The Nordic Appeal of EM Sustainable Infrastructure

on

Stockholm (NordSIP) – Of the US$2.5 trillion annual investment gap that developing countries face, 75% comes from missing infrastructure investment, according to UN estimates. For investors, the investment gap presents an opportunity to channel funding towards emerging markets (EMs) to best support the UN’s Sustainable Investment Goals (SDGs).

Felix Hermes, Head of Private Equity and Sustainable Infrastructure at BlueOrchard

In an analysis of the opportunity presented by this investment short-fall published at the end of last year, BlueOrchard reviewed how demographic trends, economic growth and sustainability concerns conspire to create demand for sustainable investments in EM countries. To understand the implications of these trends for Nordic investors, NordSIP reached out to one of its authors, Felix Hermes (Pictured), Head of Private Equity and Sustainable Infrastructure at BlueOrchard.

The Macro View

“Emerging markets account for more than 80% of the world’s population, close to 60% of the world’s GDP and contribute to the majority of the world’s population and economic growth,” Hermes tells NordSIP. Emerging markets are also predicted to grow more than 10% between 2020 and 2030. Sub-Saharan Africa’s population is projected to double by 2050. The IMF estimates EM economies will represent 63% of world GDP by 2023.

The consequences of climate change are also more acutely felt in EMs according to a 2016 Moody’s study. Due to agriculture’s large share of total GDP in EMs, as many as 8 times more people are affected by global warming, which cost 5 times more as a share of GDP in EMs than it does in developed countries.

These trends, together with low public sector capacity create demand for outside investment in sustainable infrastructure. “At the same time, there is a tremendous need for development and financing as best encapsulated by the UN’s Sustainable Development Goals,” Hermes says citing the example that most people in the least developed countries still lack access to electricity. “Against this backdrop, we believe that the case for sustainable infrastructure in Emerging Markets is compelling and viable for the long-term,” Hermes adds.

The Nordic Appeal of Sustainable Infrastructure

“Sustainable infrastructure” covers most infrastructure, so long as it is “planned, designed, constructed, operated and decommissioned in a way that seeks to be sustainable over the entire life cycle of the asset such that it supports climate change adaptation and mitigation”, Hermes explains. The term covers renewable energy but also e-mobility, ports and data networks.

Sustainable investors may be drawn into this market by the long term nature of infrastructure investments allied with the type of returns offered by EMs. “Our focus is on emerging markets globally. As a firm we are invested in over 90 countries in Asia, Africa and Latin America, leveraging our local offices and network of 20 years,” Hermes explains.

“Nordic investors have historically been at the forefront of developments in private market investing, sustainability and impact. They are therefore best placed to see the appeal of Sustainable Infrastructure in emerging markets, namely the potential for attractive and resilient returns, low correlation with other asset classes and a tremendous opportunity for environmental impact and social development,” Hermes continues.

More specifically, the sustainability of infrastructure assets is assessed in terms of its ESG as well as industry standards compliance. is typically gauged through environmental, social and governance (ESG) assessment, as well as its compliance with relevant industry standards. One important reference for investors in sustainable infrastructure is the International Finance Corporation’s (IFC) exclusion list.

Sustainable Infrastructure – Benefits and Risks

According to BlueOrchard, investing in sustainable infrastructure presents investors with five main benefits. It is resilient to economic cycles and low correlation with other asset classes and it generates predictable cash flows and stable, risk-adjusted returns. At the same time, these investments generate a positive impact on the quality of life and economic development of the communities and countries in which they are located, while often also supporting the transition to a low carbon economy.

That being said EM sustainable infrastructure is not without its risk caveats. The business risks are not to be overlooked, with the asset manager pointing to the “risks linked to the construction and operation of infrastructure assets, market risks implied in the price and volume of the services rendered.”

For Felix Hermes, these considerations warrant a balancing act. “Our strategic bias towards mid-sized assets with proven technologies and strong, predominantly private off-takers reduces the construction, operating and default risk of our investments,” he explains. “We only invest in assets where currency risk can be hedged or – as is frequently the case – revenues are contracted in US dollar. Political risk is difficult to mitigate once invested and hence requires a robust assessment process before investing,” Hermes says.

“Overall, emerging market sustainable infrastructure debt risk-return profiles are typically far more aligned with the developing world than many investors believe,” Hermes argues. He notes that although currency, business, regulatory and exchange rate risks cannot be ignored, historically this concern has not found echoes in particularly higher EM rates of default, which differ substantially depending on their geographical origin.

Together with this relatively low comparative default loss, BlueOrchard also reports investors as able to demand a 1% to 2% return premium in EM infrastructure debt versus equivalent developed markets transactions.

“Investing exclusively in emerging markets we have continuously evolved our processes over the last two decades to assure robust assessment before investing, continuous information flow after investing and proactive action should risks materialise,” Hermes concludes.

Image courtesy of BlueOrchard

Sustainable ETFs in Focus

All Eyes on Green ETFs

To put into perspective the progress made by green ETFs, our Snap column latest a critical look at the limelight cast on BlackRock's passive...

NordSIP Insights

Most read this week

Bank of Finland Adopts Net-Zero Target

Stockholm (NordSIP) - On the heels of several private institutions and governments, the Bank of Finland announced it had adopted a climate goal of...