A recent AFR article poses an interesting question; how are investors surviving in Australian water markets right now when annual returns are so low? I believe the answer lies in the different ways investors have gone about deploying their capital and what they expect from their investments. 

One group of investors has focused on buying large 'off-the-shelf' entitlement portfolios. These investments can come packaged with locked in returns from long-term annual leases and are ultimately seeking capital growth. Investors run these portfolios with low management overheads and due to their weighting towards leases they can be resilient to years when the allocation prices are low. 

A second group of investors, generally large agribusiness, has been buying up multi-million dollar single parcels of water entitlements to underpin their own irrigation developments. These investors have generally been willing to pay over market value for these entitlements but they aren't seeking annual returns in the same way the first group of investors are. Rather, these agribusiness investors are using the water for their own irrigated agricultural production and this means their returns are measured on their agricultural output not the price they can achieve for their water on the temporary water market. 

A third group of investors has been buying up smaller entitlement parcels to build large portfolios that are diversified across multiple water systems. This is a reasonable approach, but this group of investors has been doing this at a time when entitlement prices are at historical highs and allocation prices are now much lower that when these investors started raising funds. The impact of this is that these investors will have to accept much lower annual returns at the beginning of their investments than they might have expected or promised. The ability of these investors to lock in reasonable long-term lease arrangements for the majority of their water portfolios will be key to generating competitive returns over the medium term.