Hundreds of millions of people, mainly in Africa, Asia and Latin America, continue to lack access to the infrastructure that has long been taken for granted in developed markets. The latest estimates suggest that 2.2 billion people do not have safely managed drinking water, 759 million live without an electricity connection, and 450 million are not covered by mobile broadband.

Investors seeking to lay the foundations for economic development cannot therefore afford to overlook the need to improve infrastructure. “Businesses that provide basic goods and services rely on basic infrastructure – roads, ports, affordable and reliable energy, water, healthcare and education, telecommunications and internet,” says Nimrod Gerber, managing partner at Vital Capital, an Africa-focused impact fund manager. “So, if you’re an impact investor and you look at emerging markets, especially Africa, you have to take infrastructure into account.”

Investing in renewables in developing countries is a particularly popular strategy for impact investors, who are mindful of how green energy can deliver both environmental and social benefits. “Emerging markets will almost entirely drive the global growth in energy consumption over the coming decades,” says Felix Hermes, head of private equity and sustainable infrastructure at BlueOrchard, an impact investment manager. “Given the long life of energy assets, it will make a tremendous difference for climate change how these energy needs are met.”

Financing gap

Yet convincing private sector investors to allocate towards infrastructure in developing economies is far from easy. Managers must be able to point to a track record of achieving measurable impacts, as well as an ability to navigate the fiendish complexities of project execution. And they will need to assuage investors’ anxieties on a wide array of risks, ranging from geopolitics and social unrest to currency depreciation and unreliable counterparties.

The size of the challenge in redirecting investment capital towards emerging market infrastructure was illustrated in a report published by the UN Environment Programme in 2018. UNEP estimated that an extra $2.5 trillion is needed annually to achieve the UN Sustainable Development Goals, of which $1.3 trillion will need to be spent in Africa.

“Our impact investing fund seeks to deliver the same return rate as our classic private equity fund”

Renato Mazzola
BTG Pactual

Even evangelists for impact investing acknowledge that the asset class has a massive task in scaling up investments. “Infrastructure is an area where impact investing can make a big difference but has a long way to go to realise its potential,” says John Simon, founding partner at Total Impact Capital, another impact investment manager. “Infrastructure, as a general rule, is a big dollar item. You don’t have a lot of impact investment funders who can put out hundreds of millions of dollars on one particular deal.”

In practice, however, it is often hard to distinguish infrastructure investments in emerging markets that are specifically designed to make a social or environmental impact from those that fulfil commercial objectives while delivering impact as a bonus on the side.

Indeed, the universe of infrastructure managers in the impact space has expanded considerably. Specialist players that are dedicated to impact have now been joined by many of the world’s largest infrastructure managers, who are quick to emphasise their role in contributing to the Sustainable Development Goals.

Renato Mazzola, head of private capital at BTG Pactual, a Brazilian investment bank, tells Infrastructure Investor that his institution had responded to investor demand by forming an impact investing fund.

In recent years, he says, investors have been “shifting their mindsets to more sustainable products and looking for alternative investments that consider ESG integration”.

“We believe the role of the private sector today is decisive for the rebirth of the region through major infrastructure projects. Impact investing is born as an asset class which can provide both meaningful and measurable impact, as well as strong financial returns,” Mazzola says. “Our impact investing fund seeks to deliver the same return rate as our classic private equity fund, so as to not penalise investors for choosing a sustainable product.”

Private capital joins in

David Krivanek, programme manager for international development at the Impact Investing Institute, a UK-based nonprofit that seeks to accelerate the growth of impact investing, agrees that private sector investors are beginning to realise the potential of impact strategies in infrastructure.

“While emerging markets infrastructure projects have tended to rely upon financing from multilateral development banks and development finance institutions, there are clear signs of rising private investor interest in such investments,” he says.

As a result, Krivanek notes that there are a growing number of “emerging market infrastructure funds now available on the market which are specially designed to attract large private investors”. Actis notably achieved a $6 billion final close last year on a fund dedicated to energy transition investments in emerging markets, significantly exceeding its target.

Krivanek also cites the success of the Emerging Africa Infrastructure Fund managed by Ninety One and the Africa Finance Corporation’s Infrastructure Climate Resilient Fund as indications of growing interest from private investors.

Vital Capital’s Gerber argues that the significant progress in raising capital for green energy investments could stimulate other forms of impact investing in emerging market infrastructure. “Renewable energy shows that private investors can be involved in closing the infrastructure gap,” he says. “In Africa, the evolution of power purchase agreements, the idea that you can come as a private investor, provide a basic need and get the right reward for that, is leading the way for other infrastructure to follow.

“Part of the reason impact investing has done so well is the extended period of low interest rates”

John Simon
Total Impact Capital

“DFIs play a very important role. But we need to make sure their resources go only where they are needed. In industries where [Build-Operate-Transfer models] are more feasible and more mature, that’s where private investors can depart from DFI money.”

Nevertheless, Gerber recognises that development finance institutions “will always be needed in places where there are no private markets and risk is very high, in places where managers are trying to do something very innovative and don’t have track records – that’s exactly where you want DFI money to go”.

Currency and interest rate risks

Heightened perceptions of risk are a key impediment to the growth of impact investing in emerging markets infrastructure. The Global Impact Investing Network’s 2020 investor survey found that while 41 percent of investors that focused on developed markets did not perceive any country or currency risk, some 82 percent of emerging markets-focused investors perceived such risks to be at least moderate.

BlueOrchard’s Hermes describes country and currency risks as “certainly an important consideration, particularly as infrastructure investing remains a comparatively new asset class for many investors”.

But he adds that “the outcomes of sustainable infrastructure investments in these markets are far more aligned with the developed world than people tend to think”. Hermes cites a Moody’s report from 2018, which found that default rates on project finance bank loans were only slightly higher in emerging markets than in developed markets over the previous decade.

Even so, global economic developments threaten to dampen the momentum behind investing in infrastructure in emerging markets. A widely expected rise in US interest rates over the course of 2022 – on the back of rising rates in most emerging markets outside Asia in 2021 – is likely to cause emerging market currencies to depreciate. Infrastructure investors will see imports become more expensive, just as the cost of servicing dollar-denominated debt also rises.

Total Impact’s Simon cites rising interest rates as a key risk, particularly due to the long-term nature of infrastructure investments. “It’s very tough to fund long-term investments if the interest rates are much higher than they are now,” he warns.

Investors with a strong commitment to the SDGs may not be deterred from emerging markets infrastructure by these macroeconomic headwinds. But institutional investors that are drawn to these regions by the prospect of attractive returns as much as by the potential for impact may have to reconsider their strategies.

“Part of the reason impact investing has done so well is the extended period of low interest rates,” says Simon. “A lot of investors said, ‘If I’m only going to be getting 1 or 2 percent on my money anyway, why don’t I put it into something with impact, then at least I get the impact to boot.’ Now we’re going to see how that plays out when interest rates are a bit higher.”

Community projects deliver impact

A huge variety of infrastructure projects in emerging markets can contribute to achieving the Sustainable Development Goals, whether large or small.

Multi-billion-dollar energy investments dominate the headlines, but small community infrastructure projects can have an equally significant effect on livelihoods and well-being at the local level.

Total Impact Capital, for instance, manages Azure, a special lending vehicle that finances water projects in El Salvador and Honduras with loans averaging just $150,000. The initiative, which focuses on providing water meters, alongside pumps and other equipment, has been backed by the US International Development Finance Corporation and the Inter-American Development Bank. It also relies on technical assistance provided by Catholic Relief Services, an NGO, and its local partners.

Even community-level projects can attract private capital, says John Simon of Total Impact, who tells Infrastructure Investor that a pension fund has invested in Azure as part of its impact strategy. “As you see more and more families and ultra-high-net-worth individuals looking for impact, I think this type of product is something that will be very attractive. The key is to structure it in a way that makes it easy for them to buy.

“Part of the challenge of impact investing is we often – because of the types of investors we work with initially – create complicated structures. Now we have to figure out a way to simplify them for a broader audience.”