Preface

In the realm of thematic equity, water has long been discussed as a thesis that seems somewhat obvious but regularly fails to consistently impress on the basis of outperformance.

Something that may come to mind for many investors might be the closing lines of the 2015 classic financial-dark-comedy film The Big Short. As Led Zeppelin’s “When the Levee Breaks” plays over the outro, viewers are given a synopsis of how the character’s lives played out after the financial crisis. Dubbed over this imagery are vague allusions to current activities, in which heroic protagonist Michael Burry is described as now investing in one thing, water. It is presented, just like that, after a long pause

… “water.” 

Now, we all have probably all seen one or two Scion Capital 13F filings…

Burry is still buying and selling plenty of stuff that has nothing to do with water. But it’s a catchy ending with all the hallmarks of a great cliff hanger.

“This guy predicted the financial crisis…should I be shorting humanity instead of MBS tranches?” a viewer might conclude.

The gravitas of the presentation frames how the concept of water investment as a secular themes has regularly been  presented;  centered around ideas of apocalyptic scarcity.

More than a decade after the movie’s release, water as an investment thesis is becoming increasingly viable and has all the signs you’d look for in a secular trend. The irony is that it’s in ways that are orthogonal, if not entirely different, than those one might interpret after the closing lines of The Big Short. 

Another thing that comes to mind, depending on how closely one has followed sell-side research, is the numerous attempts by thematic equity analysts to convince them that this is the time they should actually care about water.

Water has what can be described as “humanity beta”, I guess. You’ll never go bust with a thesis like population growth means more water use, because that’s an objective truth. Of course, we’re not here to just not go bust, we’re here to outperform. Seemingly every year there’s another crisis that will require billions and is presented as urgent, but will likely play out over decades. While investing for the long term is great, it’s commonly considered good practice when investing in public equities to have theses that will see catalysts realized within one’s lifetime. 

To tell investors that water is important is akin to telling them water is wet. While “selling water in the desert” seems like an even more promising proposition than “selling the picks and shovels in the gold rush”, one must be careful to not invest like the world will be a desert in the next few years. However, there have been secular tailwinds in specific areas that have recently arisen and lead me to believe that not only will names with thematic exposure here outperform but that they will do so in a significant and sustained manner. This time actually is different.

Water is by far the most important commodity for humanity and it seems almost foreign to us that if there were indeed any issues with our water supply that it wouldn’t immediately be our first priority with trillions of dollars thrown at it until we were secure in our needs. That results in a dynamic where water issues straddles the lines between a nuisance that will eventually be addressed by slow moving bureaucracy, an easy ESG investment and an actual secular trend that warrants further examination. Like a quantum particle, it exists in all three of these states at once.

That’s beginning to change in very definable ways.

Why Now?

The question of “why now?” has never really had a satisfying answer for the water investing. Well, the question is finally getting a satisfactory answer. Burry does tend to be early, after all...

To make another nod towards the Big Short, Jaime Mai has a quote in Market Wizards that speaks about the fact that people often do not like to think about unpleasant things and will underprice their probability of happening to a very significant degree. To be sure, contaminated water or any sort of shortages are some of the most primal, evolutionary fears we have as humans. But that’s not really enough to get people excited. We are more about accelerating top lines than decelerating chances of survival. So the key has been to isolate places where exposure to water’s secular trends (as they have developed, which has accelerated in the past 6 months) and then utilize that to create a framework for capturing this trend.

It’s no secret that my point of view is that, over longer timeframes in public equities, you get paid more consistently as an optimist rather than a pessimist. And why wouldn’t you be - we've reached a point in technology where you wouldn’t feel safe underwriting flood insurance in Dubai! The issues we face with water, we face globally and domestically. 

Yes, we (both the US and humanity) have water problems.  

And yes, we are going to fix them. 

For this piece, then, I’d request you abandon any preconceived notions focusing on water in a macro context in terms of climate, scarcity, and ultimately, death and famine due to the lack of reliable access to clean water.

Rather, come into this piece with a frame of mind that water is a primarily low cost, high value commodity that faces a host of potential issues both now and in the future that may result in future scarcity but present an excellent opportunity now for the companies that will solve these issues most effectively. After all, water is really important. And secular trends of increased demand from power generation, semiconductor manufacturing and data centers as well as awareness of pollution and treatment for emerging contaminants et cetera must be addressed in a manner that permits us to continue using water to advances society’s goals and desires.

Reliable, clean drinking water in the developing world is a top priority…for the world. For investors, however, the framing of water as an investment thesis through the lens of supply that’s constrained by our own overconsumption is likely to see you running out of actionable ideas very quickly.

These approaches typically result in some basket of ostensibly “exposed” water providers and utilities that, even if water became exceedingly scarce, would likely have any benefit regulated away immediately. There are a few obvious layups in this theme, but then there are ones that many baskets include solely because it looks like they’ll benefit when really they may actively be harmed.

That’s not what this is. This thematic primer is going to look at water from areas of definable catalysts, with real world drivers that isn’t chock full of NGO statistics about how everything is doomed.

This isn’t a story of Ps & Qs or some vaguely foreboding warning of a global Mad Max style race to secure physical water to ensure our survival as a species. This is a story of the natural consequences of industry and development in the developed world  continuing to necessitate strict attention paid to the filtration and monitoring of our water supply, as well as the unit economics of leading edge technologies that are driving the need for water and trending to consume more of it than ever before by a massive margin.

The goal here is to create the thematic basket that water actually deserves, remaining mindful that we are not investing to fix the world but rather investing in companies that will make more money. I do believe that it is finally time that much water technology and solutions companies will see a durable benefit as it becomes a more prominent theme in our economy - large technological advancements come with large issues and questions that must be answered. As a society, we are dealing with this on two fronts - the consequences of past technological advancements in industrial production that failed to deal with these issues and the path forward for the demands of current and future industry.

The salient points we outline are definable impacts for public companies and do not rely on some global agreement on resource usage. If that happens, great. But if it doesn’t, the companies we listed will still benefit from the catalysts we are concerned with.

Those are the key areas we’ll focus on, instead of statistics that make you want to hoard beans and ammunition. 

…

Ugh. Okay, fine. I promise that’s what we’ll mainly focus on. Like for 95% of the article. But we kind of have to do this first. It’s relevant, in a kind “for background” way. 

Getting the Doom & Gloom out of the Way:

The fact is the current global water situation presents a complex challenge marked by increasing demand and diminishing supplies. Over the past four decades, water demand has surged by approximately 40% and is projected to rise another 25% by 2050. Water supply, meanwhile, has more than halved since 1970 according to the WEF. This imbalance is exacerbated by significant pollution issues; approximately 80% of global sewage is released into the ocean untreated, and microplastics are detected in >80% of tap water samples. 

Additionally, the over-extraction of water, particularly for agricultural purposes such as avocado farming in Mexico, is leading to severe environmental consequences, including increased salinity of water. The rapid depletion of underground aquifers, which provide 35% of the world's water, further complicates the scenario, necessitating urgent and effective water management solutions. Freshwater makes up a very small portion of all water on earth, as well.

The implications of these water challenges are profound, not only for environmental sustainability but also for economic stability. By 2050, it is estimated that $70 trillion of global GDP could be at risk due to high water stress, a significant increase from $15 trillion in 2010. The economic losses attributed to water insecurity were around $260 billion per annum in 2010, which is about 1.5% of the global GDP annually. These figures underscore the critical need for substantial investments in water infrastructure and management. An estimated $6.7 trillion will be required by 2030, escalating to $22.6 trillion by 2050, to adequately address these issues. 

Now, back to benefitting from solutions.

This situation presents both opportunities and risks for companies in the water sector, as they could benefit from the growing demand for innovative water management solutions but also face potential regulatory challenges. We will focus on aspects of the water thesis that will both benefit (and potentially contribute to) solving these problems, while also benefiting from current trends like increased datacenter and semiconductor fab’s water needs as well as regulatory tailwinds from significant efforts to deal with the elimination of PFAS (or “forever chemicals”) and other pollutants in our water supply

This primer is going to focus on a basket of companies with exposure to the key verticals we believe will drive a definitive outperformance for water, as we have defined it. They are:

• Metering, Testing and Advanced Treatment Solutions for Emerging Contaminants benefitting from regulatory tailwinds, with exposures to both the private sector and municipalities, benefiting from smart metering, network optimization, and advanced treatment solutions for PFAS and other contaminants

• Tailored water-as-a-service through consultants and engineering firms, with offerings encompassing treatment, recycling, and maintenance services as well as optimization in new builds

• Water infrastructure in areas that are most likely to be targeted by government spending

• Data centers, with a focus on cooling systems (liquid cooling/evaporative cooling/dehumidification), power usage, efficiency, water treatment, and recycling/monitoring solutions.

• Semiconductor fabs, leveraging ultra-pure water production/filtration, wastewater treatment, and recycling technologies

**We are standing at the confluence of technology and necessity, where the mundane becomes the cornerstone of revolutionary investment opportunities in water.**

Basket Construction, Inclusion & Exclusion

In this piece, we will identify key areas that will catalyze water as an investment thesis across new and critical technologies, regulatory tailwinds and sustainability requirements. We narrow down a broad universe of names within water to isolate only those benefiting maximally from these trends. 

Utilities that are exposed to higher costs from PFAS without offsetting catalysts are eliminated, names that are at risk for being disintermediated or have no differentiating aspect are not considered and companies that could probably use a little water to put out the dumpster fire that is their balance sheet are nowhere to be found. 

We will be very selective with the companies, avoiding some low-margin pursuits and focusing more on immediate benefit. This was the first basket I’ve added to the portfolio before releasing the primer, mainly because I was looking for some more defensive exposure and the utilities in this theme provided that. There has certainly been a macro tailwind for these kinds of names, and I think that can also lead to more examination into the drivers of their recent outperformance that will lead other investors to recognize the same significant increases to demand I have identified here. 

So, to belabor the point, this is not about stocking up on bottles of Evian or betting on a future where water becomes a tradable commodity like oil. No, this narrative is more grounded and and actionable. Let’s examine why..