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"China has identified over $100 billion that needs to be invested in water over the next five years"
Tim Weir, Wessex Asset Management |
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Worldwide, one person in three has insufficient water. China, the world’s fastest-growing economy, is water-poor; it has between one-third and one-quarter of the global average amount of fresh water per inhabitant, and most of its cities have inadequate sewerage infrastructure. Most Indians lack access to clean water; even in affluent, middle-class areas of New Delhi, water is often turned on for just half an hour a day, forcing residents to rise at 5am to fill pots and baths. Urbanization and population growth are driving up demand, and supply is limited, so prices of water and water-related services are increasing. It’s below the radar screen of most investors but the price of water is rising on average at about 10% a year. Investment opportunities are therefore emerging.
Tim Weir and Peter Chesterfield of London-based Wessex Asset Management have started a water investment fund to explore these opportunities. They set up Wessex in 1999, initially running an Asian long/short fund, utilizing the skills they had learned as Asian fund managers at Abbey Life. "Asian market volatility was putting off investors, and we saw an opportunity to set up a fund that could deliver consistent returns, rather than the asset class’s typical plus 20% one year, minus 20% the next" says Weir. In 2004, Wessex then launched a resources fund taking on a similar remit of transforming a volatile asset class into much less volatile performance, by running a diversified fund focusing on investments with relatively stable cashflows.
It was while looking for investment opportunities in Asia that Weir and Chesterfield realized the potential of a water investment fund. "One of our investments was a Singapore-based desalination and membrane specialist. There is very little fresh water in Singapore, and the country relies heavily on importing fresh water from Malaysia," says Weir. Given the sometimes strained relationship between the two countries, Singapore’s state investment company, Temasek, has been investing billions of dollars on technology for recycling water and desalinating sea water.
The next step was to up-scale Singapore-tested technology to help address the much bigger water issues in China, where urbanization is massively increasing water use. "In my opinion, the biggest single constraint to the growth of mainland China’s economy is the environment and in particular the lack of clean water," says Weir. "It’s a very major public health issue, a big economic issue and a key political issue; China has identified over $100 billion that needs to be invested in water over the next five years."
Chinese municipalities are turning to domestic companies and foreign operators such as Singapore’s, to award mandates to upgrade infrastructure, sewage works and reservoirs, and install water meters. Companies that get contracts for this work can grow fast. Weir says Wessex’s water fund spends much of its time on utility analysis. "We’re looking at which companies are likely to win contracts, then trying to evaluate the net present value of those contracts. Then the cashflow – will the company have to raise money through the capital markets to fulfil those contracts? Many companies will raise equity, and it may be three or four years before the contracts reach mature profitability. Will they even receive the promised tariffs?"
Normally the water firms being mandated by the Chinese municipalities are paid a tariff over the period of the project. "Spending money upfront and hoping to get it back has to be taken into account for these firms," says Weir. Wessex’s water fund, therefore, goes long on the firms whose business models are suitable and that are likely to win contracts, and shorts those that are unlikely to make money. "We’ve learned from China’s power station (IPP) boom in the 1990s. Some power companies were awarded mandates but the high rates of returns in the form of tariffs never materialized. There is no mechanism for forcing tariff agreements through law in China. In addition to having the right technology, a firm’s relationships within China are crucial for winning contracts and ensuring tariffs will be received," says Weir. This partly explains the success Singapore and Hong Kong water companies are having in China by contrast with US companies. The former tend to spend more time developing relationships, while the US culture can be somewhat less patient.
To a lesser extent, Wessex’s water fund looks at opportunities in the west. It tracks about 120 water stocks in the global $400 billion universe. In north America and western Europe, the infrastructure is already there, but it needs upgrading. "There is no substitute for water, and as the price goes up, the value of the existing infrastructure will increase. So even if money has to be spent upgrading, the businesses will be profitable," says Weir. Lack of substitution means that the water sector has good pricing power.
The fund launched in May with $12 million in assets and has since increased this to $26 million.