THE BUY SIDE - Genuine Liquidity

The glass is always half full for John Dickerson, who runs the $440 million Summit Water Equity Fund, the first, and until recently the only, hedge fund to invest solely in water-related companies. The fund has produced sparkling returns for San Diego–based Summit Global Management, which runs an additional $100 million in separately managed accounts. From its launch in January 1999 through May 31, 2007, Summit Water posted a 201 percent net gain, easily besting the Russell 2000’s 120 percent advance and the 37 percent rise of the Standard & Poor’s 500 index over that period.

“Just three years ago no one thought about water as an investment,” says Dickerson, 65. “But in the not-too-distant future, it will be common for every investor to have some percentage of assets allocated to water.”

The secret seems to have leaked out. The number of water industry conferences is growing, and securities firms now dedicate analysts to the business. The sector even has its own indexes — the latest being the S&P global water index, which debuted in February and comprises 50 of the world’s largest water companies. Two exchange-traded funds that track that index listed this spring — the Claymore S&P Global Water ETF, which trades on the American Stock Exchange, and Barclays Global Investors’ iShares S&P Global Water, which trades on the London Stock Exchange.

A former analyst at the Central Intelligence Agency, Dickerson became interested in water investing after moving back to his hometown of Denver in 1967 and working as a portfolio manager for Standard & Poor’s Corp. Less than a year later he left to launch his own firm, Alpine Capital Management. It wasn’t until 1979, when he became the unpaid treasurer for a small nonprofit water company in a Denver suburb, that he began focusing on water securities. Dickerson was struck by the economic anomalies of water and quickly realized that no other resource was so underpriced relative to its value.

But he was too early. Not one analyst covered the U.S. water industry at the time, and investors were similarly indifferent. In 1993, Dickerson sold the asset allocation division of his firm to a San Diego, investment company then known as Centurion Capital Management and moved there to help with the transition. A year later he launched Summit Global Management.

In 1999, Dickerson decided to open a water industry hedge fund but raised just $25 million. The only investors were clients who had already made money taking his advice on water-related companies in their separately managed accounts. Nonetheless, steady growth among water industry stocks, fueled in part by growing interest from European companies in U.S. water-service providers, helped Dickerson’s Summit Water Equity Fund avoid the carnage of the collapsing dot-com bubble, a feat made more impressive by the fact that the fund did not use leverage or short stocks in its first four years of operation. (It now shorts stocks and can use leverage, but hasn’t yet.)

Fundraising remained slow but Dickerson got a boost in 2005, when a large British investment firm that he declines to name asked Summit to open an offshore clone. Since then, new money has been pouring in. Because investment opportunities in water-related companies are limited, Dickerson plans to stop accepting new money when assets reach $650 million.

Today the Summit Water Equity Fund invests in a universe of 373 companies worldwide with a total market capitalization of $640 billion. The portfolio typically holds 35 to 40 long positions and five to ten shorts. Stocks include conglomerates like ITT Corp., whose Fluid Technology division produces products for wastewater and residential water systems, but most are small and medium-size companies that get little attention from analysts.

A value investor, Dickerson looks for water-related stocks selling at significant discounts to appraised value, which he determines by calculating a company’s cash flow; earnings before interest, taxes, depreciation and amortization; and book value. As private equity firms and hedge fund managers have sent U.S. water-related companies to dizzying multiples, Dickerson has started seeking opportunities abroad, especially in such emerging markets as Brazil, Hong Kong and Singapore.

A typical holding is Hong Kong’s Bio-Treat Technology, a microcap company, traded on the Stock Exchange of Singapore, that has developed a process to treat sludge. In the first five months of the year, its stock price climbed 54 percent. Like many companies in Summit’s portfolio, Bio-Treat is marketing its process to China — a country gearing up to spend vast amounts on its water, sanitation and environmental infrastructure. Credit Suisse, which issued its first report on the sector in June, predicts that worldwide spending on water industry infrastructure will grow 7 percent annually through 2025, with growth rates exceeding 15 percent in India and 12 percent in China.

“Asia has a very low level of infrastructure, so it really needs the private sector to supply the financing and the management expertise,” says Eric Lopez, a Credit Suisse analyst based in London who has covered the water industry for nine years. He says political resistance in the U.S. to privatizing water systems makes industry growth there more difficult to forecast. And despite a host of problems — from aging treatment plants to polluted rivers and lakes — the U.S. has not appropriated the billions of dollars it needs to repair its water systems.

R. Steven Maxwell, who as head of Boulder, Colorado–based consulting firm Techknowledgy Strategic Group advises Summit, traces the lack of concern about the U.S. water industry to politicians who have kept prices artificially low by deferring maintenance. He says one reason that privatization efforts have faced strong opposition is that Americans feel entitled to cheap water. But he predicts resistance will fade as severe water shortages and public health disasters overwhelm cash-starved public water utilities.

That may be bad news for consumers if prices climb. But for Dickerson and other water stock investors, opportunities abound. After all, unlike other resources, water has no substitute at any price.