In a yield-hungry world, the attraction of infrastructure has long been apparent. In a warming and resource-constrained world, the need to link this to sustainable goals is becoming equally so.
The connection between climate transition and infrastructure investment has recently been highlighted through US President-Elect Joe Biden’s support for the Green New Deal, and in the UK by the prime minister’s sustainable spending commitments.
Coupling infrastructure with sustainability is nothing new. In 2017, the United Nations highlighted that about USD90trn would be needed over the next 15 years for global infrastructure—more than the value of the entire existing stock. That’s a lot of supply to fill, particularly with government spending under pressure, and presents an opportunity for investors.
Ageing infrastructure in advanced economies and structural change in emerging markets underpin this imperative. Drivers include rapid urbanisation in emerging markets and the comprehensive need for a shift to a sustainable global economy.
From Grey to Green
Investors are nevertheless underexposed to the asset class, with OECD analysis earlier in the decade showing that pension funds’ allocation to direct infrastructure were less than 1%, and the ESG component considerably lower. But demand for sustainable infrastructure investment opportunities is growing. Investors see the potential for enhanced risk-adjusted returns, resulting from risk mitigation, cost reduction through better resource management, and improved sustainability.
Will this be sustained as we emerge from the pandemic? After all, there’s nothing like confronting your own mortality in one form to awaken you to other vulnerabilities. Or will it force such considerations into second place, as it did in the wake of the global financial crisis? That, at least, is the tenor of a recent Financial Times article, highlighting that “more than eight in 10 investors globally said their company has demoted ESG as an investment criteria because of Covid-19’s economic hit, according to a survey of 600 portfolio managers, analysts, chief investment officers, and stewardship teams”.
Reshaping Asset Management
On the other hand, the same paper elsewhere reports a study claiming that the “post-pandemic recovery will reshape the asset management industry”. It cites infrastructure, private markets, and sustainable strategies as important sources of new business for asset managers, which will transform the industry.
To determine if and where investors were buying into this trend, we looked at the growth in assets in relevant areas: Lipper Global Classifications’ Equity Themes Infrastructure, Alternative Energy and Water, plus the related theme of Agribusiness. While even Lipper data can’t tell the future, it can cast light onto recent trends that will allow us to make (hopefully reasonable) inferences, so it’s useful to see where and to what degree investors have been placing their bets—particularly when framed by sustainable goals.
The classification that is both largest and has seen the greatest inflows over the past three years is Equity Theme—Infrastructure. Of the £16.9bn of assets captured by these four themes, £15.2bn of them are in this ‘pure’ infra classification. Two investment trusts—the HICL Infrastructure Company and 3i Infrastructure—dominate, with £3.3bn and £2.7bn of assets by November 2020, respectively.
Chart 1: Infrastructure and sustainability equity theme assets by Lipper Global Classification (GBP bn)
Source: Refinitiv Lipper
Although ESG is increasingly influential in infrastructure, this is far from being a green asset class. Of the £15.2bn in assets in infrastructure funds, just £2.7bn is flagged as ethical. Nevertheless, that figure has increased by £1bn over the past three years, so the rate of change is considerable. More and more investors are getting behind the trend, as regulators demand, and pension funds adopt, targets linked to Paris Agreement objectives.
There is also a greater wealth of information to inform such decisions. Resources from such reputable sources as the CFA Institute and the UN-backed Principles of Responsible Investment are providing know-how and examples of best practice in accessible and actionable ways.
Renewed Popularity
Renewable energy is the most popular sustainable infrastructure investment area. The International Energy Agency estimates that the sector will take two-thirds of investment in power plants globally by 2040. In many countries, renewables are becoming the cheapest source of power generation. Sub sectors include geothermal, biomass, and hydro, with the fastest growing being solar and wind, which should continue to attract the bulk of investment.
Renewables’ increasing cost-competitiveness is down to technological development, efficient procurement, and a large base of experienced project developers globally. It’s this increasing edge over fossil fuels into which such funds are tapping.
While alternative energy is a much smaller equity theme than infrastructure, to which it is closely related, it has grown at a much faster rate, from a paltry £46m to £928m over the three years. More than half this is held in one investment trust: SDCL Energy Efficiency Income Trust.
This is an asset class where investment trusts have an edge. Not only do they have the advantage of increased liquidity and relatively low transaction costs when compared to direct holdings, but they are also arguably better suited as investment vehicles for illiquid assets, as can be seen from the example of the frequent gating of direct property funds.
Though smaller still, Equity Theme—Water and Agribusiness have seen proportionally large inflows. While all the water funds carry ethical flags, none of the agribusiness ones do. Despite both relating to UN sustainable development goals—with zero hunger being the second of 17—many large agribusinesses remain rather controversial.
Green Shoots?
How does this compare to the UK asset universe as a whole? Using the same assumptions as we calculated infra assets above,[1] total mutual fund and investment trusts assets in November 2017 were £1.86trn, and this November stood at £1.91trn—a 3% increase. Over the same period, assets under management under the four classifications have gone from £10bn to £16.9bn, or a 69% increase.
While these assets stand as less than 0.8% of the relevant universe, total infrastructure investments by UK investors are considerably higher, held largely through pension funds, which have a range of ways of accessing the asset class. Nevertheless, the global figure is still a long way off the USD90trn needed.
It seems reasonable to infer, then, that the growth of infrastructure—specifically in its sustainable forms—is far from over. Old stock, growing populations, and climate change still underpin the case for growth—as does investors’ need for yield. Infra offers that, and it remains an asset class to which most are underexposed.
I don’t often indulge in bouts of optimism, but I believe the imperative to ‘build back better’ remains strong.
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The views expressed are the views of the author and not necessarily those of Refinitiv. This material is provided as market commentary and for educational purposes only and does not constitute investment research or advice. Refinitiv cannot be held responsible for any direct or incidental loss resulting from applying any of the information provided in this publication or from any other source mentioned. Please consult with a qualified professional for financial advice.
[1] Mutual funds and investment trusts share classes registered for sale in the UK, GBP currency of record.
