Infrastructure is highly visible and long term, so investors need to stay in control of ESG concerns. Nina Röhrbein reports
By their nature, infrastructure investments are of particular interest to institutional investors. Pension funds like their long-term growth, stable cash flow and lack of volatility, which is why investments in infrastructure have skyrocketed. But how does this popular asset class fit into an environmental, social and governance (ESG) framework?
Some believe that an infrastructure project that fails to meet good ESG standards would struggle to be funded. “Most banks have signed up to the Equator Principles and other ESG standards,” says Werner von Guionneau, chief executive at InfraRed Capital Partners. “If a project does not meet such sustainability criteria, then it is unlikely that an infrastructure transaction would happen. All reputable infrastructure asset managers will have subscribed to one form of ESG standard or other.”
“The biggest ESG concern is a lack of infrastructure investment, not the investment itself,” adds Pierre Nicoli, head of energy and infrastructure group at BNP Paribas.
An infrastructure investment that is of financial interest to mainstream investors can also be attractive to responsible investors. But sustainable investors need to manage that investment by taking ESG concerns into consideration.
“Infrastructure presents a great opportunity for sustainable investors to participate in projects that have real non-financial benefits to the local community or environment,” says Anders Nordheim, head of research at Eurosif. “But they need to be careful about investments that might be perceived as having a negative impact or where other solutions might be better. Unlike with equities, investors cannot easily divest from the more illiquid infrastructure projects. They need to do their homework before investing and assess what things might be like in 20, 30 or 50 years’ time.”
As all infrastructure projects incorporate the E, the S and the G, the burden is on investors to look at these factors properly. ESG factors are specific to each project with regard to location, local population, and size, which is why investors have to analyse projects based on their merits rather than trying to use a standardised ESG framework.
Infrastructure can be accessed through the listed or unlisted sectors, through primary or secondary markets, directly or through funds.
Infrastructure funds tend to prefer to invest in brownfield sites rather than in riskier greenfield developments.
“Pension funds are not going to provide a lot of their equity for greenfield developments without some kind of liability guarantee,” says Niall Mills, head of infrastructure asset management at First State Investments. “Investments in water or electricity companies, where a big capital programme is already embedded in the business, are much more attractive to institutional investors.”
If pension funds invest directly they need a team that understands the challenges of investing in infrastructure projects in a responsible way. If they invest through a fund, investors need to make sure that their investment managers are using proper ESG procedures.
First State looks for embedded environmental and governance aspects, ideally with ISO 14001 and 18001 accreditation in its infrastructure investments. It examines a company’s resilience policy, the sophistication of emergency procedures, the staff training and its commitment to environmental targets, for example, carbon reduction initiatives.
“Pension fund trustees are looking for assurance that the portfolio companies in the infrastructure fund are top-half, ideally upper-quartile performers so that they are not potentially exposing themselves to an embarrassing risk that they will be stuck with for 10 to 20 years,” says Mills.
Increasingly investors include ESG in their infrastructure requests for proposals (RFP), in one-to-one meetings and due diligence. “Three years ago ESG probably cropped up in around a third of our due diligence and RFPs, but today it is mentioned in 95%,” says Mills.
Dutch asset manager PGGM started investing in infrastructure funds in 2005 to target a stable and long-term cash flow linked to inflation.
But three years ago it changed its strategy because it found that investing through funds did not provide all the attractive characteristics it was after, while fees were too high.
“The typical term of a fund is 10 years with an average holding period of seven to eight years per asset, while the underlying asset has a horizon of 30 to 40 years,” says Henk Huizing, head of infrastructure at PGGM. “If you want to benefit from the long-term cash flow of the asset, it is therefore probably better to invest directly in the asset because in a fund you are dependent on the exit return after seven or eight years.”
At present, PGGM focuses on direct investments in infrastructure, apart from fund exposure to China or India. Integrated across its portfolio, ESG is an integral part of PGGM’s due diligence on infrastructure projects.
PGGM aims to invest 15% of its overall €2bn-plus infrastructure portfolio in renewable energy projects such as offshore and onshore wind, solar, waste and hydro. But its main target is public private partnerships. PGGM has undertaken two large joint ventures over the last eight months: a £200m (€228.7m) deal with UK-based Lendlease, a developer of social infrastructure such as hospitals, schools, government buildings; and a similar deal with the largest Dutch construction company, Royal BAM.
“Public-private partnerships and other types of structures can be beneficial, not only by financing the infrastructure investment but also in their management as investors can improve issues such as corruption and communication with stakeholders,” says Nordheim.
Danish PKA invests 4% of its overall DKK150bn (€20.2bn) portfolio in infrastructure. It also integrates ESG across its entire portfolio.
At present it has awarded infrastructure mandates to eight fund managers. But PKA has also directly invested in a Danish wind farm. “The direct investment is done on a case-by-case basis,” says Jens Henrik Staugaard Johansen, head of private equity and infrastructure at PKA. “The development risk is concentrated with other parties within the joint venture, which allows us to assess the risk-return profile ourselves.”
Swiss-based fund adviser SUSI Partners, which has two infrastructure funds, quantifies sustainability by measuring the reduction of carbon emissions of its projects. But it also takes into consideration how the facilities will be dismantled once the lifespan of a project is over and builds up corresponding accruals.
“We want to invest in infrastructure to help in the battle against climate change,” says Tobias Reichmuth, founder and CEO of SUSI Partners. “There are three areas in infrastructure to do this: energy consumption and higher efficiency, green energy supply, as well as energy storage and distribution. The latter we plan to look at.”
PKA’s SRI department, meanwhile, is working with other pension funds in the market. “We would benefit from a shared socially responsible investment (SRI) approach across the industry where all limited partnerships demand full SRI compliance from their general partnerships,” says Johansen. “We need to know what are the infrastructure project’s specific ESG concerns. The deal-making also needs to be done in a fully transparent and shared manner.”
Social concerns revolve around outside stakeholder, labour, indigenous people and human rights issues, for which good analysis frameworks exist.
“One infrastructure issue is corruption and the long-term management of the partnership with the public provider,” says Nordheim. “Institutional investors need to realise that infrastructure is a visible, long-term investment. Social and environmental issues are always evolving, which means investors need to stay informed of what outside influences could affect their investment.”
Security and safety of infrastructure projects - as demonstrated by the tsunami in Japan - is another important issue. Terrorist threats and the future supply and demand of water and energy resources also have potentially big impacts on infrastructure investments.
But infrastructure investment opportunities differ by region, sector, IRR and counterparties. “We have to analyse every project case by case,” says Huizing. And Johansen adds: “Integrating ESG into infrastructure is slightly more complex than in other asset classes because the lifespan of the underlying asset is much longer. This makes the governance and incentive structures around such investments even more important.”