How do ESG mutual funds assess water scarcity risks?

Water scarcity is a growing global issue that affects many industries. ESG (Environmental, Social, and Governance) mutual funds are increasingly assessing water scarcity risks to identify companies that are exposed to potential operational and regulatory risks. ESG funds incorporate this critical factor into their investment strategy to align with sustainable investing and reduce environmental impact. Here’s how ESG mutual funds assess water scarcity risks.

What is Water Scarcity Risk?

Water scarcity risk refers to the potential risks that companies face due to the lack of access to water, which can impact their production, supply chain, and overall business operations. Water is an essential resource for many industries, including agriculture, manufacturing, and energy production. Companies that are heavily dependent on water can experience disruptions, increased costs, or even regulatory penalties in water-scarce regions.

As a result, ESG mutual funds assess how a company's operations are affected by water risks to ensure their investments are aligned with sustainability goals. This risk can be categorized into two types: physical risks (such as droughts and water shortages) and regulatory risks (such as policies restricting water use or imposing higher costs for water consumption).

How ESG Mutual Funds Assess Water Scarcity Risks

ESG mutual funds assess water scarcity risks through a combination of qualitative and quantitative metrics. Here’s how they evaluate and manage water-related risks:

• Data Collection and Reporting: ESG funds rely on publicly available data from companies' sustainability reports, such as those provided by CDP (formerly the Carbon Disclosure Project). Companies often disclose their water usage, management practices, and exposure to water risks, especially in regions with known water scarcity. This data is essential for ESG funds to assess how a company is managing its water footprint.
• Geographic Risk Analysis: ESG funds evaluate a company’s operations based on where they are located. If a company operates in water-scarce areas, such as arid regions or drought-prone countries, it is more vulnerable to water-related risks. ESG funds assess the geographical risk by examining the local water scarcity levels and policies that could affect a company's operations.
• Water Usage Efficiency: Another key factor that ESG funds assess is how efficiently a company uses water. Companies with high water usage, especially in industries like agriculture and manufacturing, are more exposed to risks related to water scarcity. ESG funds prefer companies that have water-efficient technologies and practices, which can help mitigate potential disruptions.
• Water Stewardship and Management Practices: ESG funds look for companies that have strong water stewardship practices. This includes actions like investing in water recycling technologies, reducing water consumption, or implementing water conservation initiatives. ESG funds favor companies that are proactive in managing their water risks and implementing sustainable practices.
• Engagement with Stakeholders: ESG funds also engage with companies to understand their strategies for managing water scarcity. This can include dialogues with company management, investors, and other stakeholders to ensure that water risks are being properly addressed and mitigated.

Why is Assessing Water Scarcity Risk Important for ESG Funds?

Assessing water scarcity risk is critical for ESG funds for several reasons:

• Operational Risks: Water scarcity can disrupt operations, especially in industries that rely heavily on water for production, such as agriculture, manufacturing, and energy. Companies with high water usage are more likely to face operational disruptions, higher costs, and reduced profitability during water shortages.
• Regulatory Risks: As governments around the world tighten regulations on water usage to combat water scarcity, companies that fail to manage their water consumption may face penalties or increased operational costs. ESG funds evaluate regulatory risks to ensure their investments comply with evolving water-related policies.
• Reputational Risks: Companies that neglect water sustainability may face negative publicity and backlash from consumers, investors, and environmental organizations. ESG funds assess the reputational risk of investing in companies with poor water management practices.
• Long-Term Sustainability: By assessing water risks, ESG funds help ensure their investments are sustainable in the long run. Companies that manage water scarcity risks effectively are more likely to perform well over time, while those that ignore these risks may struggle to adapt to changing environmental conditions.

As water scarcity becomes an increasingly important global issue, ESG mutual funds are prioritizing companies that are proactive in managing their water risks. By assessing water scarcity exposure, ESG funds help investors make more sustainable and socially responsible investment choices that align with long-term environmental goals.