This article was written by expert contributor, Wilson Asset Management
This is part 4 in a 4-part series on real assets and the investment opportunities.
The bull case for water
Australia has one of the most transparent and regulated water markets in the world. Water rights form an important part of this market structure, providing the holder of the entitlements with a specified volume storage of water from a particular source for consumptive use. Entitlements vary by State jurisdiction, but they are all transferable and can be valued at the market by observable traded prices.
The traditional owners of these water rights have been farmers, who need reliable access to water to maximise their annual productivity. Prior to 2012, water rights were not really considered an investable asset but, since then, they have been attracting increasing attention from institutional investors. In part, this has been driven by progressive market reforms, which have improved market efficiency and made it easier for institutions to invest.
Additionally, farmers have been keen to rationalise their balance sheets. It is expensive to hold water rights as an asset, and many farmers have looked to sell their water rights, and instead pay annually for access to the same source of water. Institutional investors have facilitated this transition by buying the assets, attracted to the consistent, highly regulated income stream and the prospect of long-term capital appreciation.
Historically, returns from water rights have been approximately 10%-15% per annum, driven by a combination of the regular income stream and steady capital appreciation. The capital value of the underlying asset has benefited from the additional institutional demand, alongside an ongoing shift in water use from lower-value crops to higher-value permanent produce such as almonds, citrus and grapes.
The trends that have seen water rights emerge as a nascent asset class remain in place, and we would expect institutional demand to continue to increase. The prospect of further capital gains is perhaps more modest than it was ten years ago, though the outlook for long-term returns from water rights remains attractive.
What is the outlook for Australian investors in real assets?
As we have outlined, the real asset opportunity set for Australian investors is deep and diverse. Accessing it is not straightforward for private investors, though. Investing directly in real asset projects requires multi-million-dollar ticket sizes that prevent most investors from participating.
Pooled fund opportunities represent a cheaper and more accessible route and, although there aren’t many options to select from, it makes sense to have an experienced fund manager forming partnerships with specialist investors that have expertise and experience in particular parts of the asset class.
Within a broadly positive opportunity set, it is important to be selective and invest in the right geographic areas and an appropriate combination of different assets to deliver the most appealing blend of risk/return characteristics.
With respect to inflation, we cannot know more than anyone else about whether the current bout of rising prices will prove more enduring. However, real assets represent an attractive route for anyone wishing to hedge against the risk of future inflation.
Finally, in a world of change, risks cannot be ignored. Some of the risks that face real asset investors may be amplified as a result of the climate crisis, but other megatrends, such as demographics and the increasing global demand for food, play firmly to its strengths. As a result, the long-term potential from real assets looks attractive – and differentiated.
Part 1 – What are ‘real assets’?
Part 2 – Real assets: Agriculture – grow your own performance
Part 3 – Real assets: Timber – seeing the wood for the trees
Wilson Asset Management has a track record of making a difference for shareholders and the community for more than 20 years. As the investment manager for eight LICs – WAM Capital (ASX: WAM), WAM Leaders (ASX: WLE), WAM Global (ASX: WGB), WAM Microcap (ASX: WMI), WAM Alternative Assets (ASX: WMA), WAM Strategic Value (ASX: WAR), WAM Research (ASX: WAX) and WAM Active (ASX: WAA) – Wilson Asset Management invests over $5.4 billion on behalf of more than 120,000 retail investors.
Wilson Asset Management created and is the lead supporter of the first LICs to deliver both investment and social returns: Future Generation Australia (ASX: FGX) and Future Generation Global (ASX: FGG). Wilson Asset Management advocates and acts for retail investors, is a member of the global philanthropic Pledge 1% movement, is a significant funder of many Australian charities and provides all team members with $10,000 each year to donate to charities of their choice. All philanthropic investments are made by the Investment Manager.