Morningstar - Q4 2021 - 28

Dispatches
includes an environmental segment with a
water filtration unit. Danaher's environmental
revenue, however, accounted for less than
20% of the company's 2020 revenue, and
water-related business lines made up only about
half of that. Still, seven of 10 prominent water
funds hold Danaher, even though 80% of
its sales came from healthcare and it's often
a top healthcare fund holding.
Industrial software company Roper Technologies
ROP makes smart water meters for utilities,
but the conglomerate serves a variety of industries,
including oil and gas, college cafeterias, and
toll roads. It's the second-largest holding
in Fidelity Water Sustainability FLOWX, even
though less than half of its revenue comes from
its water business.
There are even more puzzling holdings. PHO and
PIO have sizable positions in Waters WAT,
which sells drugmakers tools to analyze molecules.
Its instruments have some ancillary water
testing applications, though not enough to break
out in the firm's financial reports. The company,
named after founder Jim Waters, otherwise
has little exposure to water.
Calvert Global Water CFWIX owns household
names like Procter & Gamble PG, Nike NKE, and
Hyatt H because the fund's managers believe
that, although they have little to do with water,
they are water-efficiency leaders. While
that's laudable, these are not water companies.
Until recently, there was no way to see how
closely equity water portfolios, with their mix of
utilities, industrials, and healthcare stocks,
track the spot price of water. That changed in
December 2020, when CME Group CME started
trading futures contracts on the Nasdaq
Veles California Water Index, which tracks the
spot price of water in California. That may
be just one local market in one country and one
economy, but it's the first instrument to offer
a water price proxy, and given its size, exposure
to urban and agricultural uses, and the
growing effect of droughts on water availability,
California's water market provides a solid
illustration of what scarcity and competing
demand drivers do to the price of water.
28
Morningstar Q4 2021
How well have water funds tracked that limited
proxy? Not well. All eight that have been
around as long as data has been available for
the index, since 2019, have actually tended
to move in the opposite direction of the
benchmark's measure of the price of water.
The eclectic composition of water funds and
their performance that's out of step with the price
of water stems from a dearth of opportunities
to invest in water. There are few pure-play
water companies, with conglomerates that
oversee broad business units controlling much
of the innovative technology and heavily
regulated utilities doing the buying, selling, and
treating of water.
Thus, the funds often stretch to find investable
names and end up offering fairly standard
equity exposure. Despite that, they tend to come
with a hefty price tag. So, it's doubtful investors
need a water fund. They are niche funds
that may duplicate equity exposure elsewhere
because many of their holdings are conglomerates
that figure prominently in other more
broadly diversified stock funds. They also don't
track existing, albeit limited, proxies for
the price of water very well. Until products that
offer more meaningful differentiation become
available, the high price tag doesn't justify the
straightforward exposures.
Bobby Blue is a manager research analyst at Morningstar
Research Services.
The office segment " is likely to continue to
have higher-than-historic vacancies, " the report
says. " However, with the eventual return to
in-person work and many DBRS Morningstar-rated
issuers' central business district assets
supported by long-term leases to high-quality
tenants, DBRS Morningstar expects some EBITDA
improvements in the second half of 2021. "
For retail, DBRS Morningstar " expects a longer
and drawn-out recovery, which will keep EBITDA
below pre-pandemic levels through to 2022. "
How city centers fare hinges to a large extent on
how the work-from-home issue unfolds: How
will employers accommodate workers with flexible
work arrangements, and how many workers
will indeed return to the office?
A Stanford University research group headed
by economics professor Nicholas Bloom
believes that working from home is here to stay
and will have an impact on downtowns,
increasing the " donut " effect-cities where the
center, or core, is hollow. " The home office
isn't about to shut down, " Bloom says. " In my
research and discussions with hundreds
of managers across different industries, I'm
finding that about 70% of firms-from
tiny companies to massive multinationals like
Apple, Google, Citi and HSBC-plan to implement
some form of hybrid working arrangements,
so their employees can divide their time
between collaborating with colleagues on site
and working from home. "
Are 'Donut' Cities
the Future?
AMERICAS
Canada
Canadian real estate has been on a tear recently,
but not all real estate. DBRS Morningstar
recently released a report, " Canada's Real Estate
Financial Risk: A Post-Pandemic Rebound, "
which noted that city center office space and retail
space continue to be laggards.
Downtowns in the United States have lost about
15% of people and businesses, while the
suburbs of some large cities are thriving, says Jose
Maria Barrero, assistant professor of finance
at the Instituto Tecnológico Autónomo de México,
who collaborates on Bloom's research. Though the
team has not conducted formal interviews in
Canada, Barrero believes that U.S. numbers apply
to major Canadian cities.
Barrero recognizes that REITs don't necessarily
show this erosion. " There haven't been
many lease cancellations in office rentals, " he
says. " My guess is that this will be a fairly
drawn-out affair. "
Morningstar - Q4 2021

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