Sustainability is still hard to pin down

Investors in infrastructure assets are facing an historic opportunity. Not only is there unparalleled demand for capital – the United Nations estimates that around $90 trillion of investment is required globally by 2030 – but the potential to drive societal and environmental change is unprecedented.

Renewing ageing infrastructure, tackling structural change in emerging markets, and dealing with rapid urbanisation, all create exciting propositions for return-hungry investors. But this explosion in activity also creates the chance for infrastructure investment to play its part in delivering inclusive economic growth, eliminating poverty and reducing the risk of climate change around the world.

This transformative role is, of course, why the concept of sustainable investment is so critical for infrastructure. The sector’s  assets provide essential services to society and are the solutions to some of its biggest challenges. Infrastructure investors may be temporary custodians of these assets, but their obligations are long-term. The stakes are high.

“Infrastructure assets’ useful lives can span several decades and typically provide services vital to economic development, which is why incorporating sustainability in design, function and financing is of critical importance,” says Marija Simpraga, infrastructure strategist at LGIM Real Assets.

“Sustainability is distinctly important for the infrastructure industry,” adds Leisel Moorhead, a partner at QIC Global Infrastructure. “We are investors in essential services – ports, electricity, water. These services are critical to the communities they serve and require sustainability and resilience over the long term.”

An elusive definition

While there is a clear understanding that sustainable investment is essential for infrastructure, there is less consensus about what it actually means.

The origins of modern sustainability can be found in the Save the World campaigns of the 1960s, when organisations  such as Friends of the Earth lobbied hard to stop patently unsustainable practices, such as deforestation. But in the 21st century, sustainability has ceased to be the sole concern of protest movements and has entered the corporate mainstream.

Sustainability is also no longer just about being ‘green’. It requires investors to adhere fully to ESG and responsible investment principles. Indeed, in 2015, the United Nations published 17 Sustainable Development Goals covering everything from clean water to a decent standard of education, affordable healthcare and equal rights.

And yet, to date, the overwhelming focus of sustainability policy in the infrastructure industry has revolved around environmental issues, with far less attention paid to social and governance concerns. “I would say the focus is primarily on environmental issues,” says Paul Chapman, director of real assets at the New Mexico State Investment Council. “The ‘E’ in ESG is definitely leading the way.”

“The environmental aspect is the easiest to quantify which is probably why it gets more focus,” adds Brent Burnett, managing director of real assets at Hamilton Lane. “That said, GPs are increasingly understanding that there is more to sustainability. We do see a growing awareness that engaging with communities and wider stakeholders is an essential part of the job.”

Of course, the infrastructure industry is still relatively young and its sustainable-investment practices nascent. But there is no doubt that some form of sustainability is now at least on the radar of all limited and general partners. “Where there is third-party ownership of infrastructure assets, there tends to be a very high level of ESG,” says Mounir Guen, chief executive of placement agent Mvision.

Institutional investors, including public pension funds and sovereign wealth funds, have led the charge. Their demands as limited partners have placed scrutiny on managers’ sustainability practices, while their significant direct investment in infrastructure assets has raised the bar.

“These investors have reputational risk and accountability at the forefront of their minds,” says Guen. “They are directly representing pensioners and it is extremely important to them that mistakes aren’t made.”

“Five years ago, being a signatory to the UN’s Principles for Responsible Investment was a preference for LPs,” adds Archie Beeching, head of private markets at UNPRI. “Not being a PRI signatory can now be a deal-breaker. We are seeing a level of transparency we have never seen in the past.”

Government pressure and the rise of populism are also driving forces, while the demands of employees are key. “I think these things are often driven by the younger team members,” says Chapman. “They are passionate. The reality is a strong ESG culture can be important to hiring and retaining staff.”

“Last year, we calculated that 62 percent of our assets under management were held by ESG-sensitive LPs,” adds Mathias Burghardt, head of Ardian’s infrastructure activity. “But while there is, of course, an external drive to responsible investment, in recent years we have also seen an increase in our internal drive due to growing interest and adhesion from Ardian employees.”

Best practice

Investor demands, government pressure and employee activism mean there is only one direction of travel when it comes to sustainable investment in infrastructure. But a significant gulf persists between market leaders and those just embarking on their sustainability journey.

For those GPs at the cutting edge of sustainable best practice, ESG is fully integrated into all processes and structures. It is not simply about the exclusion of ‘sin investments’ such as coal, but about a nuanced and committed understanding of the impact these investments have on the wider world.

“Partners Group was a responsible investor with a focus on sustainability long before the industry caught on to it as a specific feature,” says the firm’s senior vice president, Private Infrastructure Europe, Esther Peiner. “For us, it is about active investment management. We drive value through deep co-operation with management teams. In doing that, we work closely with them on ESG matters like health and safety and how to enter new growth markets responsibly. We look to replicate what we believe in as an organisation in the assets we manage. It has become part of the DNA of the firm.”

But there are also still GPs for whom sustainability remains a box-ticking exercise designed to placate investors. “We certainly see a lot of UNPRI signatories using the logo to their advantage,” says James Wardlaw, head of infrastructure at placement agent Campbell Lutyens. “But I am not sure the way those principles are embedded in day-to-day activities is necessarily universal.”

In terms of best practice, it is considered important to have a dedicated ESG resource in-house, while also imbuing the wider team with a sustainable investment ethos. At QIC, for example, there is a team of two dedicated ESG professionals working across all asset classes, but each department then has an ESG champion such as Moorhead. “The idea is to integrate sustainability into the investment process so that everyone understands its importance and it becomes a part of the investment philosophy,” she says.

Partners Group also has a transatlantic ESG team creating standardised and detailed processes around decision-making. This team is influential in due diligence, but also in the firm’s approach during ownership. Similarly, Ardian undertakes annual ESG reviews of its assets resulting in concrete action plans. To better understand its impact on the real economy, the firm also mapped its portfolio’s contribution to the UN’s social development goals for the first time this year.

Some GPs have taken their sustainable-investment approach even further, raising funds dedicated to actively addressing social and environmental challenges. Partners Group, for example, raised PG LIFE in March 2018. “The PG LIFE strategy takes our existing approach one step further,” explains Peiner. “This investment strategy is actively contributing towards advancing the sustainable development goals.”

Sustainability vs returns?

Just as with general partners, LPs differ widely in their approach to sustainable investment.  While some institutional investors place sustainable principles front and centre of their investment strategies, for others ESG is a peripheral concern.

Beeching points to the Nordics, Benelux and France and some of the Australian super funds as leading the way. These investors embark on rigorous due diligence of practices and protocols, as well as in-depth examination of historic investments. ESG-aware investors are also increasingly questioning the ESG set-up of GPs.

“They want to know how many people are in the team, their background, the level of involvement of top management and what resources are dedicated to the responsible-investment programme,” Burghardt says.

Chapman, meanwhile, admits the New Mexico State Investment Council falls firmly in the group of LPs for whom ESG is not a primary focus. His concern is that managers may prioritise sustainability at the expense of returns.

“GPs make thousands of decisions that affect the assets they invest in. ESG can’t be at the forefront of every one of those or it will be to the detriment of returns,” he says. “The minute ESG flies in the face of performance it is a problem and LPs like us will resist.”

The question of whether sustainable investment practice is positively correlated to returns is critical to the evolution of sustainability in infrastructure. A relatively short industry track record and the lack of any targeted research means assertions that returns are not compromised are unproven.

“The problem is there is no data to prove a positive correlation between sustainable investment principles and returns,” says Wardlaw. “If we had that research it could go a long way to improving acceptance of sustainable investment practice amongst the wider LP community.”

There are certainly LPs that embrace sustainability as a driver of returns. Burnett believes sustainable investment is the only way to fully reap the economic benefits of a long-term asset class. “Infrastructure is all about the long term and responsible investment is all about taking a long-term view,” adds Beeching. “There is therefore a strong link between managing ESG issues well and performance.”

GPs turn to their own internal data to support the claims. Peiner says that Partners Group’s investments involving assets positively contributing to sustainability goals have a comparable track record to investments that merely adhere to ESG guidelines. Ardian, meanwhile, has assessed the correlation between financial and ESG performance of more than 140 GPs through its fund of funds’ activity and has, Burghardt says, found a clear link.

“Companies that perform well on ESG issues, for example with low accident or absenteeism rates, usually perform well financially,” Burghardt says. “We find that ESG best practice usually makes assets more competitive, attractive and sustainable overall.” Ardian recently exited Luton Airport, with Burghardt saying “a successful ESG strategy participated in the success of the deal as a whole”.

LP scepticism around the impact of sustainability on returns is exacerbated, however, by a lack of basic definitions and understanding. “There is definitely sometimes confusion between sustainable investment and impact investment, which is more altruistic,” Peiner says. “With impact investing you are not necessarily compensated for political or currency risk, for example. With sustainable investment there should be no compromise on returns.”

Wardlaw adds that sustainability is also tainted by its association with renewables. Renewable energy returns have been disappointing for many investors, with power prices lower than expected, unrealistic projections and high volatility. “If you associate sustainable investment with renewables and you have experienced poorer returns there than other parts of your infrastructure portfolio, that is going to make it harder to embrace.”

Standardisation, standardisation, standardisation

Confused terminology and a dearth of performance research are not the only challenges the infrastructure industry faces in driving sustainability. Despite a move towards hiring specialist expertise, a lack of capability and capacity remains an issue. Knowledge still often remains in the heads of a few individuals, while silos in vast and complex infrastructure organisations can be prohibitive.

Poor regulatory visibility is also a concern, exacerbated by the rise of populism and increasingly short-lived and unstable governments. But the biggest obstacle to truly sustainable investment is a lack of standardisation. While there are multiple frameworks for measuring sustainability, including UNPRIs and SDGs, as well as benchmarking body GRESB, there is no single, consistent and agreed-upon approach to measuring and reporting sustainable investment.

“Reporting standardisation needs to be a priority for the industry,” says Simpraga. “Infrastructure assets are incredibly diverse, spanning industries from airports to solar plants to schools and hospitals. Without a standardised framework it can be a cumbersome process to obtain the relevant data and benchmarks to assess an asset’s ESG merits and performance.”

In September, UNPRI attempted to alleviate some of the complexity, by launching an Infrastructure Investor Responsible Investment Due Diligence Questionnaire, which Beeching says will streamline processes. But there is still a significant way to go before the asset class reaches a degree of standardisation that will propel it to the next level of sustainable investing.

“Standardisation will ultimately lead to a set of principles and benchmarks understood by everyone,” says Peiner. “It will allow those that are highly successful at delivering a clear, bottom-up sustainable-investment strategy to benefit disproportionately in terms of recognition, fundraising and returns. In an industry driven by track record, it is this that will define how the market evolves over the years and decades to come.”