Roundtable with Russell Investments: Improving people’s lives through infrastructure investing

Michael Steingold, director, head of private markets at Russell Investments, began the discussion by identifying three key megatrends where his team identifies a growth opportunity and “sustainability leading edge”: renewables, digital and social. 

These are themes they are playing through the group’s open-ended Global Unlisted Infrastructure fund, which aims to invest in opportunities that address the need for new infrastructure solutions to meet evolving social and economic demands. 

Renewables

On the investment opportunity within the renewables sector, Steingold highlighted the growth of renewables as a share of electricity generation, while also observing the rise of natural gas alongside. 

“This is incredibly important to offset the intermittency of renewables,” he said. “What it highlights is the need to invest in more than just renewable generation capacity. We like mainstream technologies like wind and solar, but also things that support renewables as a share of the electricity mix.”

He pointed to research from consultant McKinsey following COP 28 that estimated $3.5trn is required annually in additional infrastructure capex to achieve the existing net-zero 2050 commitments made by corporates and governments. 

Delegate Julius Haswell, investment associate at London Wall Partners, made the point that given the vast capex requirements within the renewables and utilities space, a lot of this would feed down to the consumer. 

“To my mind, that puts a huge amount of pressure on ROEs and returns for utilities. Is that a threat to the investment case?” he asked. 

Steingold said this would not be the case on the renewables side, because the economics of zero marginal cost production is to the benefit of solar and wind. 

He added: “I agree with you that it is a challenge for utilities around the intermittency over the long term. The capex that needs to be spent is around grid robustness, on things that overcome intermittency directly like storage, so we see battery storage as a great opportunity today.”

Digital

Moving onto the digital sector, Steingold identified this is where the team is “taking a little bit more risk and seeing higher return opportunity”. 

He highlighted the growth of data centre stock in the US, with total data centre capacity in the US at the end of 2022 reaching around 4,000 megawatts. 

“There has been a 17% compound annual growth rate over the last eight years, which is a fantastic growth rate for any sector,” he said. “The trends that underpin that continue and we now have the new trend of AI, which we expect will really accelerate the need for data centres.” 

He highlighted recent research from the International Data Corporation, which forecasts a 27% per annum CAGR in capex spending around AI through 2026.

“We think this is a positive inflection point for digital in general, data consumption in general, and especially the growth of the data centre sector. Digital is now much more than just data centres; there is a whole ecosystem.”

Social

Finally, Steingold highlighted opportunities in the social sector, which he said the team views in terms of big institutions: municipalities, universities, schools and hospitals. 

“Our strategy within the social sector is providing capital to these institutions, to either build new facilities or renovate old ones. One of the key trends in social today is providing capital for energy efficiency, so decarbonising these mission-critical facilities at institutions. 

“When we think about the ability to be impactful with infrastructure capital, renewables come to mind first, but this [area] is extremely beneficial to the world and we are doing a lot of good here. 

“What is interesting from an investment perspective is these projects are becoming more complex and expensive to put in place for institutions. As inflation and interest rates are going up, this type of solution for institutions is incredibly important and we are seeing a lot of demand for this strategy.”

Role in portfolios

Gavin Anderson, director, private markets, at Russell Investments, then led a discussion about the role of infrastructure in portfolios and how the team is adapting to investing in a very challenging environment. 

Steingold observed: “The biggest challenge for our clients is how you protect against unpredictable inflation going forward. That has been a sea-change in the way our clients build their portfolios, so they are looking for assets which have positive inflation sensitivity, and infrastructure is one of the few financial assets that really has this. It is the first time we have seen inflation in a meaningful way since this asset class was created about 25 years ago, so that proof-of-concept has really come through.” 

He noted the other challenge clients face is higher interest rates, but added infrastructure can help investors in this environment. 

“It is a bit counter-intuitive but, especially on the social side, there is so much cash collateralisation that happens with some of the assets that they are positively correlated to interest rates. I think it is challenging for the really high-levered sectors such as utilities, as we saw with the water issues in the UK. It is about navigating that environment.” 

Al Amin Miah, research associate at Mainstream Partners, asked Steingold if he viewed decarbonisation as an important structural trend similar to interest rates in terms of top-down views for portfolios. 

Steingold replied: “For us, there are two different approaches for our clients: financial return and purely sustainability led. One is single bottom line and one is double bottom line. We are finding that you can no longer ignore sustainability on the single bottom line, so it is increasingly important to achieve the financial returns, not only from a risk management ESG framework, but also delivering on these trends. There is so much growth behind these trends driven by sustainability, not for ethical reasons but demand led.”

Sustainability credentials

The panel then raised the issue of communicating with clients on the sustainability credentials of the fund and its impact, as well as how the team assesses the sustainability of assets such as data centres. 

Steingold said: “The impact KPIs are incredibly important in any sustainability-oriented investment. In this particular fund, we are SFDR Article 8. Our focus is on our sector exposures – renewables, digital and social – at about 65% of the portfolio. We also have a coal exclusion in this portfolio. Finally, we use our proprietary ESG rankings and we have minimum requirements for all the investments within the portfolio. 

“When it comes to things like data centres, I think there is an opportunity for us to really lean on our partners to make sure they are operating in a very sustainable way. This is an area where there is a lot of good work to be done.”

Al Amin Miah asked whether the Article 8 classification of the fund had restricted the team’s mid-market opportunity set, especially considering infrastructure companies or projects may not have the capability to report their scope one or two emissions in the way the team would have liked. 

Steingold said this point links to a frequent question the team receives on ‘how much return are you giving up to be Article 8?’

“We are focused on the three sectors with the highest growth in infrastructure – renewables, digital and social – and that is where our SFDR Article 8 characteristics come from,” he explained. “The positive environmental and social characteristics we are promoting all flow from those three high-growth sectors, and it is highly economical for us to be focused there. It is a net benefit to returns to have that Article 8 designation and we are not giving up anything from a risk-return perspective.”

Fund structures

The panel then debated the best ways to access infrastructure and public versus private investing in this area, including dealing with potential liquidity mismatches. 

Gavin Anderson observed it is an interesting issue in terms of access points to this asset class for investors: “Something we often talk about a lot when we are in these kinds of forums is that debate about listed versus unlisted versus closed-ended. I would be really intrigued as to whether anyone in this room has actively committed to infrastructure over recent years and how you have done it?”

Shane Balkham, CIO at YOU Asset Management, said his team has invested a small portion of portfolios in infrastructure through listed structures. 

“When you are looking at infrastructure, you have to be very considerate of the underlying liquidity of that product,” he said. “You do not want to be on the end of the next issue with the regulator but there are good investments, depending on what structure you are holding. 

“It works if you are holding it in a unitised fund-of-funds. However, it is more difficult to hold it in model portfolios, where you are beholden to the platform or flighty investors. 

“It is a struggle to marry up that really good investment, where clients can benefit from something a bit less liquid, with the regulator saying ‘you need to be super liquid’.

Julius Haswell also asked about public versus private in infrastructure investing. 

“Especially last year, rightly or wrongly, a lot of investors had big concerns over valuation, and perhaps distrust of vehicles that invested in private assets and companies,” he said. “How do you talk about the benefits of private versus public with that in mind?”

Steingold replied that the team believes listed and unlisted infrastructure can fit very well together in portfolios. 

He explained: “On the listed side, you get access to some of the biggest and most robust platforms in infrastructure. 

“However, there are reasons why private can drive a majority allocation in a portfolio. Firstly, we can be much more selective on the private side. Individual funds may only be ten or 12 assets, so we can evaluate each individual asset in a fund. We can scrutinise that very closely and build portfolios that are very highly curated. That is much more difficult on the listed side, where you are buying into companies that already have a high level of diversification.

“Secondly, you get to bring the private equity toolkit to infrastructure. You are bringing a very high level of governance to these companies that you do not see on the listed side and they are able to really drive the business outcomes. 

“Finally, there is the asymmetrical information that you get to work with as a private investor. Our managers know these assets extremely well and they know when to sell them.”

Aniket Das, head of multi-manager solutions at Legal & General Investment Management, asked whether infrastructure secondaries are an area of interest in this vehicle or other funds the group runs.

Steingold answered: “This portfolio will do primary, secondaries and co-invests. The challenge with infrastructure secondaries is they are trading at NAV or above, unlike real estate for example. It is a great concept, and we are always there to buy our conviction investments when there is a discount available, but there is just no discount available today.”

Client appetite

Finally, the panel explored client appetite for infrastructure investments and dealing with short termism. 

Steingold said: “For us, this is a very long-term strategy. We are making investments that are going to perform over ten to 20 years, so we are very selective on investors who come into this fund.”

Kilian Thevissen, director, strategic client solutions at Russell Investments, added: “Unlisted infrastructure has been established over the last couple of years as a core asset class. In particular, the risk & return profile of portfolios that used to have a focus on more traditional asset classes and had fewer tools in the toolkit has been enhanced by the addition of unlisted infrastructure. It is a core part of many of our clients’ portfolios these days.”