Epoxy putty, including Milliput, is a mixture of liquid epoxy and filler that makes the composite the consistency of clay. The epoxy does the work of holding the mixture together and bonding it to the substrate. The filler thickens it to give it the desired handling characteristics.
Some putties, like Milliput, will be softened by water while still uncured, but that's more of a side effect of the composition than a feature. The epoxy component doesn't mix with water, it's the filler that's affected.
Water can be exploited to smooth the surface because it thins the filler and the epoxy doesn't stick when it or the surface is wet. Smoothing the surface doesn't have a significant effect on the rest of the material.
But if you mix water into the putty, some of it will be trapped when the epoxy cures, which degrades and weakens the cured material. Also, the moisture in the putty in contact with the surface it's applied to weakens the bond holding it in place. The more water you add, the more it will degrade the result.
If your objective is just a surface coating or filler for minor defects, which doesn't need to be durable and won't be subject to a lot of handling, thinned Milliput may be adequate. But it isn't the ideal solution. Epoxy-based products work best when used as manufactured; start with a product of the right consistency for your needs.
If what you need is liquid epoxy, just start with that rather than adulterating epoxy putty. If what you need is a spreadable paste, start with an epoxy paste.