamond at Intrepid Capital in Jacksonville, Fla., says the firm is investing in Connecticut Water Services, a public utility, because regulators recently approved a 22 percent rate hike over two years.

Water-sector analyst Joseph DiLillo at the Shemano Group in Los Angeles likes California water utilities because they're some of the few in the country that actually own the water they sell.

"If you want the safety of a utility with a bit of a [dividend] yield, to me this is the way to go: Buy California water utilities because they own 40 to 50 percent of the water they distribute," Mr. DiLillo says. "You get the best of all worlds," because the company owns both the commodity and the distribution channels.

Market watchers see opportunities

Investing to bring water to those who can already afford it may not thrill everyone with a driving sense of mission, but investors who require a financial return have few other options at this point.

"It is very difficult right now for people to make money in the global water space if they want to target people at the bottom of the economic pyramid," Mr. White says. "Investments seeing a competitive return on investment are generally not hitting people at the bottom."

But market watchers who trust private enterprise to solve social problems see a lot of opportunities – including many that steer clear of ethical controversy.

"Improved piping, valves, and monitoring helps detect and prevent leaks, improve efficiency, and – obviously – control costs," says Brian Dunn, a San Francisco adviser to high net worth investors with social agendas. "More efficient and effective treatment and storage technologies do the same. Private enterprise is essential to meeting these challenges."

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