Charles Robertson: Fancy taking the plunge in 'blue gold'?

GIVEN that nature delivers us so much of the stuff - and too often when we do not want it - the general Scottish consensus that water and its associated services should continue as a "free" publicly owned commodity is understandable.

However, partly motivated by a need to fund a shortfall for capital projects, the Scottish Government is believed now to favour a "quasi-private" future for the wholly owned Scottish Water, a move that would free up, for other uses, the 140 million a year currently spent on the utility.

Although rather revolutionary for us, the scenario is different from the one that exists south of the Border, where the water sector was privatised several years ago and, as an investment theme, water (or blue gold as it sometimes called) has been "doing the rounds" in the City for the past few years; funds have been launched and global water indices are available for measuring progress. Even so, water is unlikely to have featured in the portfolio of a typical investor.

With any typical investment you start with the price, which is why, perhaps, private investors might immediately encounter a problem. Other than the bottled stuff, it is not easy to determine the price of water or, having done so, to ascertain if that price is correct.

Water is an essential ingredient of life and as yet there is no substitute, so on what basis does one compare its price to that of oil, which is trading at $80 per barrel, or gold at nearly $1,200 an ounce? This is even more difficult when one takes into account the divergent uses of water, ie domestic, agriculture and industry. Worldwide, only 10 per cent of water consumption is for domestic use, while 70 per cent goes into agriculture and the remaining 20 per cent into industrial production.

There are powerful long-term trends also to be weighed up by the investor. The supply of fresh water is limited but demand, particularly as a result of a growing global population and the associated needs of agriculture, is rising.

The UN is predicting that the world's population will rise to 9.2 billion by 2050, a substantial increase from its current level of 6.8 billion. Unesco has estimated that the volume of water needed to produce 1kg of wheat is 1,300 litres. For beef the figure is 15,500 litres. As living standards rise there has typically been an increase in per capita consumption of water and an associated change in diet, with meat featuring more prominently.

The global population is also becoming more urbanized, and the rapid growth of a city causes huge problems in terms of delivering water and the treatment of waste water.

The principle investment case for water, therefore, rests on growing demand. However, as fresh water is a finite resource there is a need for technology to be developed to use it more efficiently, while investment is needed to either develop water infrastructure in emerging markets or address the deteriorating infrastructure which is typical of many developed economies.

The credit crisis and subsequent austerity budgets in many developed countries are likely to have an adverse impact on water infrastructure spending. But with water such an essential commodity, planned projects to maintain or improve the water infrastructure are likely to only be delayed rather than cancelled.

Climate change and its influence on existing water resources, rainfall patterns and agriculture is hugely topical. While the debate continues over whether climate change is actually occurring, it is clear there are significant parts of the world where water shortages exist and this will inevitably add further stress to the management of water resources.

Therefore, UK investors prepared to make direct investments in water or water-related equities have a fair degree of choice. However, in the case of investing in water it is perhaps overseas markets that offer the best potential for long-term growth, and as a result the more cautious equity investor may prefer to obtain exposure via a managed fund. The choice is limited and the funds involved tend not, despite their names, to be a pure play on water, given that the underlying companies have significant non-water business interests as well.

I consider that one of the most interesting water-related investment vehicles available is the SAM Sustainable Water Fund, given the experience of the team behind it, the sustainable investment theme and their long-term track record following its launch in September 2001. The investments are grouped into four categories covering distribution and management, advanced water treatment, water and nutrition, and demand side efficiency. Other "open-ended" funds investing in this arena are the KBC Eco Fund Water, Sarasin Sustainable Water Fund and Pictet Funds Water.

Exposure to water companies via an investment trust is strictly limited, with Ecofin Water & Power Opportunities the most obvious choice. However, its investment universe is global utilities and so perhaps does not fully capture the long-term growth story. In addition, the capital structure of the fund is more complicated than is usual and this may also deter investors. Exposure to the sector, albeit in a much more limited way, can also be obtained via Impax Environmental Markets Fund and Jupiter Green Investment Trust, which both have water-based investment themes.

Exchange Traded Funds are also available. For example, iShares, S & P Global Water and Lyxor ETF World Water.

Overall, I consider the powerful long-term trends in place (ie a growing and increasingly urban-based global population and increasing water consumption generally) are good reasons for investing in water-related equities.

However, investors should also be aware that given the absolute necessity of governments to secure and deliver fresh-water supplies, regulatory and political interference are likely to feature and, where water resources cross a national boundary, there are already many examples of increasing tension (the most significant example being in Asia and the Middle East), which could possibly even lead to conflict.

Charles Robertson is senior investment manager with Murray Asset Management