Infrastructure

Infrastructure investments have been on the back burner over the past year as simmering global trade tensions and rising interest rates weighed on the sector. Underlying fundamentals remain strong, however, and this theme should again attract attention this year as headwinds weaken and new catalysts emerge. Among these, China’s Belt and Road Initiative is pushing into Europe and will likely spur more infrastructure investment in the region. Furthermore, efforts by the G20 to better enable the private sector to invest in public infrastructure should help boost investment in this sector.

Infrastructure renaissance

The collapse of Italy’s Morandi bridge in the summer of 2018 was a tragic reminder of the struggle that many developed countries face in dealing with outdated infrastructure. Developing countries face their own challenges as they seek to build new infrastructure for clean water, energy and transport. Indeed, the G20’s Global Infrastructure Hub initiative forecasts that the global infrastructure gap will widen to USD 15 trillion by 2040.

Several catalysts should bring the infrastructure theme back into focus for investors. At the end of 2018, G20 leaders endorsed the promotion of infrastructure as an asset class to help address the above-mentioned funding gap. The G20’s roadmap aims to improve the standardization of documents for procurement and financing, among other measures, making it easier for private capital to invest in public infrastructure projects worldwide.

In addition, China’s Belt and Road Initiative – a driving force for global infrastructure development – is now on Europe’s doorstep. China signed a memorandum of understanding with Portugal in December 2018 and Italy in March 2019 covering Chinese infrastructure investments in their respective countries. 

Furthermore, governments are facing greater pressure to adopt renewable energy targets as the global climate movement gains momentum. Such policies will require major infrastructure investments to ensure a smooth transition from fossil fuel-generated electricity to renewable energy. 

Finally, the monetary policy of major central banks including the US Federal Reserve has turned more accommodative of late, transforming a headwind for infrastructure investment into a positive catalyst in 2019. The MSCI World Infrastructure Index’s recent rally appears to support this view.

2.1 Transport

Moving faster

Within our transport subtheme, we have increased our exposure to infrastructure operators (airports, toll roads and railways) and reduced our exposure to suppliers of materials and construction services for transport projects.

While rising interest rates acted as a headwind for infrastructure investments in 2018, the upside is that higher rates are linked to increasing inflation expectations. If inflation picks up in the USA and Europe, infrastructure operators with regulated business models and inflation-protected cost-plus-pricing formulas could benefit as they can raise prices to pass on the cost of inflation to their customers.

The transport subtheme provides an additional benefit in that it tends to be less exposed to economic cycles. For example, transport infrastructure operators are quasi-monopolies as they manage or own assets that are almost impossible to replicate. These companies typically generate stable revenue streams from large infrastructure assets over several decades and are thus less affected by ups and downs in the overall economy.

They also offer robust growth profiles. Airports of Thailand Pcl, for instance, has benefited from strong organic growth in passenger numbers and traffic. And Spanish toll road operator Ferrovial SA has recorded robust growth from the highways it manages in Canada and the USA.

2.2 Energy and water

Mind the climate gap

Our “closing the gap” slogan also applies to the shortfall in meeting greenhouse gas emission targets. The reduction of energy-related carbon dioxide (CO2) emissions is at the heart of the debate concerning the transition to renewable energy sources. Current government targets continue to fall short of the emission cuts that will be necessary to limit global warming to 1.5 °C above pre-industrial levels in coming decades, a target established in the 2015 Paris climate accord. The Intergovernmental Panel on Climate Change (IPCC) describes different policy pathways to net zero CO2 emissions by 2050 to avoid breaching the critical 1.5 °C ceiling. One key component requires significant growth in renewable energy.

The public pressure on politicians to take action will only intensify as climate activism gains momentum. Government policy is therefore expected to become more ambitious when it comes to setting short and medium-term renewable energy targets.

Renewable energy projects will thus need to be built faster than previously planned to close the emission reduction gap. Accordingly, the International Renewable Energy Agency (IRENA) projects a strong increase in renewable energy sources (wind, solar, hydro) as a share of total electricity generation worldwide by 2030.

In the transition toward renewable energy, nuclear energy (in addition to natural gas) continues to be an important bridge fuel. However, it still suffers from a negative public image following the Fukushima nuclear disaster in 2011. In coming years, there are likely to be more nuclear plant closures than new projects: IRENA projects that the global share of nuclear energy as a fuel for power generation will decline from 10% in 2015 to about 4% by 2050. These policy changes will have a profound impact on utility companies. Many of the large electricity generators are adding wind and solar energy to their generation mix. In our energy and water subtheme, we prefer electricity companies that have already started to adapt their business models to become leading global renewable energy operators.

Another infrastructure gap is the acute water supply shortage in the Middle East and North Africa (MENA) region, where 6% of the world's population lives with just 1% of the world's freshwater resources, according to the World Bank. As a result, 13 MENA countries suffer from an absolute water scarcity. To close this water gap, MENA has become the largest desalination market in the world and now accounts for nearly half the world's desalination capacity, according to World Bank calculations.

However, desalination in the Middle East has a high carbon footprint as the region is reliant on energy-intensive thermal desalination plants. To reduce carbon emissions, the region is experimenting with less energy-intensive processes including solar-powered and reverse osmosis desalination. Besides desalination, the region also uses wastewater treatment, groundwater recharge and the capture of rain and storm water to recharge aquifers as less energy-intensive ways to increase water supply.

The World Bank estimates that the insufficient water supply and sanitation costs MENA about USD 21 billion per year in economic losses. If the region cannot close or at least narrow its water gap, the World Bank estimates that climate-related water scarcity will cost the region 6%-14% of its GDP by 2050.

2.3 Affordable housing

Rocketing rents

Finding affordable housing remains a concern that affects households in both developed and in emerging market cities. Germany provides a good example, where rental costs for an 80-square-meter apartment in large cities have soared over the past decade: Berlin has seen rents surge by 80%, Munich by 65%, Stuttgart by 60% and Frankfurt by 50%, according to the Spring Real Estate Industry Report 2019 from the ZIA German Property Federation.

In response, activists in Berlin have started collecting signatures for a referendum proposal that would require landlords that own more than 3,000 apartments to sell them to the city – a move that the Berlin Senate reckons could cost as much as EUR 36 billion. Another explanation for the explosion in rents, according to The German Institute for Economic Research, is rising construction costs due to more stringent building regulations as well as renewable energy standards.

In London, mayor Sadiq Khan plans to address the current housing crisis by exempting private housebuilders from revealing their project’s profitability when at least 35% of the development is earmarked for affordable housing, a move aimed at making the planning process go faster. The goal is to reverse the trend of declining share of affordable housing in London’s newly built housing stock.

With these developments in mind, we seek to invest in rental housing companies, as well as in homebuilders that construct lower-income housing in developing markets and entry-level homes in developed markets.

2.4 Telecom infrastructure

Building on the promise of 5G

Our telecom infrastructure subtheme is focused on infrastructure equipment that is required for the roll-out of the new fifth-generation telecom technology. 5G will be the next major investment cycle for the mobile industry. As a result, mobile data traffic is expected to expand almost five-fold by 2024 to 24 gigabytes (GB) per user per month, according to the GSM Association (GSMA).

Mobile carriers in the USA and South Korea launched 5G services in 2018, making them the first in the world to do so. The next major wave of commercial 5G services launches are expected to take place in Japan, China and Europe. Strategy Analytics predicts that China will be the 5G market share leader with a 46% global market share in 2019 (compared with 16% for the USA). Globally, the market for 5G radio access network (RAN) infrastructure is projected to grow at a 67% compound average growth rate between 2018 and 2022, reaching a size of more than USD 7 billion.

The company selection in our telecom infrastructure subtheme is focused on 5G-related infrastructure providers such as data centers, telephone tower companies and equipment manufacturers. Telephone tower companies should generate strong growth from the upcoming 5G implementation as demand for wider bandwidth increases and the transmission distance between telecom towers must decrease to enable seamless 5G coverage. As a result, more towers will be required or mobile providers will share towers by merging them into new entities to increase their respective coverage. The recent announcement from Telecom Italia and Vodafone Italia to enter a 5G network sharing agreement and potentially combine their telecom towers in Italy into a single entity seems to confirm this view.

  • Infrastructure gap: The shortfall between needed infrastructure investments and the projects actually built.
  • Net zero carbon emissions: All greenhouse gas emissions would be eliminated or offset by negative emissions, which will be necessary to limit global warming to 1.5 °C above pre-industrial levels by 2050. To reach this goal, renewable energy generation capacity in the electricity sector will need to grow significantly.