Is infrastructure key to a sustainable recovery?
Is infrastructure key to a sustainable recovery?
Covid-19 highlighted a number of inequalities and fragilities in the global economy and there is a long road ahead to bring back economic growth to pre-Covid levels. In the recovery phase ahead, we have the opportunity to make the economy more resilient, more equitable, and more sustainable, or simply to “build back better”.
Even without the catalyst of the pandemic, the world’s growing population needs to be supported by infrastructure. Dwindling resources and rising greenhouse gas levels mean we have no option but for it to be built sustainably. $2.5 trillion a year is invested in infrastructure globally, according to a study by the McKinsey Global Institute before the pandemic. It’s a huge number, but the report estimated that annual average investment of $3.3 trillion is needed just to support expected rates of growth. If we couldn’t match expected growth without more infrastructure investment prior to 2020, we certainly can’t expect to build back better without it now.
Few asset classes are better placed than infrastructure to engage with delivering an economic recovery in a responsible, sustainable way. This is because few investments are more directly linked to how society moves, works, and communicates. Infrastructure investment is the physical fabric of the economy. Boosting economies by investing in transport, energy and the environment can help deliver a more sustainable economy, and there is no shortage of opportunities in the European infrastructure market.
Of course, from the perspective of an investor, sustainability also relates to financial performance, even if that is no longer always the sole motivation. Infrastructure, in demonstrating a history of stable returns in both debt and equity, allows investors to marry a conscientious approach with sustainability of returns.
What it means to “build back better”
The world faces intensifying challenges as environmental tensions grow, populations age and urbanise, and wealth and consumption increases. Addressing those challenges will require a rebuilding of the physical fabric of the global economy.
Infrastructure projects and companies are essential to growth and prosperity of economies, creating jobs and delivering essential services to the communities that they serve.
A study by the Economic Policy Institute estimates each $100 spent on infrastructure boosts private-sector output by $13 (median) and $17 (average) in the long run.
Certain segments of the infrastructure sector can also play a key role in building a greener future by supporting more energy efficient or environmentally friendly ways of producing energy.
More recently, infrastructure investments have become key to combating climate change through many areas:
- The investment into, and development of, renewable energy projects
- Carbon friendly transportation such as electric vehicle charging stations
- Devices to measure and more efficiently use energy
- Public transportation facilities that reduce individual carbon footprint.
If the world is serious about meeting its globally agreed goals of limiting temperature rises to less then 2°C – as per the Paris agreement - emissions must be reduced by 33% by 2030.
Crucially, after a decade of inconsistent and often patchy support, the global policy landscape is improving. Governments and local authorities around the world have set clear targets to encourage the adoption of clean technology.
In Europe, Germany has set a target to phase out all coal-fired power by 2038 . The UK has committed to net-zero emissions by 2050, while Spain is aiming to produce all electricity from renewables by this date.
Support is only likely to get stronger going forward. As an example, there is a great and ongoing push from the European Commission to reinforce green infrastructure projects. A rebalancing of the energy mix towards renewables is inevitable. Indeed, renewable assets currently account for around 50% of investments in Europe’s infrastructure pipeline. There is a lot of money being directed at the theme of renewables energy just now.
Infrastructure investment – how investors can step up
The need for infrastructure investment is clear, so too is the value in it. But, even before the Covid-19 pandemic, many governments faced difficult fiscal positions, and traditional sources of financing – banks - were constrained.
Infrastructure investors can fill this gap, and access predictable, long-dated cash flows that infrastructure projects can provide. Moreover, their long economic lives, relatively long investment horizons and the ‘buy and hold’ approach to infrastructure investing make it imperative that any project or company we invest in will be run sustainably and under strong governance for the long term.
This is the case whether investors use debt or equity to build their exposure. On the one hand, infrastructure debt forms the bulk of asset financing (usually around 75%). We have written before about the advantages, in terms of return and risk, infrastructure debt can offer relative to publically-traded corporate debt. Predictability and security of returns are especially aligned with prioritising sustainability of return.
On the other hand, infrastructure equity allows investors to have a more active role in delivering sustainable returns. Ownership over the assets allows investors to implement bespoke changes to the underlying companies and set more stringent governance measures.
Start with everything
If we intend to curb the effect that humanity is having on the planet, we need to change how we interact with it. Without ensuring that future infrastructure investment is done sustainably, we can’t hope to alter our trajectory of resource use or social inequality.
Yet infrastructure is already well aligned with the transition to a more sustainable future – only some of which we have touched upon here. From renewable energy projects and making cities greener, to avoiding stranded assets in the fossil industry, infrastructure means to us essential assets and sustainable performance. Moreover, the asset class has rarely looked more valuable as a provider of stable, compelling returns.
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