Water Investing

Our PE funds own about 40,000 acres of farmland with over 115,000 acre feet of water rights. And we're converting that farmland slowly but surely to regenerative agricultural practices from conventional. And part of the strategy is we use the water on the farms more efficiently. And by implementing fallowing programs, we conserve water and we're able to then lease or get that water to those who would like to increase their own supplies.

We've been doing this, I've been investing for over three decades. I've managed long-short portfolios. And before co-founding Water Asset Management, I spent five years as a portfolio manager at Schafer Cullen Capital Management. And prior to that, I was at Diserio Partners, which was my own long-short hedge fund. And before that, I was a portfolio manager and partner at Water Street Capital. And I started my career at DLJ and then at Paine Webber as an analyst.
EMS:Matt, you're truly a pioneer investor in the water industry. So I wanted you to share your overall outlook for the sector.
MD:Well, water is an essential resource. It's non-fungible, meaning when you need it water's the only thing that will do. The industry is made up of some of the best business models on earth, or monopolies or oligopolies with very, very strong pricing power. It's a very capital-intensive industry. And it's really not well at all understood by most investors. So there's a tremendous amount of opportunity and inefficiency that we've been able to harvest, or focus on, I should say, and then harvest and generate market-beating returns.

Our outlook is even brighter really than even how good it's been in the past because there's a steady increase in the amount of capital investment that is essential to fix the world's dilapidated water infrastructure and create more resilient supplies. So there's a multi-trillion dollar tailwind of capital that's coming into the industry that's driving the earnings growth, the dividend growth, and the asset value appreciation of most of the companies and assets that we invest in.

And I always like to mention that climate change, everyone's talking and focused about climate change. The reason climate change is bad is because it intensifies drought and flood and wildfire. And these factors provide an unprecedented period of transformation for the industry and a major investment opportunity for water. And the other thing we like to say is that while most people think about investing in renewable energy or electric vehicles, those are very important industries and essential for climate mitigation for the future. But the water industry is all about climate adaptation for the world that we have now, whether we like it or not.

You know, we believe that both awareness and capital allocation and focus and policy should equal climate adaptation as opposed to just focus almost exclusively on climate mitigation. Also, by the way, water companies will continue to thrive and prosper for decades to come offering investors like WAM or investors who invest with WAM the ability to realize long-term capital appreciation, sustainable long-term dividend growth with relatively low levels of correlation, lower risk, and lower volatility while at the same time delivering very positive, measurable impact.
EMS:Matt, and more specifically, what areas in water will present the greatest opportunities and why?
MD:Well, all the opportunities that I've mentioned are very attractive. I mean, just it's pretty basic or self-evident in the sense that in order to solve the world's water problems, whether it's supply or quality, you need more pipes, you need to fix leaking pipes, you need more meters, more pumps, more treatment, more membranes. And the companies that make those goods and services, their earnings grow by providing more of those products.

Water utilities on the other hand, which are tremendous business models, we're invested in water utilities all over the world, their earnings grow as a function of the amount of more capital expenditures that they invest. They're generally rate-based models. So the more capital that the regulator allows them to invest to fix these pipes and pumps and other water-related infrastructure, the more tariffs they're able to charge and the more earnings they're able to generate.

And this is all managed in an incredibly, really elegant way where prices don't go up. They go up, but they don't go up too much and they don't go up too fast. They go up steadily. And there's a lot of equity in the water industry where prices don't go up too fast. And people that are poor, they can't afford to pay get subsidized. And people who use more water actually pay more per gallon. And that results in a very unique system that covers all the operating costs and all the capital costs and also allows for equity in terms of the way water is charged and how people pay for it.
On the private equity side, there's a tremendous opportunity at acquiring, that we're pursuing and executing on, at acquiring very specific farms in the West with some of the most senior water rights in the West. And then what we do is we begin to implement regenerative farming practices, which lowers the amount of fertilizer and herbicide and other inputs, which lowers the expenses that we have as farmers.

But frankly, more importantly, we implement advanced water management programs on these farms, including fallowing programs, and that ultimately conserves a significant amount of that water which we're then able to make available to other farmers, to cities, to other industry, the environment that would like to increase their own supplies. And we're able to generate very attractive returns for our investors with a very low amount of correlation to other markets or the economy with very limited amounts of risk. And at the same time, it provides the low cost, low carbon, most scalable solution to water supply reliability in the Southwest.
EMS:Great, Matt. And on the other hand, what areas will present the greatest challenges looking ahead and why?
MD:If you look at the world on a macro level, we've got essentially a globally rising interest rate environment, we've got much higher inflation, and that's going to result in much higher dispersion for stocks. In the water industry, the companies are less impacted by those macroeconomic factors. Most water businesses have inflation-protected pricing power and those are the kinds of businesses that you want to own in an inflationary environment.

The next few years, we expect it to be a much more of a stock picker's market rather than a rising tide lifting all boats. And companies in the water industry we think should perform quite well because generally their businesses and their growth is not dependent on sort of broader GDP. It's really being driven by these non-macroeconomic factors of the essential need to improve water supply and water quality and water reliability. Because if we don't, the economy as we know it won't survive and really life as we know it won't survive. So those are some of the macroeconomic challenges facing all investors, but we think the water industry is pretty uniquely positioned to continue to perform well.

You know, demand for water's going to continue to increase regardless of where interest rates go. And supplies becoming more scarce in many places due to climate change, inefficient use, pollution. And as I mentioned, that means that many of the water companies we invest in are less dependent on GDP growth. And the other thing I'll add is that the world is also facing so much disruption. You know, businesses are changing. They're being challenged by technology, dislocation risk. That's a real risk for lots of other different industries. The water industry is essential and it doesn't face really any of the disruption risk or dislocation or technological risk facing so many other industries.
EMS:Matt, ESG has been top of mind for the industry. And I wanted to ask you what you're doing to embrace it at Water Asset Management through your investments or on more of a macro level?
MD:Well, the water industry is one of the best places to invest, not only for long duration, market-beating returns but also to provide positive, measurable benefit or impact to not only society but to the environment. And the reason is that all the companies and assets that we invest in are either ensuring water quality or water supply, and that clearly benefits both communities, industry, and the environment. And these companies grow their businesses providing those goods and services without any sacrifice in returns and serving the common good.

And it's interesting, that clear definition of positive impact it stacks up very well against the growing concerns that many people have about how to define ESG and ESG in and of itself becoming a more ambiguous term. The positive impact by the water industry is something that we measure. We measure that with lots of our companies. We report it to our investors. And it's pretty straightforward, not ambiguous at all. And in many ways, sort of leapfrogs some of that ambiguity around ESG.

And we're doing that both on our public equity side but also on our private equity side. For example, the water rights and farmland that we own, some of that farmland were fallowing. And that conserved water is being left behind the dam at Lake Mead, which is increasing the dangerously low water levels that you've probably all been seeing in Lake Mead, which benefits really the entire Colorado River system. So that's just another example. And as I said, positive impact is something that we see, measure, and seek in both our public equity investing and our private equity water-related investing.
EMS:Matt, we covered a lot of ground today, and I wanted to see if you wanted to discuss your future plans or have any final thoughts you would like to share with us today.
MD:Well, yeah, our future plans include, as I just mentioned, the new retail version of our, really what was an institutional focus, long only global equity strategy with WaterAid. We're also launching our third private equity water rights and regenerative farmland fund, which we're super excited about. And we just made a dedicated sustainability hire, Erin Heitkamp, who joined us just last month, who led sustainability initiatives at Northwest Airlines and Delta and actually did something similar at Pipeline Foods, which was a regenerative food company.

So we're really excited about the team and the opportunity, and we hope to continue to generate market-beating returns for our investors and at the same time delivering positive impact by ensuring water quality and water supply around the world.
EMS:Matt, thank you so much for sharing your perspective with our listeners.
MD:Hey, it's my pleasure. Thanks for having me.
EMS:And thank you for listening to the EisnerAmper podcast series. Visit eisneramper.com for more information on this and a host of other topics. And join us for our next EisnerAmper podcast when we get down to business.

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