This article is sponsored by Russell Investments.
As the transition to a net-zero economy gains momentum, climate infrastructure is providing an area of growth for investors. From electric vehicle recharging hubs to wind and solar energy generation, green infrastructure provides opportunities to generate stable returns, while also having an impact on global emissions. But with greenwashing still an issue, due diligence and authentic impact measurement are keys to long-term success. Samantha Steele, director of private markets, and portfolio manager of impact investing strategies at Russell Investments, explains the benefits and challenges of navigating this nuanced asset class.
What are the key drivers of growth in climate infrastructure investments?
The fundamental aspect is the transition to a net-zero economy. Bloomberg estimates that the transition to clean energy will require between $92 trillion and $173 trillion over the next 30 years. Annually, that equates to double today’s level, driving significant demand for this type of product.
The cost of clean energy and green technology has come down considerably. These technologies now rarely need subsidies, and offer many avenues to invest. Ten years ago, very few portfolios had exposure to renewable energy, but it is now considered an institutional investment.
There is also growing demand for investment in the electrification infrastructure that underpins this transition to renewables, such as electric vehicles and electric charging stations. Demand from corporates looking to reduce reliance on fossil fuels and become more sustainable is helping to drive this.
The other key driver is around the regulation and policies that aim to reduce emissions and promote clean energy. This is feeding through into the institutional market as investors set clear targets to align with certain regulations.
What is the role of climate infrastructure in client portfolios?
By investing in climate infrastructure you are future-proofing your portfolio ready for the transition to a lower carbon economy. And you can invest in many ways; it doesn’t have to be just one approach.
From an income perspective, climate infrastructure can provide a good cash yield, diversification, and hedge against dislocation as we move towards a lower carbon economy. You have inflation-linked contracts with cashflow linked to credit-worthy counterparties that can provide a stable income stream. These clients are investing in core strategies and established assets with an income stream that they can invest in from a long-term perspective.
And there are investors that can use this type of investment from a growth perspective within their portfolio. They are looking at investing at the corporate entity level, taking on more development risks. For this, we look to work with managers that have experience on the development side, investing in organisations that are, for example, building a wind farm, or buying an existing wind farm and making operational enhancements to maximise output. There’s a certain level of risks associated with this strategy, but we can underwrite those risks.
What approaches can investors take when it comes to climate infrastructure?
Larger, sophisticated investors usually have the expertise and in-house skill set to create their own investment strategies. However, we work with many managers whose clients are not as experienced in the asset class. We help them on the journey of understanding their risk and return profiles. From there, we help build either a tailor-made solution, or a funds solution that involves building a basket of funds where they get exposure to different climate infrastructure investments. This reduces the single-manager risk within the portfolio and increases the level of diversification, so they get a broad diversification to a range of managers and strategies.
“By investing in climate infrastructure you are future-proofing your portfolio”
This approach makes it easier to assess the portfolio and elevate the type of impact and exposure of different assets within a diversified climate infrastructure investment portfolio. You could also have more niche, boutique exposure to just one element, such as solar energy, or adopt a regional strategy. You can then blend those approaches to get the best outcome for the client.
How do you measure a portfolio’s impact on climate change?
Many investors like to look at their climate infrastructure portfolios from an impact perspective because they can quantify how their money has made a difference. There are numerous frameworks and metrics to measure impact, and for investors first going into this space it can be quite daunting.
To remove all that noise and confusion, we assess the different frameworks, take the best that we see in the market and select the key metrics that we are going to be monitoring the manager against. This means we can build a standardised framework for measuring impact. Then, rather than just giving them a page of numbers, we present impact measurements to the investors in a clear and tangible format to show the real impact of their investments. How much have CO2 emissions been reduced because of their investments? How many cars have been taken off the road? How many houses have been heated by clean energy?
It’s important for managers to set clear KPIs upfront and put them in the business plan. That way they can track performance against that starting point. There is still quite a lot of greenwashing in the market and some managers look backwards – saying what they have done without saying what they originally intended to do. We want to know what their targets were and whether they are hitting those KPIs.
What are the keys to success for investing in this space?
For our clients, we focus on diversification within the portfolio – making sure that there is diversification in managers, strategies and jurisdictions. Infrastructure is very much linked to government and the local market, which means at any point there could be a significant shift in regulation that changes everything. Diversification is the number one factor to future-proof your portfolio against such sudden changes.
The other key to success in this field is due diligence. To mitigate against greenwashing, you really need to be able to lift the bonnet and assess the quality of the product in which you are investing. The private markets are fairly opaque, so to do this you need to work with a specialist.
It is an extremely nuanced asset class and unless you have in-house expertise or resources it is difficult to run due diligence and really understand whether there are clear targets or whether impact measurement is authentic. It is easy to be wowed by pictures and statistics, but, if you want to make a difference and be successful, understanding the underlying fundamentals of that investment is still really important.