We should all pay attention when the chairman of one of the world’s largest food companies talks about water shortages and describes them as an even more pressing issue than climate change. Nestle (NESN:VX) chairman Peter Brabeck spoke in exactly these terms in an interview with the Financial Times in July, highlighting an issue which Geneva-based Pictet Asset Management has sought to address since 2001 when it launched the Pictet Water (LU0448836600) fund.

The €2.5 billion portfolio is lead managed by Hans-Peter Portner. Supported on this fund by four colleagues, Portner also has responsibility for the Pictet Global Megatrend Selection (LU0386899750) collective, a €3 billion book designed to address nine global, long-term investment themes, one of which is water.

‘The starting point of the theme is it sits at the intersection of several different megatrends,’ explains the quietly spoken money manager. ‘Twelve per cent of the world population consumes water provided by the private sector and that number is increasing.

This megatrend of growing private participation (commercialisation) will last many dozens of years. Other megatrends that positively impact the value drivers of our companies are focus on health (environmental regulation) and demographic growth (urbanisation).’

Not a drop to drink

Portner and his colleagues have a mandate to invest at least two-thirds of the fund’s assets in companies operating in the water sector. The focus is capital growth although there is an income element too, especially where the utility holdings are involved.

‘The aim is to have concentrated universes of stocks (for the megatrends), big enough to sustain portfolios of more than €1 billion,’ explains Portner. ‘In this case we look for exposure to theme where water is more than 20% of net sales, calculated by weighted average exposure. The portfolio average is more than 60% and there will be some impurities. For example, water supply is a pure play whereas technology can cover pipelines, valves, membranes.’ Applying these criteria companies such as the UK’s Pennon (PNN), Switzerland’s Geberit (GEBN:VX) and America’s Pentair (PNR:NYSE) could be considered for inclusion. By contrast, GE (GE:NYSE) could not, even if it is the world’s leading water technology company by sales, as its business here represents barely 2% of the giant US group’s top line.

The Pictet team certainly does its homework. Portner and his team assess a target universe of around 340 global stocks which have exposure to the water theme and what they do not know about water may not be worth knowing.

‘We have a database of all water contracts on a global scale so we can monitor and understand the trends. Increased private supply is linked directly to the top line of companies through water tariffs which also drive margin.’

Key drivers

Agriculture, industry and municipalities drive water demand between them and after a nine-fold increase in global water consumption since 1900 Portner sees these three areas doubling or trebling their intake again by 2050.

The money manager cites data from UNESCO suggesting only 0.25% of the world’s water is usable, not least because 97% of the available liquid is salty and of the fresh supply (making up the remainder) the bulk of it is polluted.

This helps explain the findings of a report released this year by the World Economic Forum (WEF) on the importance of water in the context of energy supply, as the precious liquid is used in fracking, steam, coal and solar in one way shape or form. That paper defines water stress as an area where water supply drops below 1,700
cubic metres per person, per year. Scarcity is 1,000 cubic metres per person per year, and absolute scarcity 500. The WEF research cites data from Population Action International and the United Nations which assert the number of countries facing water scarcity or stress will jump to 54 by 2050, as compared to 31 in 1995. The number of people involved will surge nearly 10-fold to 4 billion.

Emerging angle

Such considerations underpin Portner’s picks. The fund, which is eligible for ISAs and SIPPs and has no minimum investment for its retail class, features some 63 holdings at the time of writing. The fund manager notes the weighting by stock is around 50% water technology, 40% water supply and 10% environmental services and waste management.

‘There is no geographic restraint to the fund and the focus is bottom up,’ the fund manager explains. ‘Historically the emerging market share [of the portfolio] has continued to grow, from next to nothing to around 20% now. There is a growing middle class that can afford premium brands and also private water services.’

(Click on chart to enlarge)

Geography may not be a consideration but valuation certainly is. Even once a stock passes muster in terms of its exposure to water and business model, Portner then applies rigorous tests to ensure he is not overpaying for access to a company’s earnings stream. ‘We visit the companies we invest in and we make our own estimates on the value drivers of these companies - sales growth, margins, capex, tax rate, gearing and cost of capital. We then derive a target price based on a DCF (discounted cash flow) model and perform this analysis on the Holt platform.’ Holt is an interactive toolkit supplied by investment bank Credit Suisse which helps with fundamental research, analysis of key financial metrics and portfolio allocation.

Patience, please

At the time of writing four of the five largest holdings in the Pictet Water fund hail from the utilities sector, namely Pennon, France’s Suez Environnement (SEVI:PA) and Veolia Environnement (VIE:PA) and American Water Works (AWK:NYSE). Leading technology selections include Xylem (XYL:NYSE) and Danaher (DHR:NYSE)

The portfolio is put together in a manner in keeping with the long-term nature of the water theme. ‘We have at least one full stock market cycle in mind, at least five to ten years. Water is more of a low beta investment theme, driven by megatrends - there is a strong service element too, and lots of recurring revenues,’ Portner concludes. ‘In a bull market we may trail a little bit but once cyclical growth is fully priced in then the organic growth theme will come through.’

Hans-Peter Portner, Pictet Water-I dy GBP

ISIN: LU0448836600

Three-year annualised share price performance: 15.2%

Fund Facts

Launch date: January 2000

Market cap: €2.6 billion

Dividend yield: 1.3%

Sector: Equity Water

Share price: 162.7p

TOP TEN EQUITY HOLDINGS

(as at 31/07/2014)

Company %

Pennon (PNN) 4.0%

American Water Works (AWK:NYSE) 3.9%

Xylem (XYL:NYSE) 3.8%

Suez Environnement (SEVI:PA) 3.8%

Veolia Environnement (VIE:PA) 3.6%

Danaher (DHR:NYSE) 3.6%

Sabesp (SBSP3:SA) 3.3%

United Utilities (UU.) 2.9%

GDH (0124:HK) 2.8%

Donaldson (DCI:NYSE) 2.8%

All data as of 31/07/2014 unless stated otherwise

Source: Pictet Asset Management