Is this the time to develop a thirst for water stocks?

A scarce resource usually means a chance to invest. Jenne Mannion dips a toe in

Water isn't available by the barrel at a price of $80 or so, but blue gold is becoming an ever-more valuable commodity. In Britain, and elsewhere, water suppliers and associated companies are in a strong position: demand for their product keeps rising, but supply is dwindling. So does that spell an investment home run?

Thames Water has warned that its reservoirs and boreholes are so low that it is asking the Department for Environment to grant a "drought order" in the capital, where hosepipe bans are in force. Other companies are also warning of shortages.

The UK's problems are insignificant compared to other parts of the world. Just 0.01 per cent of the earth's total water resources are usable - 97.5 per cent is salt water and the rest is glaciers and ice caps.

Charlie Thomas, manager of the Jupiter Ecology fund and Jupiter Green Century investment trust, says 20 per cent of the world's population is facing water shortages, expected to rise to 30 per cent by 2025. Water-intensive lifestyles, climate change and population distribution are mainly to blame.

Frances Hudson, global thematic strategist at Standard Life Investments, says water ranks second only to energy in terms of natural problems faced by humanity over the next 50 years. And water is a natural resource with no substitute.

Water shortages have reached crisis levels in India, Africa and parts of Australia, but the position in China is acute; already, two-thirds of China's 669 cities are short of water.

A new industry has developed on the back of this crisis. Hudson says water-related industries include utilities and bottled water, waste-water treatment, industrial water, water infrastructure, desalination, drinking-water purification, and systems to improve efficiency of usage.

Thomas cites new water treatment technologies that have emerged, such as ultra-filtration, which removes microbial contamination without increasing concentrations of by-products. Given that filtration and purification can address water shortages, these technologies are likely to see significant growth of 15-30 per cent over the next three to five years, he adds.

Nick Clay, manager of Newton's Managed Fund, also likes water. In his fund, he holds three stocks that play the shortage theme; the Impax Environmental investment trust in the UK; Doosan Heavy Industries, listed in Korea; and Veolia Environment, in France.

Doosan is involved in desalination plants and has many projects in the Middle East. Veolia, which has won major contracts in China, is involved in the management of drinking water distribution and supplies, and water treatment systems and plant. Impax is an investment trust that invests in global water, waste and new energy markets around the world.

Nick Greenwood, a fund manager at the investment boutique Iimia, also holds Impax as a key holding, with 27 per cent of the portfolio invested in water-related shares around the globe. Greenwood says the trust is trading on a modest premium to its net asset value, but still believes shares are good value at current prices.

In the UK, the crisis partly results from low rainfall and the crumbling mains network, which loses 3.6 billion litres of water a day. Investors in water utilities at least have the consolation of the prospect of decent returns - particularly as many water bills are expected to rise by 5.5 per cent this year, after a 12 per cent hike in 2005. Thames this week announced a 17 per cent rise in its profits, which it said was due to a 21 per cent rise in its bills last year.

But Martin Walker, of Invesco Perpetual, says this does not amount to a gold rush for water stocks. Prices have risen, but these are dictated by the regulator Ofwat and are being directed at infrastructure improvements, he says. And there are other priorities, such as sewage control.

Walker, who holds Severn Trent, United Utilities and Pennon in his fund, says utility stocks should not be bought just because water prices are rising. "The overriding reason to own utilities is because they are regulated and provide stable rates of return. These are very safe stocks with good dividend yields. Given recent volatility in the markets, water utilities provide a safe haven. It's not a case of rush out and buy if it's a particularly dry summer."

Elsewhere on the UK market, you can look to water technology companies. Thomas cites Hydro International, a small company that develops technologies to manage storm waters, urban run-off and sewer overflow systems.

In funds, water is generally a theme within a fund, but there are few specialist funds. Mark Dampier, head of research at Hargreaves Lansdown, says you should look to the environmental funds, or invest in the Impax investment trust. One specialist fund is Pictet Water, an offshore fund domiciled in Luxembourg. Dampier says he expects specialist water funds to become a more prominent theme.

Liquid assets: five companies to consider

* Severn Trent: Martin Walker of Invesco Perpetual says this is a stable company that could provide reliable returns even if the current stock-market volatility continues. It's a classic defensive play, in that people's water usage does not change whatever happens in the economy. And a decent dividend yield is good security.

* Hydro International: the UK's water infrastructure is Victorian, and shortages are partly a result of leakage from crumbling pipes. Charlie Thomas of Jupiter, says Hydro has specialised in innovative technology that is slowly improving water distribution and network management.

* Amiad Filtration Systems: based in Israel and listed here on AIM, Amiad is a global supplier of automatic self-cleaning, low maintenance filtration systems. Thomas says Amiad sells its products in 60 countries. Products are used for purposes from improving the quality of drinking water and recycling water in aquaculture industries to recycling water used by car-makers.

* Bio-Treat: this Singapore-listed waste-water treatment company is pioneering the use of bio-technology for water treatment in China, says Aled Smith of M&G. Instead of sludging methods, the company treats water using bacteria, which is more cost efficient and environmentally friendly. Bio-Treat, the only company that uses such technology, is the owner of several patents.

* Guangdong: the Chinese utility and infrastructure company, listed in Hong Kong, has had financial problems in the past but turned itself around and emerged a leaner, more efficient company, says Ian Beattie of New Star. China is increasing water prices in a bid to control wastage by big industrial companies. Guangdong, as a big supplier, is a prime beneficiary of increased prices.

Independent Partners; Do you need financial advice on your investments, pension or insurance? Book a free consultation with an independent Financial Adviser at VouchedFor.co.uk

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