Infrastructure investments with impact

Infrastructure spending looks set to increase strongly over the coming years to support demographic trends, the transition to a net zero carbon economy and continued technological progress. It is one of six secular transformations we have identified in the global economy that should drive long-term investment opportunities. Below we explore how investors who follow an impact investment approach can gain exposure via green and social bonds, known as “labelled bonds”, and through investments in sustainable private infrastructure.

Companies participating in the infrastructure boom benefit from an unprecedented pipeline. rethink infrastructure is one of the six high conviction secular themes we outlined earlier this year in our rethink investments framework. In this framework we focussed on equity markets. But beyond listed stocks, significant opportunities for investors looking to achieve financial objectives while actively contributing to environmental and social goals exist in fixed income and in private assets. The latter forms part of our multi-asset sustainable investment solutions.

Strong macroeconomics, unprecedented pipeline

Five years ago, the World Bank estimated that to meet the evolving demands of urbanisation, migration, international trade, climate change and upgrading infrastructure, would require investments of USD 97 trillion through 2040. High-profile government commitments are mobilising trillions of dollars to rejuvenate or create modern infrastructure for the coming decades.

High-profile government commitments are mobilising trillions of dollars to rejuvenate or create modern infrastructure for the coming decades

Four fast-growing areas of infrastructure are especially interesting for investors: energy, transport, communications, and water. For example, in the energy sector, holistiQ¹ estimates that global capital expenditure on electric grids will increase from an annual average of USD 350 billion through the 2010s, to USD 800 billion per year by 2030. It estimates that in the US alone, cleanup costs from PFAs – widely used, long-lasting chemicals that break down very slowly and may be harmful to human health – could be USD 2.5 billion per year for several decades.

This momentum is here to stay. Investment needs in power distribution grids, recharging and refuelling infrastructure and the transportation network were all reiterated by Mario Draghi’s September report on European competitiveness. In the US, the Biden-Harris administration recently announced USD 7.5 billion of financing for water infrastructure projects. This is in addition to an existing USD 50 billion funding commitment in the Bipartisan Infrastructure Law to support the replacement and expansion of the water network. In the UK, the government has scrapped a moratorium on building onshore wind farms.

The private sector has also seen a renewal of infrastructure investment after the Covid-induced slowdown in 2020/2021. The scale of the overhaul, coupled with public finance limitations, leaves space for the private sector to help re-set power, transport, water, and communication infrastructures around the world. The Global Infrastructure Hub, a G20-founded, not-for-profit organisation, recorded sharp increases in private sector transactions in 2022. Most focussed on energy transmission and storage following the Ukraine-Russia war, as well as digital infrastructure, but there were also many transactions in renewable energy infrastructure.

The scale of the overhaul, coupled with public finance limitations, leaves space for the private sector to help re-set power, transport, water, and communication infrastructures

Steering capital towards the transition

So-called ‘labelled’ bonds, such as green or social bonds, are fixed-income securities either issued by governments or corporations. They fund projects that are expected to have positive environmental and/or social benefits. Unlike a conventional bond, where proceeds can be used to repay loans, purchase inputs, or pay employees’ wages, labelled bond issuers commit to funding a very specific project. Green bonds, the most mature segment, segregate proceeds from companies’ usual activities to finance renewable energy, clean transportation, energy efficiency, and sustainable water management.

The total global market for green bonds is now close to USD 3 trillion, with new issuance of USD 400-500 billion every year since 2021. That is two-to-three times higher than pre-Covid levels and is partly driven by the infrastructure boom. In 2023, 27% of the euro denominated corporate green bond market was made up of utility issuers. A typical green bond is issued by a utility company to finance renewable assets (e.g. photovoltaics, wind farms) or the development of new electric grids. Beyond climate change mitigation, water infrastructure companies issue green bonds to finance the maintenance and efficiency improvement of existing structures, as well as urbanisation needs. The proceeds are used to fund sustainable water and wastewater management projects, to strengthen critical water infrastructure, improve flood control systems, reduce water leakage and monitor pollution.

Financially, the duration of utility green bonds remains slightly longer than for conventional bonds (6.8 years versus 6.6 years in global aggregate indices). However the risk/return characteristics of these bonds are more comparable today. The yield differential between green and conventional bonds from the same issuer is called the “greenium.” In the very early days of the market, labelled bond yields could be more than 10 basis points (bps) lower than comparable conventional bonds because of a supply/demand imbalance. As the green bond market expands, this spread is narrowing to a nearly negligible 2 bps in the most mature geographies such as the euro area.

Green bonds are therefore a key way for investors to have an impact and help fund the sustainability transition while not sacrificing significant portfolio performance. Measurability is key in impact investing. This is why it is crucial to select issuers that are committed to detailed annual reporting on the projects financed, including metrics such as CO₂ emissions avoided, or water re-used.

Green bonds are a key way for investors to have an impact and help fund the sustainability transition while not sacrificing significant portfolio performance

Impact by design – sustainable private infrastructure

Another way to invest with impact in the theme is through private infrastructure. Governments and institutions play a key role in funding infrastructure projects, but public finance has its limitations. The scale of infrastructure needs requires the private sector’s involvement in the energy transition, water management, transport and digitalisation.

As a result, the top 100 infrastructure investment management firms today manage aggregate assets of EUR 2.2 trillion, an increase of almost EUR 1 trillion since 2020². The energy transition is the fastest growing part of the private infrastructure asset class. A recent BloombergNEF report shows that investments into this sector rose 17% to USD 1.8 trillion in 2023. 

Traditional infrastructure fund managers can drive returns through operational improvements and capital investments to enhance asset performance. When looking for both financial returns and an active contribution to environmental and social goals, investors should focus on greenfield, or new projects, where the value creation comes mainly from de-risking of both development and construction risks and operational ramp-up prior to exiting the investment. The asset is eventually sold, often to a utilities company that will eventually operate it. Here again, the impact must be measurable through the reporting of specific performance indicators including emissions avoided, clean energy capacity added, water treated, or households powered/linked to the water network.

When looking for both financial returns and an active contribution to environmental and social goals, investors should focus on greenfield, or new projects

Investors must navigate the trade-offs between pursuing innovative, high-impact but riskier greenfield projects and maintaining attractive risk-adjusted returns by carefully selecting their partners to access these opportunities. The longer investment horizon of private infrastructure compared with private equity vehicles can be a drawback for non-institutional investors. However, secondary markets, where investments can be resold, and open-ended structures, which are more liquid, are emerging, expanding the opportunity set.

From a portfolio construction standpoint, private infrastructure can provide investors with diversification, stable cash flow and a hedge from inflation. Between 2021 and 2024, returns of private infrastructure funds averaged around 13%, according to Preqin, a data provider. The worldwide need for clean energy and digital solutions lets investors build geographically diversified exposures.

Some greenfield projects have experienced a steeper initial loss, known as the ‘J-curve,’ over recent years as inflation and interest rate levels drove up the cost of materials and equipment during the construction of infrastructure assets. However, the backdrop is improving as inflation and interest rates fall in developed markets, lowering the cost of capital. These factors are accelerating deployment into greenfield assets in areas supported by unprecedented needs and policy tailwinds. Sustainable private infrastructure investments therefore represent opportunities to achieve the dual objective of investment returns and measurable sustainable outcomes.