Water presents a severe investment risk but also a transformational investment opportunity, according to DWS.
DWS noted that investors will have to address water risks both as fiduciaries for clients' investment and to deploy capital for sustainable returns.
DWS explored the risks and opportunities around water in a recent paper, noting that "an estimated US$670 billion of annual spending is required until 2030 to meet the sustainable goals associated with water." DWS is part of a working group organised by the World Economic Forum (WEF), on transformational Investment, which targets new approaches to convert global systemic risks into a sustainable return. Water is one of the six systemic risks identified by the WEF.
"DWS is bringing those transformational investments not just residing in the private equity and debt universe, but bringing them into other asset classes as well," said Michael Lewis, head of ESG thematic research. "Water is an interesting one there - in terms of the SDGs, and asset owners and managers are coalescing around these thematics."
The paper noted that water is a finite resource with only 2.5% potentially being usable for life on earth. Lewis likened measuring water risks to measuring other impacts captured by the Sustainable Development Goals (SDGs).
"You need to understand where are the high risks, medium risks, and low risks within a portfolio," Lewis said. "With climate risk, you always get red flags popping up for oil and gas, utilities, metals and miners, the risks, the heat maps are like dark reds. What's interesting with water risk and social risk, is you start to see sectors that aren't normally on the radar popping up, so it gives you a much more complete picture and a more three dimensional image.
DWS outlined five risks to water - demand growth for water given resource constraints; sustainability of water (water in the economic cycle); water-related infrastructure; virtual water, which relates to the water needed to create a product that is consumed, usually in a country different to where the product is made, and climate change.
"What we've found is where we have very high levels of risk in water and climate, preliminary findings show that the cost of capital on companies is higher than companies that have low risk in water and climate. These results lie at the tail ends - the top and bottom performers, and you're starting to see that in cost of capital of companies. It can be quite a powerful influence in terms of building more resilience, particularly in the listed equity and fixed income spaces."
Investors have a role to play, but only in concert with other parts of the investment chain - governments should legislate protection of water sources, with DWS citing the EU Water Charter as a guide for policies, and accountants are needed to develop a full ESG Globally Accepted Accounting Principles (GAAP) with auditing of countries, companies and investors regarding their entire environmental and social impacts
The multilateral push for disclosure, management and monitoring of biodiversity use, destruction and enhancement will follow the path of climate risk disclosure and management, Lewis said.
"The way climate has advanced, we've got lots of investor associations dealing with climate action, there's the TCFD, and momentum is building in climate because it's being viewed as the most important risk," Lewis said. "The guess is that water risk will be coming next, using the framework for climate, and then will start to broaden into wider ESG frameworks."
Accounting for biodiversity loss is challenging because there are multiple levels to address, from accounting frameworks to legislative and regulatory remedies, and the interpretation of risks and responsibilities. Water falls under that category.
"The initial problem is data," Lewis said. "We have spent a huge amount of time and resources trying to figure out what's out there. We started in 2007 and have been adding data and bringing in more and more data providers, looking at how you measure this and which asset class you're looking at."
Within fixed income and credit, DWS also evaluates developed and emerging markets, and corporates and sovereigns."
In addition to finding the sources of data, measuring the impacts is another challenge.
"What's been the challenge in private equity and debt is measurement," Lewis said. "What are the outcomes. For example, what the calorific improvement of the diet of families and what is the increase in education levels. We can become quite granular in seeking that information and measure the right things. That's what's interesting in listed markets. But we have to be quite careful about what is the impact, because if I buy an equity in a renewable energy company, or in a very highly rated sustainability company, am I changing, for example, carbon emissions in the real world?"