Worldwide Demographics Create Water Opportunities
Calvert Global Water Fund co-portfolio manager Matthew Sheldon sees value in water infrastructure companies amid long-term strains on worldwide water supplies.
KBI International, Ltd.
Matthew Sheldon, CFA, of Calvert sub-advisor Kleinwort Benson Investors International Ltd in Dublin, is a co-portfolio manager of Calvert Global Water Fund. In this Q & A, Sheldon discusses the factors behind his positive outlook for water-related companies, his favorite water sector, and some of the advantages of an actively managed portfolio of water stocks.
Matt, what about water-related companies makes them an attractive investment in the current volatile market environment?
There are some very broad trends that make water companies well-positioned for long-term growth. First of all, there is no substitute for water, and it is a finite resource. The world's population growth and tendency toward urbanization will only increase the pressure on water supplies, so many companies involved in the water sector stand to see demand for their products accelerate as a result of these factors. The water market totaled $500 billion in 2011 according to Bank of America Merrill Lynch, which predicted that this figure could reach $1 trillion by 2020.
Some people might think of water as a niche investmentâ€”some water companies certainly operate in niche industries, but the broad and pervasive need to upgrade water infrastructure around the world to meet the growing demand for water helps make them somewhat less susceptible to the sometimes erratic behavior of niche markets. In fact, the water theme encompasses companies in a variety of different industries, providing the opportunity to access diverse return characteristics.
How large a factor is emerging markets demand for the water industry?
There's no doubt that the booming population growth and urbanization in many emerging markets is placing very large demands on the water infrastructure in those countries, but some are much farther along than others in terms of spending to try to meet their water needs. For example, China has been a big spender on water infrastructure, increasing spending on water by approximately 15 times in its current five-year plan relative to what the country spent two five-year plans ago. India is at a much earlier point in the water infrastructure spending cycle. In the longer run, I think that in 10 to 15 years we'll be seeing African countries at about the same stage as China is now with respect to their efforts to upgrade water facilities.
While the need to build new infrastructure in developing countries is a major driver of investment, there is also a strong need to upgrade aged water infrastructure in developed nations. Some components of the water pipe networks that serve major U.S. cities such as New York date to the 19th century, although they rarely receive much attention until a major water artery bursts. The United States alone has more than 700,000 miles of pipe as part of its water infrastructure, which is four times longer than the U.S. highway system. The under-spending to date on water infrastructure rehabilitation and replacement in developed countries simply means more pent-up demand for water equipment and services going forward.
Within the water industry, which sector currently looks most attractive?
We break the universe of water solution providers into three sectors: water technology, water and wastewater utilities, and water infrastructure. We think that the infrastructure sector is attractive today, and we think that pump companies are particularly attractive within that sector.
Companies that manufacture and maintain water pumps sell their products to many types of industrial customers and energy utilities. For example, power plants that burn natural gas to generate electricity need water pumps to cool their facilities. We think of water pump companies as "long-cycle companies" because their customers tend to be involved in complex industrial projects that take many years to move from planning through construction and into operation. In many cases, these long cycles are really just starting as the worldwide economy continues to slowly recover from the financial crisis of 2008 and 2009. Water pump companies are poised to take advantage of the beginning of this long business cycle by selling equipment that industrial and energy companies need to construct new facilities. Also, in addition to providing the pumps needed for the new plants, water companies stand to benefit from selling parts and service to maintain the pumping equipment on an ongoing basis.
What are some of your favorite stocks in the Fund right now?
SPX, which was the largest holding in Calvert Global Water Fund as of January 31, is a good example of a long-cycle company. North Carolina-based SPX manufactures equipment like cooling towers, heat exchangers, and water pumps for use in industrial and energy generation applications. In December 2011, SPX bought a company known as ClydeUnion Pumps that specializes in making water pumps for power plants. About 40% of SPX's total revenue now comes from water-related businesses.
Pentair, which is another stock that we like, is a best-in-class operator with broad water market offerings in pumps, filters, membranes, and softeners that has been very successful in strategically growing its water business through acquisitions. The company's 2011 acquisition of Clean Process Technologies has enabled Pentair to evolve into a leading membrane technology company with expertise in desalination, water re-use, ultra filtration, and nano filtration. In 2012, Pentair acquired Tyco Flow, expanding its water flow capabilities, diversifying its end-market exposure, and adding meaningful opportunities for synergy. We believe that all of these improvements should enhance Pentair's earnings trajectory going forward.
What are some of the advantages of an actively managed water portfolio as opposed to a passive water exchange-traded fund (ETF)?
As active portfolio managers, we can transition the Fund's holdings into the water sectors that we believe will offer the most attractive returns over time. In contrast, a water ETF is tied to the sector allocations of its benchmark index and cannot adapt to changing market environments and water-related developments. For example, in a market characterized by significant volatility and downside risk, we would likely consider decreasing the Fund's allocation to higher-beta water infrastructure stocks and increasing the allocation to the more defensive water utilities sub-sector.
In short, our best ideas for water-sector investments become the Fund's biggest holdings. As our thinking about the best water-related opportunities evolves, the companies in the Fund and their weightings change. That sort of continual adaptation to changes in the water sector is not possible with a passively managed ETF.
Active portfolio management does have some drawbacks relative to passive management. Actively managed funds typically have higher fees and expenses than passively managed portfolios and may generate more taxable income. In addition, an actively managed portfolio may be less diversified than a passive fund and could underperform the market. However, we believe that our active portfolio management strategies can help to mitigate most of these disadvantages.
This commentary represents the opinions of its author as of 3/14/13 and may change based on market and other conditions. The author's opinions are not intended to forecast future events, guarantee future results, or serve as investment advice.
As of January 31, 2013, Calvert Global Water Fund's holdings included SPX (6.39% of the Fund) and Pentair (3.80%). Calvert may or may not still invest in, and is not recommending any action on, companies listed. For the most recently available information on individual holdings in each Calvert fund, visit www.calvert.com. Current and future portfolio holdings are subject to market risk.
Calvert Global Water Fund is subject to the risk that stocks that comprise the water-related sector may fall in value. The water industry can be significantly affected by economic trends or other conditions, such as the availability of water, the level of rainfall and occurrence of other climatic events, and changes in consumption, in addition to environmental considerations, taxation, and government regulation (including the cost of compliance). The Fund is non-diversified and may invest more of its assets in a smaller number of issuers than a diversified fund; therefore, gains or losses on a single stock may have greater impact on the Fund. A downturn in the water-related sector would impact the Fund more than a fund that does not concentrate in this industry, and the Fund therefore may be more volatile than a typical mutual fund. Lastly, foreign investments involve greater risks than U.S. investments, including political and economic risks and the risk of currency fluctuations.