Liquid Assets

It’s hard to see anything precious in a glass of water. After all, water covers nearly 71 percent of the earth’s surface. But after a few minutes talking to hedge fund manager John Dickerson, that glass of mundane refreshment seems as vital -- and potentially as volatile -- as Saudi crude.

Dickerson, 65, runs the $440 million Summit Water Equity Fund, the first, and until recently the only, hedge fund to invest solely in water-related companies. For such a bland commodity, water has produced sparkling returns for Dickerson and his San Diegobased firm, Summit Global Management, which has an additional $100 million in separately managed accounts. From January 1999, when it launched, through May 31, 2007, the fund posted a 201 percent net gain, compared with the Russell 2000’s 120 percent advance and the meager 37 percent rise of the Standard & Poor’s 500 index for the same period. “Just three years ago no one thought about water as an investment,” says Dickerson, who has specialized in the industry for nearly 40 years. “But in the not-too-distant future, it will be common for every investor to have some percentage of assets allocated to water.”

In fact, the secret about the value of blue gold already seems to be out. After decades of having the water-related industry almost to himself, Dickerson is now competing with thirsty newcomers. Water industry conferences are growing in number and popularity. New York’s Goldman, Sachs & Co. and Switzerland’s UBS and Credit Suisse Group are three of several big firms with analysts covering the industry. The sector even has its own indexes -- the latest being the S&P global water index, which debuted in February and comprises 50 of the world’s largest water companies. Two exchange-traded funds that track that index listed this spring -- the Claymore S&P Global Water ETF, which trades on the American Stock Exchange, and Barclays Global Investors’ iShares S&P Global Water, which trades on the London Stock Exchange.

Big business is investing in water too. In May, Fairfield, Connecticutbased General Electric Co., already a major player in water, announced that it will help build the biggest seawater desalinization facility in North America in Carlsbad, California. Germany’s Siemens Corp. has made several acquisitions of water-treatment companies, including the purchase last fall of 70 percent of CNC Water Technology in Beijing for an undisclosed amount.

The sudden interest in the sector is the result of increased concerns about the world’s water supply. Dickerson speaks with the dispassion of an unheeded prophet as he discusses the gloomy outlook. He warns that xenobiotic substances from things like birth control pills and chemotherapy drugs are turning up in drinking water, yet water-treatment plants can’t detect or filter them out. The oldest and often poorest U.S. cities lose as much as 50 percent of their water through cracks and broken pipes, but no money has been allocated to fix them. And more than half the world’s major rivers are either polluted or going dry.

The news keeps getting worse. An April report published in Science magazine’s online journal predicted that the severe drought that has parched the southwestern U.S. since 2000 could become a permanent reality by 2050. Arizona, California, New Mexico, Montana, Nevada, Utah and Wyoming are fighting over rights to aquifers -- water-bearing strata of rock or sand -- and the Colorado River.

These skirmishes pale beside the looming crises in India, where the country’s demand for water is expected to exceed all sources of supply by 2020, according to a recent World Bank report, or in China, where 440 of its 669 cities suffer shortages and the water table is dropping by nine feet a year. Global warming makes the situation worse.

“About 95 percent of the world’s water is provided by governments, and look at the sorry mess it’s in because of it,” says Dickerson, a former analyst at the Central Intelligence Agency who left government after his repeated warnings about rising enemy troop levels during the Vietnam War were ignored.

Unlike other resources, water, at any price, has no substitute. But Dickerson says technology can supply solutions to the world’s looming water crisis. After moving back to his hometown of Denver in 1967, he became interested in water investing, working as a portfolio manager for Standard & Poor’s Corp. -- a position he held for less than a year before leaving to launch his own investment firm, Alpine Capital Management. Yet it wasn’t until 1979, when he became the unpaid treasurer for a small nonprofit water company in a Denver suburb, that he began focusing on water securities. Dickerson was struck by the economic anomalies of water and quickly realized that no other product was so underpriced relative to its value.

But he was too early. Not one analyst covered the U.S. water industry at the time, and investors were similarly indifferent. In 1993, Dickerson sold the asset allocation division of his firm to a San Diego, California, investment company then known as Centurion Capital Management and moved there to help with the transition. A year later he launched Summit Global Management.

In 1999, Dickerson decided to open a water industry hedge fund but raised just $25 million. The only investors were clients who had already made money taking his advice on water-related companies in their separately managed accounts.

European companies, meanwhile, saw the water industry differently and began buying an array of water-related enterprises in the late 1990s, including the three largest private U.S. water-service providers. In 1999, France’s Vivendi Environnement (now Veolia Environnement) bought Palm Desert, California’s U.S. Filter for $6.2 billion; in 2000, Suez Lyonnaise des Eaux, also French, bought Harrington Park, New Jerseybased United Water Resources for $1.02 billion; and in 2003, Germany’s RWE bought Voorhees, New Jersey’s American Water Works Co. for $8.6 billion.

The combination of European interest and steady growth among water industry stocks helped Dickerson’s Summit Water Equity Fund breeze through the dot.com bubble, a feat made more impressive by the fact that it did not use leverage or short stocks in its first four years. (The fund now shorts stocks and can use leverage but hasn’t yet.) As the Nasdaq Stock Market swooned, Summit racked up a cumulative 60 percent gain, after fees, by the end of 2003. Still, few American investors cared to listen to Dickerson’s water story, and fundraising languished. Many European companies also pulled out of their investments when U.S. consolidation and privatization failed to follow the pattern it took in the U.K. and parts of Europe.

Then in 2005 a large British investment firm, which Dickerson declines to name, asked Summit to open an offshore clone. New money poured in and continues to do so. Because investment opportunities among water-related companies are limited, Dickerson plans to stop accepting new money when assets reach $650 million.

A value investor, he looks for investment candidates selling at significant discounts to appraised value, which he determines by calculating a company’s cash flow; earnings before interest, taxes, depreciation and amortization; and book value. As private equity firms and hedge fund managers have sent U.S. water-related companies to dizzying multiples, Dickerson has started seeking opportunities abroad, especially in emerging markets, such as Brazil, Hong Kong and Singapore.

The Summit Water Equity Fund invests in a universe of 373 companies worldwide with a total market capitalization of $640 billion. The portfolio typically holds 35 to 40 long positions and five to ten shorts. Stocks include conglomerates like ITT Corp., whose Fluid Technology division produces products for wastewater and residential water systems, but most are small and medium-size companies that get little attention from analysts. A typical holding is Hong Kong’s Bio-Treat Technology, a microcap company, traded on the Stock Exchange of Singapore, that has developed a process to treat sludge. In the first five months of the year, its stock price climbed 54 percent.

Like many companies in Summit’s portfolio, Bio-Treat is marketing its process to China -- a country gearing up to spend vast amounts on its water, sanitation and environmental infrastructure. Credit Suisse, which issued its first report on the sector in June, predicts that worldwide spending on water industry infrastructure will grow 7 percent annually through 2025, with growth rates exceeding 15 percent in India and 12 percent in China.

“Asia has a very low level of infrastructure, so it really needs the private sector to supply the financing and the management expertise,” says Eric Lopez, a Credit Suisse analyst based in London who has covered the water industry for nine years. He says political resistance in the U.S. to privatizing water systems makes industry growth there more difficult to forecast. And despite a host of problems -- from aging treatment plants to polluted rivers and lakes -- the U.S. has not appropriated the billions of dollars it needs to repair its water systems.

R. Steven Maxwell, who advises Summit as head of Boulder, Coloradobased Techknowledgey Strategic Group, traces America’s lack of concern about its water industry to politicians who have kept prices artificially low by deferring maintenance. He says Americans, more than most of the world’s people, feel entitled to cheap water -- one reason privatization efforts have faced strong opposition.

Maxwell predicts resistance will fade as severe water shortages and public health disasters overwhelm cash-starved public water utilities. He says within a decade consumers can expect to pay ten times more than the average $30 monthly water bill.