Commodity of the future: Does water have a place in pension portfolios?

The SmartBall sensor, made by Canadian company Pure Technologies and floated from one end of a mains water pipe to another, maps weaknesses and leaks in a water supply and has improved efficiency in a time of increasing water scarcity.

It has also generated significant impactful returns for pension schemes – Pure was acquired by another water technology company, Xylem, in a deal closed earlier this year, buying out existing shareholders at a 100 per cent premium.

There’s little point saving for a long-term future unless you’ve got a world that’s sustained into the future

Richard Butcher, PTL

The immediacy of the global water crisis will be familiar to many, with Cape Town’s return from the brink of shutting down all public supply having made headlines in the past year.

By 2025, 1.8bn people are expected to be living in countries with absolute water scarcity, according to the United Nations, with two thirds of the global population under water stress conditions.

Large schemes take the plunge

Pension schemes have sensed an opportunity to ease this problem, and profit at the same time. Swedish giant AP7 last week awarded a €75m (£66m) mandate to KBI Global Investors’ Water Strategy – one of the investors that profited from the sale of Pure Technologies – which is envisaged to last between five to 10 years.

As at July last year, the Environment Agency Pension Fund had a 4.8 per cent allocation to water infrastructure and technology.

So should more UK schemes follow suit? The decision need not stray outside the confines of financial decisions about risk-adjusted returns, according to proponents of water strategies.

“The evidence is increasingly clear, bordering on overwhelmingly clear… that there is no need to give up returns to invest responsibly,” said Eoin Fahy, head of responsible investing at KBI.

“We aren’t sure if the world will continue to need fossil fuels, for example, in 20 or 30 years’ time, but the one thing we will absolutely need… is water,” he added.

KBI’s water strategy, an actively managed listed equities fund, has outperformed the MSCI All Country World Index by 3.3 per cent annualised gross of fees since inception in December 2000, albeit with a volatility that is higher by 80 basis points, at 15.2 per cent.

Those returns could be sustained, if demand for cleaner water is anything to go by. Despite massive improvements, less than 50 per cent of the rural population in China – one of the world’s largest and fastest-growing economies – had access to piped water in premises in 2012, according to monitoring by the World Health Organisation and UNICEF.

Not just a financial decision

Still, returns are evidently not the only motivating factor on investor’s minds.

While Fahy said some of his investors are driven purely by financial reasoning, others display “a strong interest in [environmental, social and governance] impact”, and are attracted to water as “the ultimate life-saving-or-preserving commodity on the planet”.

These investors tend to demand that the impact of their investments be quantifiable, for example by managers assessing whether individual revenue streams of companies held within the fund contribute positively or negatively to the UN’s sustainable development goals.

Define purpose of trusts

Trustees with a fiduciary duty to pay member benefits may be nervous about impact investing, given its demand for positive change alongside returns.

Non-financial matters can be considered by pension funds, said Ralph McClelland, partner at pensions law firm Sackers, as long as the strategy is set “having satisfied yourself that the decision that you’re making will enable the scheme to pay its pensions”.

“Looking at what the purpose of the trust is we can construct a strategy and a framework in which this makes sense,” he said, adding that “the concept of fiduciary duty is quite a flexible one here”.

Scale could prevent UK mandate awards

But it is the specificity of impact mandates such as water investing that may make it inaccessible to many UK schemes, which lack the scale of peers like the EAPF or AP7.

Richard Butcher, managing director at trustee company PTL, said impact investments might contribute along with other investments to one of the scheme’s particular objectives such as cash flow, return or liquidity. Those objectives in combination make up the fund’s overall strategy.

“There are relatively few small schemes that can disaggregate it to that extent – they generally buy pooled funds because it’s a more cost effective way to do it,” he said.

However, he stressed that trustees should not take a fund’s reporting of its progress against impact standards such as the UN’s SDGs as an indication that it is not focused on generating returns.

“That’s entirely consistent with mitigating a financial risk, because there’s little point saving for a long-term future unless you’ve got a world that’s sustained into the future.”