Building the new economy

Can you tell us why pension funds, including the LGPS, should consider investing in infrastructure?

Osorio: Infrastructure is an asset class with an opportunity set that is undergoing massive structural change. Once considered one-dimensional and anchored in the provision of public services that are typically large in scale, we are seeing the triple effect of decarbonisation, digitisation and demographic shifts. These shifts are tilting private investment opportunities toward a whole new core of resilient, future-proof infrastructure projects that are focussed on the ‘new’ economy. Specialist investment managers are offering differentiated access to compelling long-term returns across a much wider opportunity set. 

We believe the emergence of this new era – which we describe as Infrastructure 2.0 – is  the principal reason to invest in infrastructure today. It is in subsectors such as energy transition, digital and social, the later with the most acute need, where funding gaps are most persistent. Institutional investors including public pension schemes can meaningfully contribute to positive social and environmental outcomes through exposure to resilient, scalable platforms, while still generating sustainable financial returns for their members.

What are the portfolio benefits of making an allocation to infrastructure?

Osorio: Investors have historically looked to infrastructure as a defensive allocation that offers an attractive yield profile suited to long-dated liabilities. Being essential in nature and generally less volatile than the wider economy mean that infrastructure investments tend to exhibit a low correlation to traditional equity and fixed income allocations. An allocation advances a portfolio’s efficient frontier while bringing material advantages in the form of diversification and stable future cashflows.

Cogley: Long-term performance in infrastructure investing ultimately depends on the skill and experience of the manager. But a rigorous investment selection and management process is also an important part of what drives value creation. High-quality, institutional-grade assets can offer superior returns – which can be further optimised and enhanced through active management – but this can be easily undone if key risks are not well understood and appropriate plans are not put in place to manage them.

Cogley: Mid-market infrastructure is a broad investment category but, generally speaking, we would narrow it down to companies with an enterprise value of up US$1.5 bn. Here, we’re avoiding large-cap and ‘mega assets’, focussing instead on strategic opportunities in the new economy, where relatively more value can be generated through a relationship-oriented approach to uncovering opportunities and actively managing investments.   

Osorio: From an institutional investor’s perspective, infrastructure’s middle market offers access to a larger volume and broader dispersion of scalable companies with sustainable alpha. This alpha can be derived from exposure to geographically and sectorally diverse platforms comprising high-quality, long-lived assets and companies. It is also at a scale where managers can remain close to the assets and their respective management teams. A manager’s competitive advantage is in its ability to analyse and manage risk, underwrite deals and perform due diligence and operations, as well as how these influence value over the life of an investment.

Cogley: At a high level, value creation in the mid-market segment is the product of four interrelated considerations – deal sourcing, execution, alignment and hands-on ownership.

In terms of deal sourcing – because we are thematic investors – we are not constrained by geography or sector. While there are guiderails, so-to-speak, in the form of preferred jurisdictions, the breadth of the sandbox we operate in and the proprietary relationships we have with management teams mean we can be highly selective. We still retain the option to exploit less heated sectors and changing market conditions.

The ability to navigate a changing environment is further supported by our open-ended fund structure, which permits us to be patient with respect to capital deployment and ownership. This style of investing aligns well with long-term capital, but also philosophically with the underlying infrastructure assets that are by their nature long lived. It means we can build businesses while giving full attention to the creation of sustainable value over time, without an eye always having to be focused on a ticking exit clock.

Osorio: Adding to Jason’s thoughts on the subject of active ownership, we are hands-on with companies to optimise cost, management and capital. This may mean we take a marginal gains approach to our review and encourage the adoption of new processes, such as workforce alignment and technological enhancements in pursuit of operational excellence. It may also mean refreshing the capital structure or selectively revisiting contracts to unlock growth.

We propel operational and financial improvements across our platforms by leveraging deep investment expertise. And our global approach means we can bring this expertise to bear to create value within our platforms that serve LGPS funds across the UK.

Cogley: Roughly 45% of our portfolio is invested in the UK, including our platforms that support a circular economy. We have invested in and are actively expanding one of the nation’s leading resource management companies – Cory. This business owns and operates one of the largest energy from waste (EfW) facilities in the UK, processing roughly 17% of London’s residual household waste annually. Our active management is driving a transformative investment that will nearly double the company’s processing capacity when the second facility begins operations next year. Cory is expected to generate enough electricity annually to power more than 350,000 UK homes.

We have other examples in sectors such as renewable energy generation, where we have enabled low-income households to access free solar power, and social housing, where we are helping fill a critical need for supportive accommodation serving vulnerable populations. However, Cory is striking for the range of ways it works for communities – whether in its use of barges on the River Thames to move waste and eliminate lorry movements on roads, its development of what will be the largest EfW decarbonisation project worldwide or its development of district heating in London.

Osorio: LGPS investors should feel confident that their partners in the mid-market space are philosophically aligned with their own objectives – financially, of course, but also from a social and environmental perspective. After all, a prosperous future is one that is sustainable, and on this point we should not waver.

Cogley: The best partners are deeply committed to the sector and its evolution, but also to the value it can create for fiduciary capital. Agility is necessary to guide the sustainable growth of an existing portfolio, but to capture the most promising opportunities the asset class presents you must have a genuine passion for it.