Infrastructure could play a central role in ESG allocations and the move to decarbonise economies. Christopher O’Dea reports
As fund beneficiaries and campaigners scrutinise what pension funds are doing to advance environmental, social and governance (ESG) initiatives, institutional investors might find a template for innovation in an unexpected quarter – the capital earmarked for deployment to infrastructure strategies. Infrastructure has attracted investors because the asset class can generate strong income returns over the long term, often with inflation protection. But it can often check the ESG boxes.
An ESG approach is already woven into the fabric of infrastructure investing. Infrastructure assets tend to provide essential services to citizens and taxpayers, often on an exclusive basis and sometimes with governmental guarantees. They are therefore often subject to relatively high public scrutiny before being built, to substantial environmental, engineering and social-impact assessments, and to stringent regulation.
Infrastructure investing tends to require long-term capital, thereby avoiding the volatility of public markets, and it can focus on backing active management strategies that include consideration of environmental performance, social policies and governance practices.
Infrastructure can help diversify narrowly focused ESG portfolios that can otherwise result in an unwanted concentration of risks and potentially outsized bets on economies, market trends or new technology. While most infrastructure assets deliver a social benefit, a carefully selected infrastructure asset can tangibly affect ESG factors, helping to achieve a portfolio’s ESG objectives while increasing diversification.
“Consideration of ESG factors comes fairly naturally to private infrastructure investors,” says Stephen Dowd, partner and head of infrastructure investments for CBRE Caledon Capital Management. “One of the key characteristics of infrastructure is that the assets provide an essential service, and when you’re providing an essential service, you have to be dealing with the relevant government authorities, whether they’re political or regulatory, and you need to be engaged with your community as well. Adopting ESG policies and targets can provide a more formal framework, but infrastructure investors are engaged in those issues, and that sort of discipline comes naturally.”
The discipline applies to the environmental domain. “There are positive consequences for being a good environmental citizen,” says Dowd. In the energy sector, for example, “major institutional investors have been a big part of investing in renewable assets in natural-gas infrastructure, adding an ESG element”, he says. “Requests for ESG-friendly investments are growing all the time.”
To satisfy client interest in ESG factors, infrastructure investment managers should make the infrastructure characteristics clear. “Investors are becoming much more conscious of ESG factors. Many of them have an ESG lens when they look at who they’re going to work with, so it becomes more important for managers to be systematic about how they incorporate ESG considerations. They need to prove out their policies to institutional investors and show how they apply [ESG factors] to their investment processes.”
Investors can also use infrastructure allocation to increase ESG impact through active strategies in listed infrastructure companies, says Collin Bell, managing director and client portfolio manager at Goldman Sachs Asset Management. “We believe those that have scale can better influence change at the company level. By employing a fundamental approach, one can be better informed on ESG via corporate engagement, where disclosure is still lacking, take an active rather than passive approach by buying or selling a security based upon ESG-related views, and be more effective in the space. In the real asset space, most subsectors are ESG-friendly. Infrastructure and real estate are critical to our social development and economic growth.”
“There are positive consequences for being a good environmental citizen” Stephen Dowd
Environmentally, some investors will find energy transportation acceptable, for example, since they transport energy rather than drill for it, while others might want no exposure to the sector, Bell explains. Similarly, some investors see data centres as ESG-positive because they help reduce paper consumption and deforestation, while others might find their high energy consumption a reason to avoid the sector.
On the social front, there clearly is more value in building a school rather than an airport runway. “Those are all the things that can and should be debated,” says Bell. Such considerations “filter into our investment process. Additionally, since investors have their own independent value systems that may vary from our own, we’re willing to customise portfolios to better cater to their respective values.”
Investing through listed vehicles also rewards scale since the more assets under management one manages, the more influence they can have on company-level ESG outcomes, says Bell. Whereas private fund managers can find it difficult to deploy large amounts of capital efficiently due to the limited stock of assets available.
The flipside is that buying shares in a company subjects owners to company-level disclosure policies on details such as energy expenditure that would be under direct control in a private transaction. The solution is to use share ownership to influence behaviour. “On the listed side, corporate governance has and always will be a big focus,” says Bell. That is where size matters. “More money helps facilitate corporate engagement and ultimately gives you more power with your respective vote.”
Some of the ramifications of taking a more systematic view of how ESG policies can be realised through infrastructure allocations will likely be evident at the overall portfolio level. “Implementing an ESG policy through an allocation to infrastructure can allow institutional clients to achieve a greater degree of diversification than is typically possible from mandates that focus on narrower strategies,” says Alistair Perkins, head of infrastructure debt at NN Investment Partners.
The company recently launched the European Sustainable Infrastructure Debt fund targeting €200m in investment in the real economy in western Europe, which will contribute to UN Sustainable Development Goals.
While renewable energy generation and supply has become the go-to sector for investors seeking to finance a greener future, NN has taken a broader approach. “We’re aiming to focus on the wider decarbonisation agenda, including the transportation and heating sectors,” Perkins says. These assets can have a significant impact on “the whole of the energy transition in the broader sense, and also create a more diversified and balanced portfolio”.
NN adds a quantitative overlay to its ESG framework to monitor key metrics and sustainable development goals. “It’s a more developed ESG model than you might see in other investment institutions in infrastructure debt,” Perkins says.
NN is focusing on infrastructure designs that enhance resilience by adding capacity or increasing redundancies to allow for future population growth or other demographic changes, that improve health and safety by reducing accidents, or that strengthen resilience to flooding and climate-change events.
“Efficiency and resilience are both part of our asset selection approach that we have developed for the infrastructure market,” Perkins says. “The model does not just exclude investments that wouldn’t fit the strategy, but actively selects those assets that can contribute positively.” Building a bypass would more likely to meet the fund’s criteria than a road through the countryside, since a city bypass reduces congestion and improves air quality and public health.
The positive case for high-speed electric rail and light rail is more obvious, he says. “You’re decarbonising transportation and increasing the capacity of the system and reducing overall congestion. When it comes to the road sector, we have to make some clear choices.”
As the focus on carbon-reduction increases, infrastructure might become a more attractive choice for investors seeking an efficient way to implement their ESG strategies.