This article is sponsored by Actis
With developed markets awash with capital as the global economic recovery gathers pace, there may never be a better time for global infrastructure investors to turn to growth markets in the hunt for value. There is certainly no shortage of demand for investment in infrastructure, with McKinsey estimating that developing countries need to invest $2 trillion per year in infrastructure to keep pace with expected economic growth.
Torbjorn Caesar, senior partner at Actis, tells Infrastructure Investor that investors benefit from a highly favourable risk-return equation when putting money to work in the low-carbon energy value chain and digital infrastructure in growth markets.
Why focus on hard assets in growth markets?
The three key elements supporting such a strategy are climate change, digitalisation and yield.
Climate change is the defining issue of our time, with global temperatures at the highest they have been in three million years. Rapid decarbonisation and a full-scale energy transition are crucial for a sustainable future. We need to rebuild the existing base of power generation to rebalance towards low carbon technologies.
In non-OECD markets, $14 trillion will need to be invested to meet power demand over the next 20 years – that is equivalent to $1.7 billion a day. Growth markets benefit from strong solar irradiation and winds, which give renewable wind assets the potential to generate three times European capacity.
The next one is digitalisation. Trillions of dollars need to be invested in the next 10-20 years. Growth markets represent 80-85 percent of the world’s people, and these people are demanding to be connected. Think about all the infrastructure – the cables and data centres, all the things that are required. And then all the investment that comes after that – when people start shopping, working, socialising online, you have all the logistics and the infrastructure below that where investment is needed.
Then there is yield. We are in a world where quantitative easing and an oversupply of capital has meant that the yields have generally gone down. There are historically low interest rates. Pension funds and sovereign wealth funds are getting little to no yield with their traditional strategies – so we will see trillions of dollars moving into the alternative asset space.
With investments in renewable power generation, how can you achieve compelling returns?
The cost of renewables has declined by around 80 percent since 2010, and it continues to do so. They are the cleanest and quickest sources of energy to install.
Globally, the majority of the capital for renewables is going to Europe and the US. But then you look at where the investment opportunities are – bearing in mind you need to build a whole new planet of power plants – they are in the growth markets.
In the growth markets, you clearly have a supply-demand and capital imbalance. It’s not that you’re replacing power, like with renewables investments in the US or Europe. In Africa, Latin America or Asia you are adding new capacity.
Obviously, there is a lot of investment needed to replace thermal power with renewables and that is also a big opportunity. But the investment opportunity set in the growth markets is just much, much larger.
The shortage of capital compared to demand creates a better risk-return balance in Africa, Latin America or Asia than in developed markets. The fundamental supply-demand imbalance of capital, combined with the supply-demand imbalance in the electricity markets, means we have been able to get outstanding returns compared to classic infrastructure investments in developed markets. Why do a project in Germany or France, when we can get a much better deal in Chile or India?
That has created an opportunity for us to deliver a very attractive risk-return to our investors. That can be sustained for a very long period of time.
In many ways, we need more market participants, more people to come into our markets, to create more exit opportunities. I think it will take many, many generations of funds until the supply of capital and the competitive intensity is the same in growth markets as in Europe and the US.
Transmission and distribution are sometimes overlooked when it comes to the energy transition. What are the opportunities?
On the distribution side, we have invested very successfully. To have the understanding of distribution is the important part, because if you understand distribution, you have a better understanding of grid stability and how the whole market will operate and take intermittent capacity that comes out of solar plants and wind farms.
Distribution has been a regulated monopoly business in most of the markets where we operate. It is all about connecting more and more people and driving down losses, so again it is about growth – you invest in the distribution businesses and by investing in distribution you connect more people who use more electricity and you have more revenue. So, your investment in that regulated asset base drives the growth of the business.
Compare that to a distribution business in the UK, where there is no growth. Electricity demand is fairly static, at best. So, when you invest in distribution businesses in the UK, you are under intense scrutiny, because you need to invest to keep the asset going, but you will always hear that distribution businesses are under scrutiny for increasing prices.
Consumers in growth markets just want to get connected, they want more investment so that they have a stronger and more stable system where people can use more electricity.
There is another element here, which is as renewable energy takes a larger and larger role, the distribution systems can themselves be more distributed. In India, say, you can build wind farms closer to the consumers.
If you can put the generation facilities closer to where the electricity is used, not only do you then have lower losses, but the investment into the transmission and distribution system is slightly different. It means you could leapfrog into more distributed power generation facilities and then set up the system as a distributed system, rather than have gigantic power plants sending power to users in distant places. In the growth markets, you have the opportunity to plan in a much more future-proofed way.
And why should digital infrastructure be a priority?
We have 80-85 percent of the world’s population demanding better digital connections. There are huge, huge investments going into the digital infrastructure space. We became involved with data centres when we acquired Standard Chartered’s real estate business in Asia, and through that gained a lot of competence in the data centre space. We have been very successful in building some of the leading data centres across Asia and also in Nigeria and other places in Africa.
Data centres are an area where we see huge opportunity and there are not many players in this space. If you want to build infrastructure in the growth markets, Nigeria for example, you need real, proven technical and operational expertise.
We have found huge complementary competencies between our energy infrastructure investments and our digital infrastructure portfolio.
You might know everything there is to know about data centres, but you need to really know your way around in Nigeria as well. Then you need electricity – reliable, affordable and, ideally, green electricity. So, you need to know a lot about generating and distributing electricity in these countries.
What is necessary to execute the strategies you’ve described in growth markets?
We believe in being hands-on, operationally minded investors. I am an engineer myself – I started my career, 34 years ago, as an engineer building a power plant in Egypt and I fell in love with emerging markets. I mention this as the whole operational mindset, of being industrialists in the investment space, is very useful.
That is, of course, very important when you are adding new capacity. Our operational experience and expertise means we are not just a financial player – we know how to be hands-on industrialists. That gives us the opportunity to pick and choose, so we make sure we work on the right deals and it gives us the opportunity to make a true difference to these opportunities that we back and build.
And in terms of our footprint, being on the ground in growth markets and knowing our way around means we are able to differentiate real risk from perceived risk.
That experience and ability to execute is absolutely integral. It is a very different thing from having a core business in Europe or the US and then flying in and out of the growth markets.
How does your approach to sustainability fit into your investment strategy?
We believe that values drive value. There has been a real zeitgeist around ESG issues and impact investing has become more and more important over the last five years, but it has been fundamental to us ever since we started 20 years ago, and we can show our LPs and other stakeholders a long track record of successful action.
I believe it has to be rooted in the culture of the firm as that’s what informs behaviours. There has been a real drive across the industry in the DEI space where I see the same need for a cultural commitment. We believe that at Actis and for the businesses we invest in, a diverse team operating in an inclusive culture quite simply makes better decisions.
We’ve certainly seen the S of ESG thrown into sharp relief during the pandemic but we have always seen that if you engage with communities on the ground, and make sure you maintain good relationships, then not only do you achieve the licence to operate and de-risk the investment, but you increase its value at exit. That has been our conviction from day one.
We have ‘values drive value’ at the centre of our deal-making framework. It was an esoteric theme 10 years ago when we spoke to some of our stakeholders, but we’ve never seen a compromise between investing responsibly (and impactfully) and delivering a compelling investment return. In fact, we have always seen them as mutually reinforcing.