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On the day the U.K. experienced its hottest day on record, people glued to their TV screens saw a row of burning houses. Rather than fretting about the surreal sight of wildfires so close to central London, Mike Fox’s attention was on a power cable in the background of the flames.
“My thought was, Okay, it probably isn’t anything to do with that pylon. But supposing it hadn’t been properly maintained and created a spark that created the fire,” he says.
The scenario made him think of Pacific Gas & Electric Co., the largest utility in the U.S., which filed for bankruptcy in 2019 after trees that fell on its power lines caused widespread forest fires. U.S. headlines labelled it the world’s first climate change bankruptcy.
It’s Mr. Fox’s job to think about infrastructure risks caused by climate change because he runs a sustainable fund at Royal London Group. But most companies and investors, he believes, do not. “The risk to existing infrastructure is quite considerably mispriced by markets,” he argues.
This needs to change. The July heat wave that swept across Europe made it hard not to notice the failings of existing infrastructure in extreme weather.
Trains had to move more slowly. A runway at London Luton Airport buckled. Some operating theatres got too hot to function and schools closed. In a hotter world, infrastructure will need to adapt. All this creates opportunities for investors.
There has long been a good case for investing in infrastructure. It’s been popular among institutional investors because it offers steady returns in relatively resilient sectors, such as utilities or transport, that are often based on long-term contracts and linked to inflation.
Retail investors can also put money into many infrastructure funds – although, as they have to access the asset class through listed equities, they have to accept some extra volatility.
But the returns have been steady. For example, iShares Global Infrastructure ETF IGF-Q has returned 8.5 per cent a year over the past decade. In a year that has been horrendous for equities, more generally, it lost just 1 per cent, compared with a near 17 per cent drop for iShares MSCI World ETF URTH-A.
With the effects of climate change becoming ever more apparent, investing in infrastructure is more likely to be friendly to environmental, social and governance (ESG) factors. Traditional infrastructure funds are eyeing green energy; they can’t ignore it. Holdings in iShares Global Infrastructure ETF include Australia-based toll road operator Transurban but also NextEra Energy Inc., the world’s largest wind and solar power generator.
A report by law firm Linklaters LLP at the start of the pandemic found that global infrastructure funds expected to grow their green assets to more than a fifth by this year. Green and climate-resilient real estate and electric vehicle infrastructure were two of the top areas of interest.
Catherine Hampton, an investment manager at Cazenove Capital, views some infrastructure funds that don’t have ESG in their name as essentially sustainable investments. These include International Public Partnerships, a listed investment trust. Among its holdings is Thames Tideway Tunnel, which will improve London’s water sewerage system and is expected to offer steady inflation-linked returns when it becomes fully operational.
In general, Ms. Hampton says real asset investments are “less correlated” to equity and bond markets, provide stable inflation-linked returns, and can weather some of the volatility now seen in other markets.
Of course, stability usually means lower growth in the good times. During the past 10 years, the MSCI World Index has produced an annualized 11.6 per cent return, while funds in Morningstar Inc.’s equity infrastructure category returned 7.5 per cent.
Another core concern is better air conditioning. Ursula Tonkin, manager of the Patrizia Low Carbon Core Infrastructure Fund, which has annualized returns of almost 7.5 per cent for the past five years, says this is a key area of investment for infrastructure funds in a hotter world.
Using air conditioners and electric fans to stay cool accounts for almost 20 per cent of total electricity use in buildings, according to a report from the International Energy Agency (IEA) – and 10 per cent of all global electricity consumption.
But consumers are not buying the most energy-efficient units available; investing in more efficient air conditioners could cut future energy demand in half, the IEA says. No surprise, then, that energy-efficient air conditioner start-ups are a common beneficiary of climate tech funding – Bill Gates’s investment in 75F being one example.
Of course, solutions to infrastructure problems that rely on new technologies are not the safest place for retail investors. But there are steadier options, too.
One example is electricity grids. Ms. Tonkin argues that, with their stable returns and heavy regulation, there is a good way for retail investors to access the energy transition.
“They’re not inherently green but they’re a necessary part of the transition in building out renewable energy,” she notes. Her fund owns the national electricity grids of Italy, Spain and the U.K., among others.
As with any products that have an ESG label or call themselves sustainable, retail investors should be aware that they aren’t necessarily investing in companies that are actively doing good. It’s often easier for them just to strip out the worst offenders, which is why ESG funds have historically been overweight tech stocks, a result of ditching fossil fuel companies.
Fund managers may also opt for a “best in class” approach: investing in companies that do better than their peers in cutting emissions or transitioning to clean energy. The Patrizia fund owns Hawaiian Electric on these grounds: historically a heavy polluter but one that has recently moved more into renewable energy.
Of course, being prepared for a hotter world doesn’t just apply to infrastructure.
Mr. Fox takes this approach from a climate risk perspective: which companies are taking it seriously, and which are not? National Grid PLC, he believes, is well prepared. The commercial real estate sector is aware of the infrastructure risk posed by climate change; residential real estate, not so much.
Ultimately, it’s easy for investors to forget that their final return is what they gain minus what they lose. If they’re not focused on which companies are best preparing for a hotter world, the losses could take them by surprise.
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Editor’s note: Please note that the average annual return figures for the iShares ETFs cited in this piece are in euros.