Necessity drives the argument for investment

Written By: Colm O'Connor Senior Portfolio Manager KBI Global Investors

Colm O’Connor of KBI Global Investors contends that while the demand for significant investment in infrastructure continues unabated, institutional investors have been slow to take advantage of the opportunities presented

Many commentators estimate that trillions of dollars of sustainable infrastructure investment are required for the provision of clean, safe and high-quality water, energy and food to the global population over the coming years. The critical need for this investment is a direct result of:

• Ageing and depleted assets in dire need of rehabilitation/replacement
• Population growth
• Rapidly expanding cities
• Societal and economic demand

The multi-decade trends of population growth and expanding cities are most evident in emerging market economies. Across China and India alone almost 700 million more people will live in cities by 20501. There is already a huge necessity to build, expand and improve the infrastructure in these economies to meet the population’s most basic needs. Billions of people are already without access to electricity, security of food, safe drinking water or basic sanitation.

But this isn’t just an emerging market requirement – developed market economies face significant challenges too. Here, the existing infrastructure is aged and depleted, with devastating environmental impacts such as contamination of the water supply, vast wastage of food and inflexible and aged electricity grids, which are unable to cope with variable production from new clean energy sources.

While infrastructure investment across developed economies has been decreasing for the best part of 40 years, improving regulation combined with social and economic necessity, means that we have started to witness a sea-change. Government spending on sustainable infrastructure has increased across the globe, driven to some extent by high-profile and highly-publicised pollution incidents, which in turn has lead to more regulation and greater enforcement. The recent water crisis in Cape Town and in Flint, Michigan highlights both the consequences of chronic under-investment and the dangers posed by the spread of disease. An estimated one million people are killed by water, sanitation and hygiene-related disease each year2.

Within the energy sector, utility capital expenditure continues to focus on strengthening the electric grid infrastructure and adapting to increased penetration of clean energy solutions. Whilst electricity grids must learn to become more flexible to handle the rising contribution of clean energy, further investment is also required to combat the dangers posed by climate change. Recent extreme weather events, such as the storms in South Australia in 2016, underline this point and governments are increasingly coming to recognise the need to improve grid resilience in the wake of changing weather patterns.

Despite these issues, and the improving trend, institutional investors appear to be significantly under-exposed to these vital infrastructure sectors.

While many have exposure to energy, it is typically through traditional energy infrastructure such as oil and gas pipelines. In contrast clean energy is now cost competitive and a growing part of the energy mix. Higher renewable penetration also requires significant grid investment, for whilst clean energy is now competitive, it is also unpredictable and many grids are badly equipped to handle their intermittency. Clean energy investment is increasingly important given the global commitments to decarbonisation. Some investors have exposure to water, but it appears to be minimal and focused on regulated utilities in OECD countries.

We know that water spend in OECD countries will increase steadily over the coming years, but we expect even higher investment in emerging markets, where access to safe drinking water is still a critical issue. In China alone, between 25-33% of the population still have no access to safe drinking water3.

Food or agriculture is perhaps a smaller part of the infrastructure universe, but farmland owners, food storage and transportation companies play a critical role in the provision of food to the global population. Again, it would appear that institutional investors are woefully under-exposed.

Given the desire of institutional investors to diversify their portfolios, we understand the need for private market investment given its lower equity market correlation; however, the reality is that investors can immediately access companies in these areas through public markets.

Importantly, listed infrastructure companies are demonstrating many of the same desired characteristics in the infrastructure asset class, such as asset-intensive businesses with stable cash flow generation and long-duration contracts, often with strong regulatory/government backing. Investments are available in all regions; this ensures we can invest on a geographically diverse basis and delivers inflation protection with strong income distribution. Costs are lower, and there is full liquidity.

We know of companies whose earnings are typically linked to movements in inflation, across a wide variety of end markets – grid operators, clean energy utilities, water and waste water utilities included. Asset owners are another example, with a variety of business models available – waste and energy companies, Yield cos, Farmland REITS as well as storage and transportation facilities.

Many global forums, such as the World Economic Forum or the United Nations Conference on Climate Change, have highlighted the need for investment in these areas, and so too have many independent commentators.

What is evident is that there is almost universal agreement on the need for significant investment in the infrastructure so essential for providing the global population with our most critical resources, but infrastructure investors remain overwhelmingly under-exposed. It’s time for investors to reassess this asset class.

KBI Global Investors Ltd is regulated by the Central Bank of Ireland and subject to limited regulation by the Financial Conduct Authority in the UK. Details about the extent of our regulation by the Financial Conduct Authority are available from us on request.

1. https://stansberrychurchouse.com/real-estate/real-estate-prices-cities-will-rise-decades/
2. https://water.org/our-impact/
3. http://content.time.com/time/photogallery/0,29307,1724375_1552669,00.html