Slow Money Moving Slowly Forwards

I participated this week in a conference at Quebec’s Caisse de Depot, the Provincial Pension Fund Manager. Before they were recently over taken by CPPIB, they were the largest Government fund in Canada, and for 12 years I ran their Emerging Markets Equities team there.

I used the opportunity to talk to friends and former colleagues, and to get an update on what they were doing in Emerging Markets. I have to say it was reassuring to hear that so many of the strategies I had helped initiate with Ghislain Parent, the former CFO, were still progressing.

It was also interesting to hear the list of countries they were targeting for increased infrastructure investment; It was a short-list of countries that the press today insists are about to undergo major crises. They confirmed my point from last week that the duration of any crisis would be so short compared to not only the construction cycle but also the life of the project as to be irrelevant.

This is slow money moving slowly forwards.

Every year the Caisse holds a conference on sustainable investment, this year’s conference was on the subject L’EAU EN ACTION$
Implications pour les investisseurs.

From the title alone, it should be clear that this was the Caisse looking ahead years and decades rather than weeks and months; slow money moving slowly forwards.

Why do organizations like the Caisse take such a long view, and why are they not as panicked as the press by all these imminent crises?

These funds have very long-term liabilities, and their planning needs to match that. Here in Canada, our main pension funds are regularly tested to make sure they are actuarially sound for 70 years. That may seem obvious, but too many pension funds across the world are in deep trouble precisely because their sponsors failed to plan adequately; Detroit’s recent bankruptcy filing was merely the tip of an iceberg.

By planning this far ahead, the Caisse and others identify new and up coming opportunities to invest in AND threats to their existing investments. They get to invest in horseless carriages and pocket calculators rather than continuing to invest in buggy whips or slide-rules.

Growing up in rainy England, we had regular droughts through the 70’s and 80’s, as the storage of all that rain was simply inadequate. Here in Canada, we tend to think of water as a limitless resource, but even that can be over optimistic. The dormitory town I live in just out side of Montreal is looking for their second new water supply in only 5 years because the previous new water wells are already silting up.

China has about 20% of the world’s population but only 6% of the world’s usable water. Most people are aware of the air, ground, and water pollution in China even if they haven’t even been there, so it is probably uncontroversial to say even that 6% is optimistic; I have never been to that part of China, but I am told the water behind the Three Gorges Dam was basically an open sewer before the dam was even finished. China has even started blocking new production facilities because the designs do not include adequate plans for water supply or treatment.

India is in many ways worse than China, with 16% of the world’s population, yet only 4% of its water resources. Recall also that India’s population is expected to outstrip that of China in a few years.

I borrowed the chart below from the presentation by Pierre Fournier of National Bank, which shows the historic and UN Projections for increases in demand for various agricultural products – Meat, Milk Products, Cereals, and Vegetables

It illustrates nicely how increased wealth leads to increased protein consumption.

If we combine that idea with another of his charts, below, that shows how much water is currently used in the manufacture of 1KG of production, we get to see how agricultural demand for water is set to skyrocket.

Luzerne is Alfalfa in English.

We can repeat this analysis for many different sectors, and get similar results, from Industry to Energy.

It would be easy to simply dismiss this as an Emerging World problem, to say water shortages will derail the Chinese economic miracle, but we in North America will be unaffected. Unfortunately such isolationist thinking misses the point, and emphasizes the importance of organizations like the Caisse holding conferences like this.

China is currently the world’s largest car market, and a huge source of profits for GM, Ford, et al. GE, Coca Cola, and many other household names have tied their future growth to the growth of these markets. If that growth gets derailed, they get derail; think about the recent hype over whether Apple would introduce a low-end iPhone for the Chinese market.

Many places in Europe, such as the UK and Germany face similar water shortages to China, whilst Belgium is worse than India, according to the World Bank.

North America is no longer immune to disruptions in global food supplies. In recent years we have seen spikes in the overseas price of rice, and wheat translate into higher prices domestically, whilst the underlying prices of meat on the CME continues to rise, see chart below.

Inflation can be a major threat to pension providers like the Caisse over the long-term, as it erodes real returns whilst increases index linked liabilities.

What then is the opportunity? According to McKinsey $57 Trillion needs to be spent on infrastructure, of which $11.7 Trillion alone needs to be spent on water infrastructure, between now and 2030. China expects to spend $850 Billion over the next 10 years on water infrastructure, including a 4-fold increase in desalination facilities.

India currently has about 1/5^th the storage capacity of China. Much of the Monsoon water just floods the land then runs off, so there are plenty of opportunities to build storage dams, which could be linked to hydropower as well. India is also building desalination plants. The Minjur desalination plant, at 36.5 million M³ is South East Asia’s largest.

There is also a huge need for improved treatment of wastewater – India treats only a fraction of its used domestic wastewater.

Again, it would be easy to dismiss some of this as yet more infrastructure spending, especially in China, in countries that are economically too dependent on infrastructure spending, but as José Serra showed in Brazil, increasing spending on water treatment can reduce healthcare costs, as fewer children catch and die of gastrointestinal diseases. Remediating wastewater may not return rivers to their former glory, something like 28 000 in China appear to have stopped flowing, but turning rivers like the Tietê and Pinheiros from open sewers to at least livable-with makes citizens lives less unpleasant.

For an organization like the Caisse, these represent a variety of opportunities. Desalination plants can be built and operated under long-term concessions, as can municipal water services. Municipalities may issue infrastructure bonds, backed by utility taxes. The companies that actually construct these plants may list their shares, or raise project finance.

The companies providing these services may be from Quebec, they may be European like Suez, or they may be part of the Emerging Portfolio; one of the first Indian construction companies I ever met had just finished building a new sewer system in the unfashionable part of Saudi where I had lived as a teenager.

I am embarrassed to say, I do not know how long it takes to build a desalination plant, but I would guess 5 years including permitting and land acquisition – possibly less in China, more in India. So what are the chances of a crisis during the life of the project?

India last had a Foreign Exchange crisis in 1991. It has been obvious for a while that a new one is brewing, even if not as bad as ’91, so if India has a major crisis ever 25 years or so, that puts the probability of a crisis during the construction phase at about 20%, and during a typical 25 year concession period 100%.

Brazil had a mini crisis a year or so after the introduction of the Plano Real, as the euphoria wore off. It had a major crisis following the Russian default, then again when it became clear Lula was going to win the Presidency in 2002. If we add the current correction to the list (I think that is pessimistic) we get a minor crisis about every 5 years, so we would get one crisis during the construction period and 5, at least one of which could turn major, during a 25 year concession.

So stepping back, it is clear that taking such a long view of investing makes perfect sense for organizations like the Caisse or CPPIB, even if voters do occasionally complain. I think the many citizens in the US and elsewhere will be soon wishing their Governments had been so forwards thinking.

It is also clear why so many of these firms like the Caisse and the Norwegian Pension Fund take Socially Responsible Investing in all its forms so seriously. Only then can you really quantify the spectrum of risks they face going forwards.

It was a great conference and my compliments to Meggie Daoust and Johanne Pichette for such a great job.