Building a better world by integrating ESG into infrastructure investments

Text size

This is a sponsored article from M&G Investments.

Alex Araujo
Fund Manager of the M&G Global Listed Infrastructure strategy

In this Q&A, Alex Araujo, Fund Manager of the M&G Global Listed Infrastructure strategy discusses the themes which are underpinning the sector and explains why he believes ESG principles and processes are inextricably linked to future success

What are the main themes that are driving listed infrastructure?

AA: At the moment, we are seeing the convergence of a number of themes. Coming out of a global pandemic — and its economic consequences means that we have this quite unusual  co-ordinated global set of efforts to revitalise economies.  Whether that’s North America, Europe or Asia, much of it is centred on fiscal stimulus and much of that stimulus is built around infrastructure.

The impetus is also for a green recovery, a sustainable recovery. This is a planetary and societal requirement and renewable energy, cleaner forms of energy generation and sustainability are at the centre of it all.

Digital infrastructure assets, which are an essential part of the unlisted infrastructure strategy at M&G, are an important driving theme because many of us still work remotely and entertain ourselves remotely. If anything, we’ve all learnt over the past year and a half how dependent we are on digital infrastructure to support our work and personal lives. In our view, all of that converges quite conveniently for a strategy such as ours, with so many different sets of exposures which can capitalise on these important themes.

Where are the most attractive investment opportunities within renewables? 

AA: This might surprise you,  because it’s not in the most obvious places. Pure renewable type businesses have been a go-to investment strategy for many investors, particularly ESG-minded investors. This has driven valuations up quite considerably, while increasing volatility in those kinds of cases.

We see greater opportunities in transition-oriented businesses. Examples here could be in electricity generating companies that are transitioning their own energy mix from more carbon intensive sources to renewables. I would argue such companies are actually contributing in a much different, perhaps even more supportive way because they’re affecting both sides of the balance sheet: deploying renewables, but decommissioning carbon intensive energy sources. These two case studies illustrate how we engage with renewable energy champions on both sides of the Atlantic: Enel and NextEra.

At the same time, these are complicated stories. Very often it requires engagement with management teams, with boards on how to accomplish that transition. We have to put pressure on — and sometimes we have to financially support — these initiatives. For that reason and for that added complication, the valuations tend to be more attractive. Therefore, what we accomplish in these investments is, of course, doing significant good for the environment when it all plays out the way we’d like it to, while capitalising on the valuation rerating, which is typically accompanying these kinds of stories.

I’d throw one more element into the mix, and that is transition fuels. We hear a lot about hydrogen as an ultimate fuel source. However, there are crucial transition fuels such as natural gas that can take an intermediate step in displacing coal-fired power and coal-fired heat in certain countries where renewables and cleaner forms of electricity generation aren’t yet available. That’s another interesting opportunity. Again, not obvious, and therefore with some attractive valuations attached to it.

Watch the videos to learn more:

Hydrogen is the cleanest burning fuel yet discovered. It’s already creating opportunities for infrastructure investors, particularly in the utilities sector.
Watch the video
Around the world, governements are prioritising renewables as the way to rebuild infrastructure sustainably. The opportunity to invest for net-zero is immediate and global. Watch the video

How does the investment approach differ from more traditional strategies for infrastructure investment?

AA: There are probably three specific areas I’d highlight here.

Firstly, is our focus on growth, but more specifically on dividend growth that we seek to extract from the businesses in which we are invested. The Global Listed Infrastructure strategy has an objective to grow the income to our unitholders every year in base currency terms, which for most of our audience would be sterling. This is achieved, naturally, by way of growing dividends, and you can only grow your dividends as a business if you have the kinds of assets and growth opportunities that can drive higher and higher cash flows. It’s very simple.

Rather than being more of a defensive-type of strategy, which is the traditional approach in the infrastructure world, we’re focused on the long term, consistent, reliable growth and cash flows and therefore dividends from the businesses in which we invest.

Secondly, a difference is on the scope and the breadth of what we invest in. I think historically most infrastructure investors have been focused on ‘core’ or ‘traditional’ economic infrastructure. We do that too of course — that’s the bulk of our exposure in the form of utility businesses, transportation infrastructure, energy infrastructure type holdings. But we extend the opportunity set for our investors to include social infrastructure, which has been incredibly important in the past year and a half. Think of hospital infrastructure, for example within primary care or hospital-type facility provision, educational infrastructure, civic infrastructure and so on. These are all involved in social infrastructure, which is a very defensive element of the strategy.

Thirdly, we add on what we call evolving infrastructure. This is the physical infrastructure required for the increasingly digital world in which we live. I have alluded to it earlier, but this is where we get into mobile phone towers, data centres, fibre optic networks etc. These are the kinds of digital infrastructure assets that we can’t do without if we want our internet, our zoom calls and so on.

Bringing these three elements together gives us some diversification within the sector because not all of these sectors and areas move in the same way at the same time. They have different market environments and we’ve benefited from that.

The final point I’ll make here is on ESG integration. This is where we examine and scrutinise the sustainability of the underlying assets and the business’ management teams that are managing them to ensure that those cash flow streams which we seek to grow over time will actually appear. This is particularly so over the long term, because we are long term investors with a very long term investment horizon.

Watch the videos to learn more:

See beyond renewables and discover the real investment opportunities in the decarbonisation of the infrastructure sector. Watch the video Discover the impact of natural gas on tomorrow’s infrastructure and how transition fuels are on a journey around the world. Watch the video 

Why is ESG so important for listed infrastructure?

AA:  For our strategy, it’s the nature of what we’re investing in, the nature of the asset class. We are investing in fixed, immovable, real assets at the core of the businesses that we hold in the portfolio. They typically have impact and they are exposed to potential impact — think of climate-change related events such as flooding, storms, forest fires etc. which pose a risk to those assets. In addition, those assets could become stranded for one reason or another, depending upon what they’re used for. So our ESG approach is one of examining the sustainability of the assets and, the businesses, because that’s the governance element, the societal impact of those assets and any exposures to risk. That is the proprietary approach we take. There are obviously financial implications of these kinds of risks. We aim to protect investors and their capital. That’s how our ESG approach is structured for the strategy.

How does inflation affect the asset class?

AA: That’s a complicated question. Very often, inflation fears can manifest themselves in listed infrastructure types of businesses from a sentiment point of view. It’s the historical linkage between inflation risk and interest sensitive businesses, because these are all dividend- paying companies in our portfolio. This tends to give us great opportunities because our ultimate protection and hedge against inflation in this portfolio is what I discussed earlier: that focus on growth. In my opinion growth is your best hedge against inflation risk. So, if we think about the kinds of businesses in which we invest and where they get the growth, you can see that having inflation accompanying growth— even if that means the higher interest rates that go along with it — can certainly benefit these businesses. Let’s consider a toll road infrastructure business. What does that toll road need? What it wants is growth, it wants recovery, passenger traffic, cargo traffic etc. Inflation allows the business to increase its tolls.

And so you get this effect where the economic sensitivity, the growth, the inflation, even the higher interest rates can positively affect these businesses. About two thirds of our portfolio itself has some form of inflation linkage in terms of protection. Sometimes it’s explicitly contractual,  such as you tend to find in social infrastructure, or it is less direct, such as in certain economic infrastructure businesses. It can even be in commodity price linkages, where infrastructure is serving commodity producing types of businesses.

These offer protections within the strategy. We have an objective to grow our dividends, expecting them to grow at a rate in excess of the G7 inflation rate, and this is how we seek to protect our investors from the eroding returns that inflation can sometimes bring.

The value and income from the fund’s assets will go down as well as up. This will cause the value of your investment to fall as well as rise. There is no guarantee that the fund will achieve its objective and you may get back less than you originally invested.

The views expressed in this document should not be taken as a recommendation, advice or forecast.

For Investment Professionals only. Not for onward distribution. No other persons should rely on any information contained within. This guide reflects M&G’s present opinions reflecting current market conditions. They are subject to change without notice and involve a number of assumptions which may not prove valid. The distribution of this guide does not constitute an offer of, or solicitation for, a purchase or sale of any investment product or class of investment products, or to provide discretionary investment management services. These materials are not, and under no circumstances are to be construed as, an advertisement or a public offering of any securities or a solicitation of any offer to buy securities. It has been written for informational and educational purposes only and should not be considered as investment advice, a forecast or guarantee of future results, or as a recommendation of any security, strategy or investment product. Reference in this document to individual companies is included solely for the purpose of illustration and should not be construed as a recommendation to buy or sell the same. Information is derived from proprietary and non-proprietary sources which have not been independently verified for accuracy or completeness. While M&G Investments believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and management’s view as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumptions which may involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such statements. All forms of investments carry risks. Such investments may not be suitable for everyone. Australia: M&G Investment Management Limited (MAGIM) and M&G Alternatives Investment Management Limited (MAGAIM) have received notification from the Australian Securities & Investments Commission that they can rely on the ASIC Class Order [CO 03/1099] exemption and are therefore permitted to market their investment strategies (including the offering and provision of discretionary investment management services) to wholesale clients in Australia without the requirement to hold an Australian financial services licence under the Corporations Act 2001 (Cth). MAGIM and MAGAIM are authorised and regulated by the Financial Conduct Authority under laws of the United Kingdom, which differ from Australian laws. Singapore: For Institutional Investors and Accredited Investors only. In Singapore, this financial promotion is issued by M&G Real Estate Asia Pte. Ltd. (Co. Reg. No. 200610218G) and/or M&G Investments (Singapore) Pte. Ltd. (Co. Reg. No. 201131425R), both regulated by the Monetary Authority of Singapore. Hong Kong: For Professional Investors only. In Hong Kong, this financial promotion is issued by M&G Investments (Hong Kong) Limited. Office: Unit 1002, LHT Tower, 31 Queen’s Road Central, Hong Kong. M&G Investments is a direct subsidiary of M&G plc, a company incorporated in the United Kingdom. M&G plc and its affiliated companies are not affiliated in any manner with Prudential Financial, Inc, a company whose principal place of business is in the United States of America or Prudential Plc, an international group incorporated in the United Kingdom. This financial promotion is issued by M&G International Investments S.A. in the EU and M&G Investment Management Limited elsewhere (unless otherwise stated). The registered office of M&G International Investments S.A. is 16, boulevard Royal, L-2449, Luxembourg. M&G Investment Management Limited is registered in England and Wales under number 936683, registered office 10 Fenchurch Avenue, London EC3M 5AG. M&G Investment Management Limited is authorised and regulated by the Financial Conduct Authority. M&G Real Estate Limited is registered in England and Wales under number 3852763 and is not authorised or regulated by the Financial Conduct Authority. M&G Real Estate Limited forms part of the M&G Group of companies.

This is a sponsored article from M&G Investments.

Related Tags

Topic

Register Now: Limited spaces available to APB Summit 2021

Asian Private Banker returns with its much anticipated annual APB Summit – live in Hong Kong and online on 1 December 2021. Join us as we bring Hong Kong's private wealth management community under one roof again after a two year hiatus. This year’s Summit will look back at the events that have shaped the industry over the past year, and look ahead to the opportunities and challenges as we optimistically anticipate a return to business order in 2022.

➤ Register Now