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By Edmund Ingrid, Senior Portfolio Manager, Columbia Threadneedle Investments
As featured in LPEA Insight/ Out magazine #20, December 2021.
The Covid-19 pandemic has underscored the important role infrastructure plays in our lives, societies and economies. It has also accelerated pre-existing economic trends such as digitalisation; urbanisation; environmental and climate change awareness; and social and demographic change, leading to a “new normal” for ESG (environment, social and governance) integration and management.
On one hand, social pressure and consumer preferences have led to a distinct shift in the expectation that private investment should address both societal issues and climate challenges, in addition to generating financial returns. What has fundamentally been a social and healthcare crisis has put the “S” in ESG firmly at the heart of the discussion. Moreover, there has been a growing realisation that environmental and social impact go hand in hand. This is even more salient for infrastructure investment, where ESG issues have been key investment considerations even before ESG became a recognised concept, due to its inherent characteristics and purpose of delivering essential services to the communities they serve and creating jobs. A recent IMF paper concluded that every dollar spent on carbon-neutral activities generates more than a dollar of economic activity[1], with this positive multiplier effect persisting for at least four years and the impact on economic activity being two to seven times larger than those associated with environmentally detrimental measures.
Regulation has not been slow to follow suit and create a much stronger framework for companies and investors. Take the 2015 Paris Agreement as an example – currently, around 66 countries have net-zero emissions targets, a significant increase from the 21 who had outlined their targets pre-Covid[2] The European Union was among the first to commit to carbon neutrality – by 2050[3] – and has gone furthest in publishing investment plans to enable a green transition, with the Green Deal aiming to deliver a reduction of 50%-55% in carbon emissions by 2030 compared with 1990 levels.[4] Add the Taxonomy Regulation, the Sustainability-Related Disclosure Regulation, the Non-Financial Reporting Directive and the Shareholder Rights Directive and it is absolutely clear that ESG is here to stay, with huge momentum behind embedding it into investment decision-making.
There is also growing recognition and empirical evidence that ESG issues can have a material impact on the value of an investment, and the appropriate management of such risks will preserve and enhance value. For example, infrastructure usually involves large capital investments in assets that are designed to operate over the long term and therefore is more exposed to a changing climate and the resulting more extreme weather events. The direct threats range from disruption to critical systems, such as power outages and flooding, to operating cost increases and significant knock-on effects on communities which are reliant on those infrastructure assets and services and the broader economy.
Is now a good time to invest in infrastructure?
From our perspective, it is an exciting time for the infrastructure investor. The post-Covid world provides a complex environment of opportunities and challenges, but crucially there is an undoubted requirement for a more sustainable economy and infrastructure. As an asset class, infrastructure has proven its resilience during the pandemic and delivered on the narrative of more stable cash flows and performance. That’s not to say there haven’t been losers as well as winners over the past 18 months.
Transportation, and in particular airports, were hit hard by the outbreak. With government-enforced travel restrictions lasting more than 18 months, air travel fell sharply prompting airlines to cut capacity, leading to almost complete paralysis of revenues[5]. However, those assets more dependent on freight than discretionary passenger traffic, or generating revenues from availability payments, have fared much better. Take, for example, Condor Ferries, one of our investee companies, which continued to provide a lifeline service and connectivity to the inhabitants of the Channel Islands by delivering essential freight such as food and medicine and providing connectivity during the pandemic. Regulated assets such as utilities or renewable energy benefitting from feed-in tariffs or fixed power purchase agreements have been more resilient than those more exposed to the economic cycle. Fibre and data centres have established their position in the infrastructure mix and have been clear winners.
Therefore, having core infrastructure characteristics is not enough – the definition of core infrastructure requires a deeper analysis to really understand what drives the risks and performance and how to build a portfolio which plays the defensive role expected of an infrastructure allocation.
We have identified several secular trends – green energy transition, decarbonisation of brownfield essential infrastructure and digital – where we see a strong flow of attractive opportunities, especially in the mid-market where we are active. All of these play to the sustainability agenda and can deliver significant environmental and social positive benefits.
Significant investment is required across all sources of renewable energy – the more established ones such as wind and solar have become more “commoditised”, whereas biogas and green hydrogen are rapidly developing and could provide a source of higher risk-adjusted returns. Energy storage is another big focus, particularly to address grid constraints due to variations in electricity generation by renewable sources.
Most importantly, they are all complementary and can create a virtuous ecosystem. Green hydrogen involves the production of hydrogen produced by the electrolysis of water which, if done using a renewable energy source, is itself a zero-emission source. Green hydrogen can transform power into emission-free heat, synthetic gas or ammonia, which is essential to be able to achieve the decarbonisation of industrial sectors such as heavy transportation, steel and many more. For example, it is estimated that transportation needs to see a 90% reduction in greenhouse emissions by 2050 to support the EU carbon neutrality targets. Hydrogen can also store large amounts of electricity over long periods of time, a benefit that battery-based storage is unable to provide. Demand and supply are both growing, and we are beginning to see countries weave hydrogen strategies into their net-zero emissions plans, with 20 of the 66 countries who have such strategies doing so[6].
The perpetual capital model
We believe an open-ended fund structure is ideal for infrastructure investing. Simply put, open-ended funds have no fixed term or investment period, meaning there is no specific date upon which the fund or any of its investments must be liquidated, and the fund can provide perpetual capital for new and existing investments.
Open-ended structures are often associated with low-risk assets with a long life and a steady long-term cash-flow profile, enabling consistent yield generation. One of the key benefits of perpetual capital availability is the ability to react and adapt to disruption to secure those stable financial returns – it is clear than no assets will remain immune to unexpected changes coming from technological, climate or regulatory changes. The next 30 years of infrastructure asset ownership will most certainly not look like the past 30 years – especially when also taking into account aspirations and the need to decarbonise in certain infrastructure sectors over a longer period than a limited ownership period would allow. In addition, there is a huge opportunity to invest in platforms that can be grown and matured over decades. This provides competitive advantages and alignment with the management teams that often created the businesses and would like to retain involvement into the next stage.
Ultimately, the power of this model is that it provides patient capital, bringing together a mix of financial and strategic mindsets and allowing for more value creation and active ESG asset management within the lifecycle of a long-term management approach.
[1] IMF.org, Building Back Better: How Big Are Green Spending Multipliers (March 2021)
[2] IEA (October 2021).
[3] European Comission – 2050 long-term strategy – https://ec.europa.eu/clima/policies/strategies/2050_en
[4] State of the Union: Commission raises climate ambition and proposes 55% cut in emissions by 2030
[5] IFC – The impact of Covid-19 on Airports: An Analysis
[6] Morgan Stanley Research: The Hydrogen Handbook.
