If investors are not aware of water risks, now is the time to get up to speed, argues Monika Freyman
Water, like carbon, is a growing operational and strategic risk that investors must look out for. But unlike the threats of higher carbon prices or regulatory changes due to climate change that continue to build, today's water threats can lead to immediate and significant, or even total, value destruction.
Water resources, already at risk in a more climate volatile world, are also under growing threat from pollution, a rising global population, and skyrocketing water competition from growing cities, power generation and food production needs.
Floods. Shortages. Spills. Community backlash. Every day, we're seeing how water security translates into water risk overnight.
Newmont delayed a $5 billion mining project in Peru after community protests over water concerns. Competition with farmers for groundwater in India forced Coca-Cola to close plants and abandon some expansion plans. BHP and Vale face a $48 billion fine stemming from compensation claims. These are just a few proof points.
So what can investors do? Do what investors do best — research the risks and manage them.
That's where Ceres' new Investor Water Toolkit comes in. Created for investors by investors, the "Toolkit" is the first ever investor-designed, comprehensive resource to help investors better understand and evaluate water risks throughout every step of the decision-making process — from creating institutional priorities and goals, conducting portfolio attribution analysis, to buy/sell decision-making and much in between.
The Toolkit was produced in partnership with over 40 members of Ceres' Investor Water Hub, collectively managing $6 trillion in assets. It provides resources and tools on analysing water risk along with real-life case studies from pension funds, endowments and asset managers. The Toolkit offers different levels of analysis, meeting investors wherever they are on their journey of integrating water risks into portfolio decision-making. These range from understanding and evaluating risks to providing recommendations for advanced methods of scenario analysis.
It also showcases that a broad spectrum of industries have exposure to potential water risks. A new water footprint analysis Ceres released alongside the Toolkit reveals that the majority of stocks in the MSCI World, MSCI Emerging Markets, S&P 500 and Russell 3000 are in industries with medium to high water risk.
That's why serious analysis of these risks is more important than ever. Water risk footprinting, also known as water risk heat-mapping, is one of many important investor water research methods.
And in fact, some investors are already leading the way. For instance, ACTIAM, a Netherlands-based firm managing €54.6 billion in assets, is measuring the footprint of its portfolio as part of its 2030 goal to limit the water use and impacts of its portfolio — the first ever public commitment by a large institutional investor.
In the US, the Florida State Board of Administration (SBA) analysed the water risks of its $15 billion passive investment portfolio, using water risk scores to create a heat map. The map visually represents the financial exposure of Florida SBA's investments in companies with varying degrees of water risk exposure.
Many investors are also beginning to see the value of scenario analysis and stress testing not only to assess the impact of climate change but also to more fully understand water risk exposure. This mirrors the call for scenario analysis by the G20's Task Force on Climate-related Financial Disclosure.
Investor water risk exposure can be very different from corporate water risk exposure, because investors need to evaluate the risks throughout their portfolios, including their aggregate exposure to high-risk industries or geographic regions. And given that investment firms may own hundreds, if not thousands, of companies or securities, investors also need to prioritise which entities to research and engage further on water risks. The Toolkit has a number of recommendations for just how to do this, using the size of holdings, ability to influence change, and geographic exposure analysis as key considerations.
The online Ceres Investor Water Toolkit is designed to fill a critical gap for investors who have been looking for ways to integrate water and other sustainability considerations into investment decision-making. While there are many other resources in the marketplace to help companies model their water risks, there are few that specifically target investors.
Water risks are increasingly material. Climate change and other drivers are turning water into a scarce commodity, increasing competition for available resources and making protection of water quality more vital than ever. These risks have to become an integral part of investor research and risk management processes and daily financial decisions. Otherwise, investors will be blind to a risk that is only continuing to grow.
Monika Freyman, CFA is Director of Investor Engagement, Water at Ceres, a sustainability non-profit organisation working with the most influential investors and companies to build leadership and drive solutions throughout the economy.