Schroders Capital: Flying in the face of change

Infrastructure still offers notable opportunities, despite prolonged recessionary risk and macroeconomic uncertainty, says Schroders Capital’s global head of infrastructure, Chantale Pelletier

This article is sponsored by Schroders Capital

Chantale Pelletier

What makes infrastructure stand out against the current macroeconomic backdrop?

There is a two-way push and pull between inflation, recessionary risk and geopolitical tension and mega-trends such as climate change, decarbonisation and the technology revolution. All of these trends are embedded and will influence the infrastructure space.

In the past, there have been acid tests that showed the resiliency of the asset class, and more recently through the pandemic.

While infrastructure might be facing a different test now, the core characteristic is the essential need of those assets and businesses. When society depends on these essential assets, resiliency is built in and that makes the asset class less likely to be affected by the current economic downturn when compared to other types of business.

In this environment, there is also a flight to quality and from private equity towards alternative investments like infrastructure that are inherently resilient. We are seeing a lot of appetite from LPs towards infrastructure, and many are increasing their allocations to the asset class, aimed at diversifying their portfolios.

There is also more movement on the risk spectrum towards core and super-core, as we see more value add.

How do you see infrastructure faring in the face of rising macro pressures?

The potential benefit for infrastructure investors is that revenues in this sector have historically risen along with inflation, but clearly there is a limit to that in the current environment. Consumers need to be able to foot the bill. Again, the positive thing for investors is the essential quality of infrastructure assets, plus the support that national governments typically provide.

We also need to be careful about assessing the impact of supply-chain disruption, construction delays and accessing materials. Equally, there is a global labour shortage, but the asset class is less labour heavy so will be less affected by potential prolonged shortages.

How does the recessionary environment impact competition?  

The recession will bring a slowdown, but there will still be a flight to quality. That means more appetite for infrastructure and more capital directed to the asset class. It is important to consider those megatrends I mentioned, too. Climate change in particular will bring about huge opportunities within the asset class.

If we want to build a greener and cleaner world for tomorrow, we have no choice but to invest in new infrastructure and to refurbish existing infrastructure. Then there is also the energy efficiency angle. All of that requires a lot of money, and governments will have to be involved, but they will not have the capacity to fill in all the gaps. Private markets need to step in, and the infrastructure asset class fits right in the middle.

If the global downturn proves to be more than just a blip, how resilient do you expect the infrastructure asset class to be?  

I think the dynamic will be the same, but under that scenario we would need to assess the growth prospective. The world will always require water and energy. The current security of supply crisis in Europe has highlighted the importance of these assets. National governments will also always prioritise and maintain what is essential for their populations to thrive.

This means that governments will work to keep the lights on and provide hot water, simply because the population demand is there. If the recessionary economic situation persists longer than expected, we will just need to find a way of maintaining those essential assets.

Energy price volatility and the war in Ukraine have led to a focus on security of supply. How will this dynamic influence the net-zero journey and the pace of change?

It is a wake-up call. Everyone realises we need to accelerate the energy transition and adapt, not just because of the climate, but because the world needs to become more energy independent. We cannot rely on one singular energy source anymore.

Governments understand that they need to provide strong policy that supports the energy transition and helps build out more clean energy capacity, especially considering many countries signed net-zero emission agreements.

Since the war in Ukraine, this dynamic has accelerated and investor demand is now especially strong. But we are also seeing more deglobalisation and a rise in national focus, as every nation has a very different energy mix. Countries are focusing on their own reality to cope with the energy supply crisis. This might mean taking tough decisions to get through the winter, as phasing out dirty energy takes time.

There is a fine balance to be achieved, but I strongly believe we need to move faster. We have also seen an evolution in opinion over nuclear. Some consider it clean energy, but others find this source a problem with the waste that it generates. Popular opinion has differed between countries, and the reality is that places that rely on nuclear energy will find it more acceptable.

When thinking about building out more capacity, the issue is that nuclear takes years to develop. Investors need to think about what the world might look like in the future and whether it will be economically viable in 15-20 years when it finally comes online.

The other question is oil and gas. Do we just invest in purely green assets or understand that a combination is needed as we transition to a greener world? It is a delicate balance, and hydrogen may yet play a role as we go through the transition.

Amid rising interest rates and inflation, where do you see the most exciting opportunities for infrastructure investors?  

As we have discussed, climate investing is particularly interesting. There is a lot of work to be done and it is a big opportunity for us and investors to do social good while meeting those net-zero goals. At the same time, investing in the energy transition results in very resilient assets and from an investment perspective brings diversification. Infrastructure is evolving fast into a diverse, investable universe.

In the past, the asset class was very focused on transmission and distribution – for example, airports and roads. Today, the asset class is expanding into various emerging industries and technologies. These include electric vehicle charging, energy storage, the circular economy, fibre, digital telecommunications and so forth.

Investors are aware that they can participate in this exciting change, building diverse exposure to these industries, while at the same time knowing that they are doing a social good.

What are the key challenges that the asset class faces looking ahead to the coming year?

There is tectonic change in the industry. One of the key challenges that infrastructure needs to come to terms with now is what the future will mean for stranded assets. If we are talking about an oil pipeline, will it be needed in 20 years’ time? You need to take a long-term view and assess the potential risk. If you are investing in these assets, what will your returns look like under different scenarios?

In the past, utilities hardly changed at all for maybe 100 years. They delivered consistent cash yield. Today, the landscape is changing rapidly and particularly when we think about sustainability regulations. This is partly because we need to address climate change and build a low-carbon economy, and government legislation will have to play a role in addressing this reality. The biggest challenge is to have a long-term perspective, and active management will be essential.

Infrastructure is critical to the mega-trends of decarbonisation and the technology revolution. By diversifying portfolios, investors can engage with all the emerging subsectors that will help deliver these goals.

Is the industry doing enough to ensure that the decarbonisation roadmap remains on course?  

I would say it is never enough, and recent events have been a wake-up call, but the world needs to manoeuvre around a lot of issues. Everyone needs to be moving in the same direction and making sure that we all align around those same interests.

Recently, we saw the US pass the Inflation Reduction Act, which involved a big stimulus package aimed at boosting the energy transition. It will be very interesting to track progress there. The reality is that, unless everyone is brought along on the same journey, unless we are all doing our part, the entire world is at risk. At some point, there will be an even more dramatic wake-up call unless we take immediate action to prevent climate change. We are already seeing noticeable changes in the temperature and unseasonal weather patterns.