‘High water risk will manifest itself in lower stock prices in the future,’ says consulting firm Anatase
Markus Barth is CEO of Anatase, a financial products consulting firm, and the developer of the TSC Water Security Index, which was launched earlier this year by Thomas Schumann Capital (TSC) – currently the world’s only sponsor of investable indices and financial products for water security.
An industry veteran, Barth has been designing investable indices for the past 30 years – including in 2007 the first climate-focused investable indices that included proprietary valuation metrics for both a low carbon footprint and attractive valuations.
The TSC Water Security Index Family are equity indices which measure the performance of large cap stocks, weighted by their exposure to water risk, as quantified by a proprietary methodology designed by Anatase and sponsored by TSC.
The index aims to offer a high correlation to the equity markets while ‘significantly reducing the water footprint in order to advance responsible investing, and the UN Sustainable Development Goal number six: ‘Water security’ in global capital markets.’
Barth talks to IR Magazine about why water matters.
Why was the TSC Water Security Index necessary?
The market has ignored the pricing of water risk in securities, which means there is no representation in an investable product that takes water risk into account. Despite the market failing to account for water risk in portfolios, it is an absolute that companies with poor water stewardship and high water risk will inevitably see this risk manifest itself in lower earnings – and therefore lower stock prices in the future.
The TSC Water Security Indices are the first of their kind to incorporate water risk by tilting the portfolio away from higher water risk and towards lower water risk by weighting the constituents by their level of water risk. Therefore, the index is underweight higher water risk companies while overweighting lower water risk.
It is expected that in the future, as companies begin to show earnings weakness as a result of poor water stewardship and water scarcity, those companies with lower water risk will outperform the ones with higher water risk. The index is an excellent means for investors to hedge against this risk while diversifying their ESG investments (particularly climate investments) from being solely based on carbon emissions as a representation of climate risk.
How do you gather the information that makes up this index and what could companies be doing to make their information more accessible?
We source our water metrics (a total of nine different measures of water usage, water stewardship and environmental violations) from Refinitiv, which is the world’s leading provider of company-level water metrics.
However, reported water data is not suitable for determining the level of water risk. The methodology used in the TSC Water Security Indices involves quantitative techniques, which enable us to create a level playing field for transforming reported water data into measurable water risk.
What differences do you see between the way that investors and companies are thinking about water?
While everyone seems to agree that water is one of the most important aspects of climate change, we see zero investment products that are focused on water risk (which is why we developed our indices).
The market for climate change investments is entirely focused on carbon emissions. It is ironic that companies with high carbon emissions are still able to operate, sell product and grow earnings while companies who are dependent on water (pretty much across all sectors) will have to shut down if they are unable to access water. Consider The Coca-Cola Company – what happens to its production output if it can’t access water? It would have to cease operations.
So which risk implies direct impact to corporate earnings and stock prices: carbon or water?
While there are many ‘water indices’ in the market, these are highly concentrated baskets of companies who manufacture water purification equipment and water utilities – so despite their presence, none of them address water risk at all.
We also see that some investors are looking at water as a commodity and they speculate on the price of water increasing by investing in water futures. We see this as an injustice given that water access is an inalienable right to humanity and brokers who treat water as a commodity (like gold, cotton, frozen OJ) are effectively capitalizing on the demand for water. Millions are dying of thirst from a lack of water and there are speculators taking advantage of water shortages for profit.
There’s been a huge increase in ESG demands on companies in recent years. Should they prioritize reporting on water use and what advice can you offer for those trying to sort their ESG priorities?
I wouldn’t say that companies should be prioritizing water reporting over other aspects of ESG as they are all important to the ESG story. What is relevant is that companies need to apply the same level of diligence in reporting on their water usage as they have been doing in regard to carbon emissions, governance and other ESG criteria.
The problem is that there is no incentive for companies to report water data – especially those that are excessive consumers of water in their manufacturing processes. Company managements do not want to draw attention to any risks that they face because they don’t want to indicate their vulnerability to the market.
While nearly all companies report on their water policies (because this is a positive aspect), only about 75 percent of companies report on water usage, water recycling and waste water discharge. This will only change when regulators (and investors) demand that these companies comply with transparent water reporting requirements. More importantly, there needs to be a set of standards on what needs to be reported and how it is measured so that investors are able to compare water usage across companies, sectors and countries.
Finally, what do you think needs to change to improve reporting around corporate water usage?
The way to accomplish better disclosure is at the board level and with CEOs as they are the ones with the power to make changes. There are already instances where significant stakeholders have placed new board members with an agenda of bringing about ESG change.
Peer pressure from companies that do report water usage [is also important], plus investors of consequence (the largest pension funds, endowments, mutual funds and asset management firms) need to put pressure on company management to report on this data by divesting investment in those that do not report.