Sustainability: Expanding infrastructure’s parameters

The first six months of 2022 saw the most active fundraising ever for infrastructure, surpassing $127 billion according to data provider, Preqin¹. That slowed over the second half of the year as it became evident that the pace wasn't sustainable in terms of continued flows, but an impressive year for infrastructure nonetheless. Looking ahead, Preqin expects infrastructure to achieve a compound annual growth rate (CAGR) of 13.3% by 2027².

What's been behind the rise of the asset class and where do we see the key opportunities today?

Martin Lennon: On the demand side, clients have increasingly recognised the benefits of the infrastructure asset class. At its heart it's essential and resilient, which gives it the basis of which to be a strong performing asset class throughout the cycle.

“One of the core characteristics of the asset class is that it’s a real asset class and therefore it does provide protection to inflation.”

Many investors see that as an important part of their diverse portfolio. Of course, it also has the ability to deliver yield and inflation, which has got a little bit more topical in recent months. Altogether we see a really broad and growing opportunity set. Some of the main themes that we've been following, which are still relevant today, are around decentralisation – moving infrastructure away from the centre closer to the communities from which it serves, technology or digitalisation, and increased focus on sustainability and everything that brings.

Ed Clarke: It feels like the infrastructure space is going through a kind of industrial revolution at the moment. Historically when we started, what infrastructure was all about was investing in existing, stable, secure assets like water companies and electricity networks. What we've seen in recent years is the drive towards sustainable sources of power and energy needs – accentuated by the war in Ukraine – to have resilient local infrastructure, and this has driven a whole change in the way that infrastructure is provided. You layer on top of that the technological changes, and really it gives rise to a whole new set of opportunities, and we've really been working hard to play in that space.

If those are the trends, what specifically have you been looking at?

Ed: We've had a number of key themes which really drive it. For me, one of the most interesting ones at the moment is looking at the way that big corporates are all setting themselves net zero targets, and then trying to backfill their supply chains, their processes to all deliver on that net zero promise. A great example in our portfolio at the moment is a business in the Benelux called Inland Terminals Group. It operates terminals inside the factories and distribution centres of major European corporates who receive goods coming up from Asia via the ports of Antwerp and Rotterdam.

What our business does is it moves these goods by barge to their distribution centres or to their factories, taking trucks off the road and allowing them to significantly cut their carbon emissions. On top of that, we're now working with some of those customers. Nike is an example where we're introducing hydrogen power barges to really make that leg of the supply chain carbon negative.

How do you see our role when it comes to plugging infrastructure gaps in order to deliver positive and measurable outcomes for our communities?

Ed: I think we have a really crucial role in delivering the capital that's needed to enable a lot of these projects and businesses to prosper. As the world goes through this kind of industrial revolution, we see in some of the major corporates that used to be the traditional bellwethers of the infrastructure space – the big utility groups, the big telecoms groups – that they often have small business units trying to develop and do things, but they find it difficult to access capital because it's not part of the core business.

A great example – we entered into a partnership with Fortum, one of the big Nordics utilities where we took a 70% stake in its electric vehicle charging business across the Nordic region. This business – probably the leading one in the region – had developed so far, but actually, the need to keep developing it required a lot of capital, which Fortum wanted to share the burden of.

We came in initially with a 70% stake and we've now taken 100% control of that business and are really reinvigorating the management and accelerating that growth, which is obviously a key part of the transition to electric vehicles in that region. I see our role as working with businesses, working with entrepreneurs, working with the major corporates to help the visions that they have about the development of infrastructure become a reality.

Infrastructure is traditionally associated with a degree of inflation protection. What's the relationship between the two and how does the asset class offer protective benefits when it comes to inflation? As investors, what else can we do to de-risk and make our assets resilient?

Martin: One of the core characteristics of the asset class is that it’s a real asset class and therefore it does provide protection to inflation. We've all been a bit spoiled because inflation's been low and it's been stable for such a long time that we've lost sight of it. Of course, the last 12 to 18 months have put that back into prominence.

Actually, I think it's been a great learning experience for people that aren't that familiar with infrastructure and the inflation protection qualities that the asset class brings. Let's remind ourselves why infrastructure does provide inflation protection, and it comes in a variety of different forms. Regulated industries such as utilities very often have a regulated pricing model, which is reviewed periodically by the regulator of that particular sector. That normally provides for quite a significant degree of inflation passed through, so it's baked into that regulatory model.

Equally infrastructure businesses that operate through long-term contracts, again, very often have inflation protection mechanisms embedded within those contracts, so another form of inflation protection. Even those infrastructure businesses that don't have these two qualities, if they have a strong market position, going back to that essential characteristic, then again, they're very well placed to be able to pass on inflation to their customers, be they business or otherwise.

Whilst I wouldn't say inflation is 100% perfectly hedged within the infrastructure space, I think if you look across different asset classes, infrastructure stands out as being one of the very best in times of high inflation. We still need to be mindful of the broader stakeholders. I think spikes in inflation can have very significant impacts on businesses and customers as we know, so we can't be complacent.

We still need, as infrastructure business owners and managers, to make sure that we do everything we can ourselves to mitigate the impact of inflation rather than just relying on passing it through to the end customer. I think that way we continue to maintain our license to operate, if I can put it in that way, given the importance of the sectors that we invest in.

Ed: The watchword when we are looking for new investments is that essentiality is really the key component and that's what justifies the infrastructure tag. Essentiality, high barriers to entry and sustainability more and more at the moment. Those characteristics and the customers’ need for the service that you are providing, no matter the economic environment, gives you security and safety, which is why investors have invested so heavily in the infrastructure asset class of late.

¹Preqin, “Preqin quarterly update: Infrastructure Q4 2022”, preqin.com, January 2023.
²Preqin Global Reports 2023: Infrastructure.