Water gets back to outperformance

 

European water stocks provided the best performance, with average prices up 16.3%. This was primarily due to the UK investorowned utilities, whose revenues are indexlinked. Higher inflation rates bring the expectation of higher earnings (although there is some lag). The two French giants, Veolia and Suez Environnement, saw their shares slip back, however, reflecting the fact that both companies have struggled to make real headway in the current municipal services outsourcing market.

 

American water stocks also performed well, with equipment stocks leading the way (see commentary p10). The GWI Americas Water Index is now back above 100, the figure at which our water indices were established on 1st January 2008.

 

Despite all the media hype about the rise of Asia, stocks in the region performed poorly, with the Shanghai composite index down 14.3% over the year. The GWI Asian Water Index slipped back 0.3%, primarily due to the poor performance of the largest stocks in the index, Kurita of Japan and Chongqing Water of China, which both saw their share prices fall over the year.

 

The top performer of the year was Kemira, the Finnish water treatment chemicals company. Besides enjoying a strong recovery in terms of revenues, the stock benefited from becoming a water pure-play in March 2010, when the Tikkurila paints division was spun off. Asia Water Technology was the weakest stock in the index (it required a rescue rights issue which diluted shareholders). Energy Recovery Inc. was the second biggest loser, as its share price fell, reflecting the slowdown in the global desalination market.

 

Water’s outperformance during 2010 should attract more theme investors into the market, as most fund managers make decisions based on past investment performance. The three-year bull run for water stocks between 2004 and 2007 helped attract an estimated $15 billion into specialist water investment funds, but the sell-off in 2008 (which did not hit water stocks as badly as other stocks), and the failure to keep up with the rest of the market in 2009, made water a harder theme to sell. We would estimate that the total value of specialist water funds currently in operation is in the region of $8 billion.

 

The biggest managed fund remains Pictet, with €2.56 billion under management (down from €4.6 billion at its peak in 2007). It delivered a strong performance in 2010, mainly due to its exposure to US utility and technology stocks, as well as a large exposure to Sabesp, the Brazilian utility (it is now the second-largest stock in the fund, representing 3.9% of holdings). The SAMS Sustainable Water Fund had a disappointing year – it has been more adventurous in China than Pictet. This was an enormous benefit to SAMS in 2009 when the fund delivered a return of 33.8%, but it paid the price for this exposure in 2009. The PHO Powershares Water Resource Portfolio is the largest exchange-traded fund covering the water sector. It tracks the Palisades Water Index of US water stocks. Although it outperformed the benchmark S&P 500 index in 2010, the size of the fund remains well below the $2.4 billion invested before the 2008 crash. The best performers in the market were the smaller European funds such as those run by Sarasin and Swisscanto, both of which were launched in 2007. Eurobased funds were at an advantage to dollarbased funds last year in terms of percentage returns because of currency movements.