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Hong Kong/Shanghai. There is a clear winner as China pumps in billions of dollars to reverse the damage to its water resources and provide clean water to its people: water-treatment firms.

Private equity and venture capital firms are pouring money into Chinese water-treatment companies, targeting high returns from the industry heavily supported by the government.

The mainland’s rapidly expanding water sector, valued at $48 billion, is the third-largest in the world, according to research firm GWI Global Water, behind the United States at $110 billion and Japan at $59 billion. Analysts estimate the industry will triple to reach at least $150 billion over the next five years.

“Investing in water plays in China is one of the easiest decisions I can make as far as where to allocate capital,” said Aaron Visse, portfolio manager for San Francisco-based Forward Management. “I can sleep very well at night with these investments and the valuations that they are sitting at right now.”

Investments from Chinese private equity and venture capital firms into the sector have jumped more than 40 times to $382 million so far this year from $8.6 million for the whole of 2010, according to consultancy firm China Venture.

Buyout firms such as Sequoia Capital China and CDH Investments, known as China’s Blackstone, have been among the major companies that took stakes in water-treatment firms over the past few months.

Growing cities, overuse of fertilizers and factories that heedlessly dump wastewater have degraded China’s water supplies to the extent that half of its rivers and lakes are severely polluted.

China is more than doubling its investment in the waste-water sector, spending around 300 billion yuan ($45 billion) over the next five years as it tries to undo the damage caused to its water resources by 30 years of untrammeled growth.

Asset managers investing in renewables say the sector is making up a growing chunk of their portfolios, particularly after the nuclear crisis in Japan highlighted the need for more water-treatment facilities.

“One huge positive of investing in water companies in China as opposed to say, many alternative-energy areas, is that you get a lot of identifiable cash flow, and much of it is recurring,” said Visse, who manages the firm’s Global Infrastructure fund, valued at around $115 million.

Guangdong Investment and China Water Affairs are among Visse’s top picks. Shares in Guangdong Investment have gained around 10 percent, while China Water Affairs has risen more than 4 percent since March 17, as China detailed its spending plans for the sector during the month.

Sequoia Capital China recently made an investment in Beijing-based water-treatment firm Zhongchi Environmental Protection Development. Beijing-based buyout firm CDH Investments offered to buy Sinomem Technology, a Singapore-listed water-treatment provider, for around $280 million in March, while KPCB China has invested around $10 million in Scinor Water, previously known as Mobius Water, a leading membrane-based water-treatment firm.

While the water-treatment sector is enticing, there is only a limited number of listed firms, many of which are small and lack transparency and good corporate governance. Investing in water companies does make business sense, but assessing risk profiles of the firms remains a challenge, said Francois Perrin, head of Asian SRI Equities for BNP Paribas Investment Partners.

“Unfortunately, we had a couple of disappointments in that space, with very nice companies and potentially very nice products,” Perrin said.

Reuters