AI is driving up demand for water

July began with cautious optimism, but market condi­tions quickly became more challen­ging. The renewed escala­tion in the Middle East caused energy prices and long-term bond yields to rise. At the same time, highly valued U.S. techno­logy stocks came under pressure. Profit-taking and growing doubts about the finan­cing of the AI boom weighed parti­cu­larly heavily on the Nasdaq. Europe fared better. A solid earnings season supported the markets and fostered a rotation into more defen­sive stocks, value stocks, and small- and mid-cap compa­nies. Overall, July was charac­te­rized less by broad-based price gains than by greater diffe­ren­tia­tion among compa­nies.

Focus on Water

In the water sector, the focus in July was prima­rily on the high water demand of artifi­cial intel­li­gence. Large data centers require considerable amounts of water for their cooling systems. In light of incre­a­sing public pressure, their opera­tors are now being more trans­pa­rent about how much water they consume and how they manage this resource. In Virginia, for example, a utility is building an exten­sive network for treated water to supply the region’s large data center cluster. The project has already been described as a kind of “Silicon Valley of water.” For provi­ders of cooling, measu­re­ment, monito­ring, and water reuse techno­lo­gies, this develo­p­ment opens up a long-term growth oppor­tu­nity.

The second major theme was the contrast between abundant capital and continued insuf­fi­cient invest­ment in infras­truc­ture. Global Water Intel­li­gence reported equity commit­ments of $687 million for water techno­logy in the first half of the year—a new record. At the same time, Bluefield Research reported the highest level of M&A activity in the sector since 2021. A total of 161 transac­tions were recorded in the first half of the year; in the second quarter alone, activity was 42% higher than in the previous year. However, this capital is flowing prima­rily into techno­logy compa­nies and acquisitions—and thus not automa­ti­cally into public water networks and facili­ties. EurEau conti­nues to point to a growing invest­ment backlog in Europe, as spending on water infras­truc­ture is lagging behind infla­tion. In the U.S., Bluefield also warns of the expira­tion of tempo­rary subsidy programs. States and munici­pa­li­ties already account for about 96% of water infras­truc­ture spending. Capital is there­fore available in the water sector—yet the struc­tural funding gap persists.

Company News

Pentair was the biggest disap­point­ment of the month. In the pool business, retailers reduced their invent­ories by a surpri­singly large margin. As a result, revenue in this segment fell by 42% in the second quarter, while conso­li­dated revenue declined by 17% to $933 million. Manage­ment subse­quently lowered its full-year forecast. The abrupt slump raised questions about how well Pentair can assess trends in its distri­bu­tion channels. The overall picture, however, remained mixed. The “Flow & Water Solutions” division achieved record margins. In addition, Pentair announced the acqui­si­tion of the Taco Group for $1.425 billion, thereby streng­thening its commer­cial water solutions business. The dividend was also increased for the 50th conse­cu­tive time. Follo­wing the nearly 20% decline in the stock price, we increased our position.

Most other compa­nies reported stronger results. Veolia raised its full-year outlook after net income rose 10% in the first half of the year. This was driven by effici­ency gains and the comple­tion of the $3 billion acqui­si­tion of Clean Earth. Xylem reported a 42% increase in order intake, inclu­ding the largest contract in the company’s history. As demand from the data center sector more than tripled, the company also raised its profit forecast. With the acqui­si­tion of sensor specia­list TriOS, Xylem is also conti­nuing to expand its software and digital measu­re­ment techno­logy capabi­li­ties. Tetra Tech also raised its outlook. The inter­na­tional water business grew by 12%, and the company was selected as the lead designer for the largest municipal PFAS treat­ment plant in the U.S.

Itron also delivered strong results. Record-high gross margins and an upward revision to its full-year forecast showed that the metering techno­logy and network software business is becoming incre­a­singly profi­table. The stock reacted positively as a result. Andritz reported a record order backlog of 12.6 billion euros. The hydro­power business performed parti­cu­larly well, with orders incre­a­sing by 82% in the first half of the year. Georg Fischer also benefited from strong demand from the semicon­ductor and data center industries while conti­nuing to divest non-strategic casting opera­tions. Sika raised its full-year forecast as effici­ency measures offset the continued subdued demand in the construc­tion industry.

Arcadis rejected a takeover bid from its compe­titor WSP. Manage­ment believed that the offer did not adequa­tely reflect the company’s value or its prospects. Opera­tional perfor­mance supported this stance: Strong demand for projects in the water, infras­truc­ture, and power grid sectors led to a record level of new orders.

Weaker results were parti­cu­larly evident in areas where problems were already known. Wiener­berger lowered its full-year forecast after weak residen­tial construc­tion activity in the U.S., the U.K., and Canada weighed on second-quarter earnings by appro­xi­m­ately 30 million euros. By contrast, the infras­truc­ture and renova­tion segments, which now account for more than 60% of revenue, remained stable. A. O. Smith reported a similar picture. Revenue in China fell by 28%, while the North American boiler business continued to grow strongly.

Develo­p­ments outside our portfolio were also revealing. Badger Meter further expanded its position in the digital monito­ring of waste­water networks. The company acquired Smart­Cover for $185 million and the British company UDlive for $100 million. Meanwhile, Scottish Water awarded contracts for digital services worth up to 230 million pounds to Accen­ture and BT. Both examples illustrate how the industry is evolving from indivi­dual devices toward connected systems, data analy­tics, and smart network control.

Overall, demand remained robust in the municipal water supply, infras­truc­ture, and digital solutions sectors. By contrast, residen­tial construc­tion, certain consumer-driven sectors, and compa­nies heavily depen­dent on the Chinese market saw weaker perfor­mance.

Fund Perfor­mance

Against this backdrop, the Tareno Global Water Solutions Fund posted a return of ‑0.74% in the W‑EUR tranche in July. There was a signi­fi­cant rotation within the water sector. Several compa­nies that had under­per­formed in the first half of the year rebounded strongly. Enginee­ring and consul­ting firms were parti­cu­larly in demand. Arcadis and Tetra Tech made a positive contri­bu­tion, as did Georg Fischer, Andritz, and Mueller Industries.

On the other hand, some of the year’s top perfor­mers so far gave up some of their price gains. In parti­cular, the previously high expec­ta­tions for compa­nies closely tied to data center expan­sion cooled somewhat. This weighed on Gorman-Rupp, Watts Water, and Advanced Drainage Systems. Regio­nally, the balance of forces also shifted: Europe supported the perfor­mance, while North America and Japan weighed on it. The portfolio’s broad diver­si­fi­ca­tion across utili­ties, industrial compa­nies, enginee­ring service provi­ders, and construc­tion-related business models helped offset these diffe­ring trends.

Positio­ning and Outlook

Earnings season remains in full swing and is likely to continue driving signi­fi­cant price movements in the coming weeks. We there­fore expect volati­lity to remain elevated, but we also see oppor­tu­ni­ties in this. In addition to geopo­li­tical risks, we are paying parti­cular atten­tion to the recent rise in interest rates. This could become a more signi­fi­cant headwind for the markets. Our approach remains unchanged: We focus on broad diver­si­fi­ca­tion and a careful analysis of funda­men­tals. At the same time, we are currently maintai­ning a slightly higher liqui­dity ratio of around 5% to enable us to respond flexibly to new oppor­tu­ni­ties.

In closing, a look at Switz­er­land illustrates why the issue of water is gaining importance even in regions that are suppo­sedly rich in water. This summer, the highest drought alert level is in effect nation­wide. At the end of July, reser­voir levels stood at around 51%, well below the long-term average of 68%. Numerous munici­pa­li­ties have intro­duced water restric­tions. This makes it clear that clean water is neither a given nor suffi­ci­ently available every­where. Compa­nies that contri­bute to the protec­tion, treat­ment, and more efficient use of this resource are there­fore addres­sing one of the central challenges of our time.