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The Next Phase of the AI Investing Boom? Water

In a gold rush, sell picks and shovels. In an AI rush, sell chips and server racks… and water.

Sparklers and Champagne Glasses

Arguably, the biggest beneficiaries of the AI-driven rally of the last year-plus have been the AI chipmakers and infrastructure plays.

Nvidia (NVDA) has been the best-performing “Magnificent Seven” stock since the end of 2022, but even its staggering returns (up over 500% as of this writing) have been dwarfed by the performance of Super Micro Computer (SMCI), which is up over 1,000% in the same timeframe.

Whether those returns are sustainable (let alone repeatable) is the million- (or billion, or perhaps even trillion) dollar question. But it does bring to mind a quote apocryphally attributed to Mark Twain: “When everybody is digging for gold, it’s good to be in the pick and shovel business.”

In essence, bet on the clear beneficiaries of a dominant trend rather than the competitors in the arena. Every miner needs picks and shovels, regardless of whether they strike it rich. By that same token, every AI company needs high-powered GPUs and data centers full of servers. Hence the performance of NVDA and SMCI cited above.

But for all the money flowing towards chipmakers, there is another picks-and-shovels adjacent AI trend that is just as investible: water.

There are credible estimates that a single interaction with ChatGPT (5-50 queries; so perhaps a single question and a few follow-ups or a brief “conversation”) consumes 500ml of (primarily) potable water, the equivalent of a typical bottle of water.

In their 2023 Environmental Report, Google alone disclosed that their water consumption in 2022 was 5.6 billion gallons, up 20% from 2021.

And they’re not alone. Microsoft saw similar spikes in its own water consumption, which rose 34% from 2021 to 2022, to nearly 1.7 billion gallons, per their 2022 Environmental Sustainability Report.

The water consumption in question is owed largely to the proliferation of large (hyperscale) data centers, which consume huge quantities of water for cooling and humidity management, to say nothing of water consumed by chipmakers in the production of those data center chips. (Global chipmaker water consumption is estimated to rival that of the city of Hong Kong and its 7.5 million residents.)

The usage is ubiquitous amongst large tech companies, with Amazon (for their web arm, AWS), Meta Platforms and Apple also using billions of gallons annually.

Now, to give the (thirsty) devils their due, four of the five companies listed above (excluding Apple) have committed to becoming either water-neutral or water-positive (returning more water to the ground than they consume) by 2030.

But with data center growth (and water consumption) showing no signs of slowing down, there’s a case to be made that parched server farms are turning water into a fringe AI investment in its own right.

The downside of taking the water angle on AI is that you’re unlikely to experience the massive speculative upside of a pure-play AI investment such as a software company or chipmaker.

The upside, however, is that it’s a more conservative angle that’s less likely to get caught up in the market’s AI-driven hype cycle.

Plus, it’s more straightforward. It doesn’t matter whether Dall-E 3 or Midjourney is the better AI image generator, nor does it matter whether Google’s Gemini (nee Bard) gobbles up market share from OpenAI’s ChatGPT or Microsoft’s Copilot. All of them will be slurping up groundwater for years to come.

Investors looking to put a little water weight into their portfolios would be well-served by any number of ETFs. The First Trust Water ETF (FIW) is a fund we’ve written about before. With $1.5 billion (give or take) in assets under management (AUM), it also happens to be one of the larger water-focused funds. It’s up just shy of 6% YTD with an expense ratio of about 0.5% and a modest yield of 0.7%. This fund broadly invests in companies that derive the majority of their revenues from potable and wastewater services.

The Invesco Water Resources ETF (PHO) is an equally large ($2 billion AUM) fund with a similar yield and expense ratio (both right around 0.6%) but is a more concentrated portfolio that prioritizes water conservation and purification. It’s also modestly outperforming FIW, up 7.7% YTD.

The Invesco S&P Global Water Index ETF (CGW) is a slightly smaller fund ($970 million AUM) that has comparable expenses, but a higher yield (1.5%) and lower YTD returns (up 4.4%). CGW invests globally in the largest companies in the water business and thus offers more exposure to utilities (hence the higher yield and lower performance).

Global water management is likely to have long-term tailwinds as the climate changes and, for now at least, it also looks like a long-term AI winner, regardless of what software comes out on top.

Brad Simmerman is the Editor of Cabot Wealth Daily, the award-winning free daily advisory.