Shorting a shortage of water

Are people shorting water related firms or is the shortage of water one of the great investment themes of our time? Monday’s FT/fm covered this topic since there are at least four big funds dedicated to this area managed by Pictet, SAM, Sarasin and KBC. If you add the iShares S&P Global Water (LON:IH2O) fund there are combined assets under management of EUR 4.4 billion in Europe alone. As ever, we will look at where the money is going and feature names like the iShares S&P Global Water (LON:IH2O), American States Water (NYSE: AWR), Cadiz (NASDAQ:CDZI), China Water Affairs (HKG:0855).

ETF

Professional funds do not seem thirsty to trade water via an ETF. There is no institutional ownership of the iShares S&P Global Water (IH2O) amongst the USD 7.5 trillion of equity holdings that we currently monitor. There is also no demand to borrow it either showing that investors are not hedging long exposure to this sector or taking a directional view. With this ETF up 13.4% over the past year it is not surprising no one is betting against it but it is unusual that no one is hedging their long exposure. Is this because they are not too heavily invested in water related firms in general?

Popular Shorts

It must be said that, on average, short selling is very low in the water sector at 1.2% of all shares on loan. The biggest short, Cadiz Inc, is not very high at 6.4%. The table below is listed in descending order by the size of the short selling. The only non US name in the top 10 is Hong Kong listed China Water Affairs (HKG:0855). This company ‘is an investment holding company’, operating in city water supply, construction and sewage treatment. Long only funds like this stock (it is listed in both screens below) as much as short sellers dislike it so it will be worth watching.

Many of the firms with higher than average short interest are trading on rather high price to earnings ratios so they look like value orientated short sales. York Water is on a P/E of 23 for instance.

Popular Longs

The most popular company owned by funds who lend is American States Water (AWR) and this is not because it is the biggest name by market cap. Institutional investors hugely increased their holdings in this name in mid May from 4.8m shares to 5.6m or a massive 30% of this $624m firm. American States Water is regulated, like any other utility, but is allowed a higher return on equity than other firms. The combination of low teens annual growth plus a healthy dividend leads to it being a popular investment.

Wider context

There is a degree of regulatory risk behind investing in the water arena. Many firms are tightly regulated utilities with capped profits. So, despite paying attractive dividends, their growth is constrained. Around the corner could lurk new political directives that could harm their prospects and this angle probably attracts the short seller. However, opportunities abound for water related companies if there is a political will to force power companies to spend money on technology to reduce their environmental impact (tracking and reducing the killing of fish when plants bring in water from rivers for cooling). On top, it does not seem likely that alternative energy will materially replace traditional power stations any time soon. Coal, natural gas and nuclear plants remain very water intensive.