Share prices for U.S. water utilities are on the rise as investors inject more money into socially responsible companies.
While most utility shares are outperforming the markets, water utility stocks are being boosted by fears of water shortages and the rapid increase in assets of sustainable funds known as ESG.
ESG measures -- which investors can use to assess the level of a company's environmental, social and governance responsibility -- are increasingly being considered in investment decisions, and U.S. water utilities are reaping the benefits. In 2019, Aqua America, American States Water Co and American Water Works have soared to record levels, outpacing the S&P 500 and other utility stocks.
"A lot of those ESG funds use water utilities as a proxy of water scarcity,'' says Angie Storozynski, managing director and senior analyst at Macquarie Capital. "They have been doing particularly well because there is this additional environmental oversight."
Globally, there is a meaningful shortage of publicly traded water utilities. That makes these companies desirable for investment from ESG funds over other utilities like electric or gas, which have also done well this year as investors flock to these defensive stocks when fears of a recession are amplified.
"[Water utilities] all have acknowledged the inflow from ESG funds," said Durgesh Chopra, analyst for Evercore ISI. "Clearly, it's a driver."
Storozynski says that the issue of water scarcity is a misguided investment angle as many publicly traded U.S. water utilities are in the Northeast where there isn't a lack of water supply like in other areas of the world.
Companies are given ESG ratings based on how sustainable and socially responsible they are, which helps guide investors' decisions. Ironically, these water utilities have weak ESG scores. However, Storozynski doesn't believe these scores are an accurate representation of the U.S. water utility's sustainability efforts.
"They have limited resources to follow ESG disclosures and questionnaires and that's probably, frankly, the main reason why they're not scoring well from an ESG perspective," she said.
Poor ratings haven't stopped Impax Asset Management from investing in Aqua America, which is up about 33% in 2019. The group, which is the eighth-largest shareholder of the Pennsylvania-based utility, considers ESG criteria when assessing companies and says it makes investments towards a more sustainable economy. Though, it does not label itself as an ESG fund.
The UK-based company has a water investment strategy that has been in place since 2009. It invests in securities that it believes provides solutions to water-related challenges across the world.
"The idea that solving environmental challenges, in particular in this case, water challenges can lead to better earnings growth is central to our investment thesis," said Siddharth Jha, portfolio manager for Impax Asset Management.
Impax declined to comment on specific stock holdings due to regulatory reasons.
If an environmentally-minded fund genuinely wanted to invest based on water scarcity, then American States Water Co., up about 38% percent in 2019, is the most sensible investment as the company is based in California, which has been stricken by drought for years.
American Water Works -- which says it has always operated with sustainability principles in mind -- performs slightly better than its peers in ESG ratings. Its stock is up about 35% in 2019. The New Jersey-based company implemented a more comprehensive ESG strategy about two and a half years ago, where the company now has resources and staff to help promote its ESG-related goals.
"We are confident that through focused attention on ESG and transparency that our ESG score will become yet another differentiator for us vs. our competitors," Ruben Rodriguez, senior director of external communications at American Water Works, said in an email.