Concerns over environment a big priority with investors

Infrastructure — not unlike other asset classes — faces increased scrutiny from asset owners aiming to limit adverse impacts on the environment, including through investments that specifically target the United Nations' Sustainable Development Goals.

The race to meet the 2015 Paris Agreement objective of keeping temperature increases below 2 degrees Celsius has found global investors intensifying efforts to actively manage their assets' environmental, social and governance risks, despite President Donald Trump withdrawing the United States' support for the accords.

And the palette of environmentally and socially crucial factors that are now considered by investors range from an asset's water usage and waste management efficiency to transport networks' energy output, all part of the U.N.'s Sustainable Development Goals.

ESG-related infrastructure investments can take many forms when addressing various environmental, social and governance issues, including:

• Energy
• Water
• Waste management
• Transport

One asset owner, PenSam, Farum, Denmark, has committed a combined 750 million Danish kroner ($112 million) to date to support projects that include a solar plant in California, a wind park in Sweden and an energy distribution utility in Norway. In total, PenSam will invest 8 billion Danish kroner by 2025 in infrastructure assets that are supporting decarbonization, said Carsten Grohn, head of private capital and real assets at the 140 billion Danish kroner multiemployer plan for elder care, technical service and education workers.

"Looking at different types of infrastructure assets, decarbonization is high on the agenda, meaning that we do prioritize renewable energy or energy distribution networks to drive efficiency in terms of usage of energy," Mr. Grohn said. "Also, investments for improving transport networks to enhance carbon reduction are considered important."

Managers are seeking investments in markets that are going to benefit from the increasing penetration of renewables.

Simon Ellis, London-based head of origination Europe at AMP Capital Investors Ltd., Europe, said: "The challenge is making returns from a pure renewable play in these mature markets, so we are now looking at ways we can support renewables being brought onto the grid, given renewable energy brings problems around intermittency," when it is captured and delivered irregularly.

"We are therefore looking at small, flexible sources of power that will meet the demand when, for example, the wind is not blowing," he added. "So, we look at solutions such as battery storage and small gas-reciprocating power plants, which support the buildout of more renewables."

AMP Capital had $14.3 billion in infrastructure assets under management.

Managers also say they are evaluating if their assets are efficiently managing the cost of daily operations such as water and waste management. Care Management Group, one asset that AMP Capital has acquired, has a very good energy waste management system and is good at measuring inputs and outputs, said Malcolm Brown, head of asset management, Europe at AMP Capital in London.

"And it makes that information very accessible to the management. They have reduced their water consumption significantly," he added.

In transportation-related infrastructure, DWS Group GmbH & Co.'s portfolio company, airport operator SAVE SpA, has hired falconers to eliminate bird strikes at the Venice Marco Polo Airport, noted Jessica Elengical, director and head of ESG strategy, alternatives at DWS Group.

When DWS Group executives make an investment, they take environmental impact into account, she said. Hiring falconers to chase birds away is a carbon-neutral approach to avoid birds hitting airplanes, Ms. Elengical added. It also complies with an Italian standard on wildlife that takes an ecological approach.

Investor interest in ESG factors has picked up recently, especially with much of the activity around energy, managers say.

"There's been a discernible shift in the last six months in the frequency of ESG, climate change and sustainable investments," said David Scaysbrook, co-founder and managing partner of Quinbrook Infrastructure Partners. In May, Quinbrook closed a $1.6 billion fund, Quinbrook Low Carbon Power Fund, its first fund that is solely focused on lower-carbon and renewable energy infrastructure investment and operational asset management in the U.S., U.K. and Australia.

"We are at a tipping point. There are more funds (institutional investors) looking to allocate (to infrastructure with a strong ESG focus) over the next two years," Mr. Scaysbrook said. He could not point to an exact cause for the increased interest but said that it could be the United Nations-supported Principles for Responsible Investment and awareness of climate change leading to general momentum. Even so, U.S. investors have been slower to adopt. Less than 5% of the total commitments in Quinbrook's new fund are from U.S.-based limited partners. The rest is from investors in the U.K., continental Europe and Australia, he said.

European investors are more demanding when it comes to ESG factors in their infrastructure investments, said Jane Seto, managing director and portfolio manager for DWS Group's first European infrastructure fund.

ESG is part of the investment thesis, Ms. Elengical said. But, she added, "at the end of the day, LPs are looking at the financial returns" and how ESG factors could negatively impact their investments.

In other areas, however, investors are finding the imperative to ensure long-term returns more in harmony with ESG-related goals.

For example, with renewable energy sources growing quickly from a small base, infrastructure managers today have to think carefully when making investments in large-scale non-renewable energy, said Neil Johnson, Hong Kong-based managing director and head of China for Macquarie Infrastructure and Real Assets.

"MIRA has now implemented a policy where we will not be investing in coal-fired generation globally," noted Mr. Johnson. While partly a matter of "aligning ourselves with global objectives in terms of climate change," at the end of the day "we just believe that renewable energy sources will be a better match for the long-term nature of the investments we make," he said.

MIRA managed roughly A$178 billion ($123 billion) in infrastructure assets as of Sept. 30.

In April, Partners Group AG signed an agreement to acquire Norwegian midstream infrastructure company CapeOmega on behalf of its clients.

But Esther Peiner, managing director in Zurich on the private infrastructure team at Partners Group, which had €9 billion in private infrastructure assets as of Dec. 31, said: "Gas exploration and production creates carbon emissions. You clearly need to think about the exposure of your assets, so strategies to transform this asset to reduce its carbon footprint are critical for our investment thesis."

Ms. Peiner said that ESG regulatory obligations are pushing investors to be conscious around ESG issues. "Some clients have asked us to help them select responsible investments that will generate an attractive financial return as well as creating impact, so we created a specific strategy, PG Life, which has a demonstrable and measurable impact and in addition has a mainstream private markets risk-return profile," she said.

Earlier this year in the European Union, regulators agreed on a new set of disclosure requirements that compels European investors to disclose how their investments are influencing the environment and communities in which they operate. In turn, investors are seeking more specific information on the ESG implications of infrastructure assets from their managers.

David Russell, head of responsible investment at the £64 billion ($81.4 billion) Universities Superannuation Scheme, London, said: "Disclosure should be asset specific."

"We expect whatever material issues — from health and safety to human capital management to noise — to be disclosed (by the manager) if they are material and relevant for the asset," he added.

Mr. Russell added that well-managed infrastructure assets will assess and manage their interactions with local communities. USS has deployed more than £3 billion in real assets, including in energy, social housing, transportation assets and executed around 15 transactions globally.

But sources said that conversations between pension funds and managers are not limited to investing in projects that would reduce carbon output or water usage. The dialogue now tackles a more elaborate examination of ESG risks and how infrastructure assets are run by managers, including factoring in risks such as whether an airport is under noise restrictions that could reduce flights in or out or how expensive waste management is for the asset.

"Investors are looking for managers that have a strong ESG policy and are rejecting a manager who doesn't have a robust policy," said Declan O'Brien, senior analyst, research and strategy, infrastructure at UBS Asset Management in London. "This means that you have a clear policy and that you are reporting on that policy."

"Reporting has improved materially," he said. "But it still has a long way to go," he noted, adding that "we expect that managers will increasingly be asked to show how they are keeping track of key metrics, such as water or carbon use of their infrastructure projects."

In the past five years, ESG reporting on infrastructure investments has improved on the back of initiatives such as real asset ESG benchmark GRESB Assessments, which captures information regarding ESG performance and sustainability best practices for infrastructure portfolios.

However, infrastructure is still behind real estate in this respect. And sources added there is a lack of standardized benchmarks due to providers being too small to capture the market.

Darryl Murphy, head of infrastructure debt at Aviva Investors in London, noted "the sector is in the very early stages of defining ESG in a meaningful way, although approaches are similar across the industry as a whole." However, he said there is no consolidation of the methodology. "It's very hard to achieve because providers of ESG assessment in infrastructure are small entities, so they are not in position to align the whole market just yet," he said.

Still, managers say they are a crucial component to adapting ESG policies to infrastructure assets. AMP Capital's Mr. Brown thinks managers have scalability to help improve ESG practices using the experience of successful businesses in another market or sector in their portfolios.

"For example, one asset we have got happens to be in the U.S. and struggled with ESG because it had never had to do it," he said. "To get them off the learning curve we have used the experience of another asset to accelerate their learning and development of ESG — something asset owners, without an established portfolio, couldn't do."