The $25 billion Australian water entitlements market is proving a lucrative and attractive allure for investors that want to diversify their portfolios with the alternative asset class.

Picked to influence current alternatives and mainstream investment sectors, this emerging asset class is one with liquidity and a natural resources-type exposure according to Kim Morrison, managing director, Blue Sky Water Partners who recently launched their own water fund for the Australian water entitlements market.

The water markets in Australia have been evolving since 1994 when a cap was placed on the issuance of water rights, with the Murray Darling Basin cap and water trade particularly sophisticated. 

"This asset that we are investing into is finite, there aren't any going to be any more water rights issued for the Murray Darling Basin, the government is buying back some 10 per cent, so we believe capital growth will be driven by this scarcity of water."

Morrison said the returns for such an investment are not correlated to other traditional forms of investment such as property or the stock market, but driven by climatic conditions.

"From that perspective putting some of this exposure into your portfolio obviously changes diversification strategy and returns and that has some appeal for investors," said Morrison.

Currently there are two markets that operate in Australia.

The permanent market, or water rights, allows investors to buy a right to a set river system, essentially taking a share of that resource each year. The investor is allocated a volume of water every year that can either be used or sold.

The temporary market buys these volumes of water.

"We expect capital gains to be 7-12 per cent per annum and derive an annual income from water sold which we expect to derive a yield between 3-7 per cent per annum," said Morrison.