How to incorporate water concerns in investment portfolios

How to incorporate water concerns in investment portfolios

How to incorporate water concerns in investment portfolios

The importance of carbon footprints has been well established as a critical piece of ESG. But with impact of climate change on economies and financial systems coming into sharper focus, it may well be time for investors to consider another overarching environmental theme: water stress.

“We have found that understanding water-related risks is a vital component of evaluating the long-term sustainability risks and opportunities of an investment portfolio,” wrote Emily Steinbarth, quantitative analyst at Russell Investments.

In a new white paper titled Moving the climate focus beyond carbon and on to water, Steinbarth noted that water-related risks are multi-dimensional. Aside from their potentially catastrophic impact on communities, water risks are captured in two-dimensional data sets: any given amount of water consumed has to be indexed against the specific location where it was used.

“As awareness of water risk grows, so too has the availability of tools to incorporate water exposure into an investment process,” the paper said.

Multiple industry-provided frameworks touch on water, including those from the Task force on Climate-related Financial Disclosures (TCFD), the Task force on Climate-related Financial Disclosures (TCFD), and the Global Reporting Initiative (GRI). Each framework is able to answer different questions on water risk — which companies should be monitored, what metrics matter, why water should be incorporated in investing decisions, and how to incorporate water into an investment portfolio — though Steinbarth said no single framework can address all of them.

She also noted that investors who wish to incorporate water risks in their portfolio must consider several things when it comes to analyzing water risks. First, non-financial data reporting on water is low: while coverage for data on water withdrawal (water that’s drawn from freshwater sources, used in production, and eventually returned) ranges from 43% to over 80% across industries, information on water consumption (which measures water that’s used but not returned) is scarcer with roughly 16% coverage for the MSCI All Country World Index.

“[W]e find that water usage, both in terms of withdrawal and consumption, is highly concentrated in a handful of companies,” Steinbarth continued. Weighting companies’ water usage based on their capitalization, she said, reveals that 10% of companies contribute 91% of the aggregate water withdrawal within the MSCI All Country World Index. The highest usage was observed in the utilities, materials, and energy sectors; even within sectors, concentration of usage among a small number of industries was also observed.

There’s also a gap in regional data on water stress. While the ideal situation would be to know what percentage of water consumption occurs in high-stress regions, there’s still a lack of data granularity in that respect. Focusing on companies with over 20% of their operations domiciled in high-water risk regions, Steinbarth and her colleagues have reportedly found that they make up 71% of the companies in the index portfolio, suggesting significant exposure to regional water risk.

Finally, she said, investors with an interest in water stress exposure should consider any water-related targets and proactive steps to “ensure availability and sustainable management of water and sanitation for all” — also known as the United Nations’ Sustainable Development Goal 6 — as forward-looking elements in their portfolio decisions.

 

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