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Why ESG is essential when investing in infrastructure

We take a closer look at the importance of ESG when investing in infrastructure.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

Infrastructure underpins our society. From the energy that powers our homes, to the water we drink, the roads we drive on and the way we communicate.

It’s an essential part of our day-to-day lives and has the power to enhance personal wellbeing and reduce our impact on the environment. That’s why it’s so important that infrastructure companies are managed in a responsible way, taking all stakeholders into account.

There are a number of environmental, social and governance (ESG) risks for infrastructure investors to consider. We’ve outlined some of the main ones to think about.

This article isn’t personal advice. If you’re not sure if an investment is right for you, ask for financial advice. All investments will fall and rise in value, so you could get back less than you invest.

Why environmental risks are important

Climate change is one of the biggest dangers we face. It’s causing our glaciers to melt, sea levels to rise and more extreme and unpredictable weather.

Infrastructure companies consume significant amounts of fossil fuels which create high levels of carbon emissions when they’re burnt. While many are moving towards more sustainable energy sources to reduce emissions over the long term, some are making better progress than others. Leaders in this area will more likely be on the right side of future regulatory changes, and less likely to suffer any reputational damage.

One of the companies that’s made the most progress is Danish energy firm Ørsted. Ten years ago, it was one of the most coal-intensive energy companies in Europe. Now it’s ranked among the most sustainable companies on the planet. It has a 30% share of the offshore wind market and 90% of the energy it generates comes from renewable sources.

It’s not just emissions investors need to consider though. Some infrastructure companies extract and transport harmful materials across thousands of miles, often passing water resources. Operating these businesses in a safe way is essential for the environment. But also for companies as any issues can have a serious impact on a company's reputation and result in some hefty fines.

The 2010 Deepwater Horizon oil spill, for example, saw 4.9m barrels of oil leaked into the Gulf of Mexico. Aside from the widespread environmental impacts it had, clean-up costs, charges and penalties were estimated to have cost BP more than $65bn.

Some infrastructure companies also run the risk of ‘stranded assets’. That’s where a previously valuable asset becomes obsolete or unneeded before it reaches the end of its useful life. Lots of assets in the coal industry have become stranded in recent years as alternatives like shale gas have become cheaper.

Why social considerations matter

Social considerations are all about the way the company treats its customers, employees, shareholders and suppliers.

Infrastructure companies are normally quite monopolistic. By that we mean they tend to have a lot of power in the market – customers usually don’t have a choice of which rail network they use when they board a train, for example. That means the quality of service can come under intense pressure from regulators, politicians and the media.

Governments and regulators award licenses to let companies operate. Poor service can lead to fines or those licenses being taken away. So it’s essential for infrastructure companies to put society at the centre of their decision making.

Safety is also very important given the large scale of the assets involved. Infrastructure companies have to have a mix of policies and procedures that work well, and a safety-obsessed culture.

The importance of governance

Governance is how organisations are directed, controlled and held to account. It sets the foundation for a high-performing organisation.

When considering a company’s governance structures, you should think about how its people are paid. But also whether senior executives’ incentives are aligned with those of investors, employees, regulators and customers. You should consider whether they have a meaningful investment in the company – will they do well when you do well, and suffer when you suffer?

Board diversity is also important. The board should have a variety of skills, backgrounds, industry experience, races and genders. A diverse board will help encourage challenge and make sure all aspects of a decision are considered.

ESG in action: a case study

First Sentier Global Listed Infrastructure aims to deliver income and long-term capital growth by investing in a portfolio of companies from around the world that own or run infrastructure assets.

Managers Peter Meaney, Andrew Greenup and Edmund Leung invest in companies including utilities, transport, energy and communications providers. They have the flexibility to invest in emerging markets which, if used, adds risk.

The managers look for companies with high barriers to entry from competition, companies that can raise prices without impacting demand and predictable cash flows. Their investment process also integrates ESG analysis, including the considerations discussed above, from stranded asset risk to management incentives.

The managers also try to influence the companies they invest in to adopt ESG best practice. Whether that’s highlighting areas for improvement or encouraging more disclosure on ESG issues.

The managers recently engaged with pipeline operator Kinder Morgan. The company's board recommended voting against the company providing methane emissions reporting and a climate change scenario analysis report. The managers requested that Kinder Morgan improve their environmental disclosure procedures, particularly relating to greenhouse gas emissions. The company later committed to making a significant investment in their environmental data collection, assessment and production systems.

While we’ve outlined some of the main ESG risks to take into account when investing in infrastructure, this is not an exhaustive list. It’s important to carry out your own research before investing in infrastructure.

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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