Institutional investors are paying a lot more attention to the potential financial impact that flooding, water scarcity, water pollution and other water risks could have on their portfolios—and financial advisors should too.

According to an assessment by Ceres, a nonprofit focused on sustainability, more than 50 percent of the components of the S&P 500, MSCI World, MSCI Emerging Markets and Russell 3000 indexes are exposed to medium to high water risks.

Even fund managers whose strategies don’t have an environmental, social and governance (ESG) theme are starting to do more water due diligence, says Monika Freyman, a CFA and the director of investor engagement on water at Ceres.

The Investor Water Hub, a working group Ceres started in 2015 with two-dozen institutional investors seeking to become more water aware, has grown to more than 110 members.

“Climate change risks are often manifesting as water risks,” said Freyman, noting that floods are becoming more frequent and droughts are getting longer. In the near term, water is the climate exposure that’s the “most catastrophic and most material,” she said.

This week, a judge in Brazil ordered Brazillian mining giant Vale SA to pay for all damages related to its deadly dam collapse in January. He said $2.9 billion of Vale’s assets would remain frozen by the courts. Vale, which knew its dam was at heightened risk of collapsing, posted a first-quarter loss of $1.6 billion.

Newmont Mining Corp. (now Newmont Goldcorp) was forced to abandon a $5 billion mine in Peru following community concerns about water pollution and water shortages, noted Freyman.

Another poster-child for water risks, beverage behemoth Coca-Cola, was forced to abandon bottling plants that competed with local water needs in drought-plagued parts of India and has faced boycotts from retailers there, she said. Last year, floods in Japan severely disrupted and caused losses for a Coca-Cola bottling subsidiary.

Water risk is also rising in the U.S. According to Reuters Breakingviews, the Colorado River, whose average flow has dropped by a fifth since 2000 and is set to fall further, supports about $4 billion in GDP and at least $1.3 trillion in stock value across seven U.S. states. Ceres has identified a handful of major food companies with direct exposure to potential disruptions of water supply in the region and noted many companies may be indirectly impacted.

Freyman encourages financial advisors to be aware of sectors with high water dependencies or water risks—including energy production, mining, food and beverages, chemicals and semiconductors.

According to the September 2017 Ceres report “Feeding Ourselves Thirsty,” food companies rely on 70% of the world’s freshwater to grow crops, feed livestock and process ingredients. Water demands are expected to increase with rising food demands.

Ceres’ Investor Water Toolkit, rolled out in December 2017 and posted on Ceres’ website, helps investors understand the physical, regulatory and social risks associated with water. The toolkit also provides steps for establishing priorities, buy/sell analysis, portfolio and asset class analysis, and water engagement with companies.

Whether looking at equities or fixed income, “investors really have to accelerate their water awareness,” said Freyman.

Know What You Own

Financial advisors concerned about water risk shouldn’t just assume an ESG fund has this covered because these funds “are not all created equal,” said Cyrus Lotfipour, who leads the models and R&D function within the ESG research team at MSCI, a provider of indexes and portfolio analysis tools.

With any fund, “advisors need to understand what’s under the hood,” he said, and to ask fund managers about their processes. For example, does a portfolio underweight or exclude companies “that run the risk of having a water-related production disruption or losing their license to operate as a result of community opposition?” he said.

Water stress is one of the many metrics evaluated by the MSCI ESG Ratings tool. How big a risk it is for a company depends on its industry and on the geographic exposure of its assets, said Lotfipour.

According to MSCI, 37 percent of companies in the MSCI ACWI index have more than 50 percent of their operations located in high stress water regions. Twenty-two percent of companies in the index have a quantifiable water reduction target. Consumer-facing companies tend to be more transparent about water targets, said Lotfipour.

Emerging market economies can be more vulnerable to water risk. Large global equity funds tend to have less water risk, he said, because they’re diverse across geographic regions and industries.

 “Know what you own,” he said, “and what the exposure is.”