Embracing ESG: An obvious question

Embracing ESG: An obvious question

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February 23, 2022

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Responsible investing as a core component within the decision making process has been almost universally embraced and is now mainstream.

But investors might be asking a rather obvious question. Is an enthusiasm by asset managers for embracing ESG principles simply about being a responsible custodian of investors’ assets, or is it seen as an opportunity to actually improve investment returns? As investors in direct infrastructure, at Igneo we believe the answer is both. In fact, within the asset class, we believe it is a prerequisite to adding value and delivering the reliable returns investors seek.

ESG – uniquely relevant to infrastructure

‍Infrastructure businesses are often providers of essential services: water, electricity, transport, communications etc. The services they provide can be critical within certain communities who depend on them for heating their home or their ability to get to work. They add immeasurably to their quality of life and communities could not function without them.

From an investment perspective, this offers unique advantages to investors considering direct infrastructure. People in these communities will always need heat and electricity, their sewage treated or the ability to travel or communicate easily. In theory, this should make direct infrastructure an ideal vehicle for those investors looking for stable, dependable cash flows with low volatility and high predictability.

But, whilst this should be the case, is it? That depends on the factors an asset manager considers when deciding whether or not to buy an asset. Is the investment genuinely capable of providing a clear and sustainable stream of returns? In the end it comes down to quality: quality of the business model, management team, internal processes and company culture. Without these being present, the risk of disappointment is high.

‘Is the investment genuinely capable of providing a clear and sustainable stream of returns?’

With almost 25 years’ experience managing infrastructure assets, at Igneo we are certain about one thing. A robust approach to embedding ESG principles within our businesses, particularly around environmental standards and employee welfare and development, is essential to meeting investor’s needs.        ‍

Mitigating risk, enhancing returns

ESG is not just about being a responsible custodian of often vital pieces of infrastructure, it is also about protecting and enhancing potential cash flow and investment returns. Within infrastructure assets, adoption of ESG best practices can identify and mitigate operational risk and enhance investment returns.

‘ESG best practice can identify and mitigate operational risk’

Many infrastructure businesses have a very public face. Any failures are highly visible with stakeholders – customers, regulators, government – prepared to rapidly intervene in response to public concerns or complaints. Competitors, journalists and politicians will leap at the opportunity to highlight shortcomings. Breaches in health and safety or environmental standards can bring immediate negative publicity and possible financial sanctions. This can seriously impair the value of the asset under scrutiny. For this reason, ESG analysis is part of the initial screening process and, post investment, fundamental to our management of the asset.

Seeking to mitigate such risks through embedding an ESG culture within a business is vital and will in itself likely improve returns through avoidance of reputational and operational risk. However, the gains do not end there. A management team with an ESG focus almost certainly will identify areas of the business where policy or operational improvement can improve efficiency and productivity. The link between good ESG practice and superior investment returns is undeniable.

Sophie Durham, Director of ESG, Infrastructure Investments

While the reporting side of ESG is clearly important, it’s also important for box ticking to not become a distraction from the material risks and opportunities your businesses face. It’s not uncommon to see a massive gap between policies companies have on paper and ESG implementation, a scenario commonly acknowledged as ‘Greenwashing’.
The difficulty for us as investors becomes this: how do we find ways to show that we are good at ESG that doesn’t necessarily involve or isn’t solely based on ratings. The five minimum standards we have for our portfolio companies are very clear and practical and they allow our portfolio companies to go beyond in areas that are material to their businesses.
The way that we show progress on the work we are doing with companies along with reporting is through the case studies in our annual ESG report. Which provides quantitative data and really teases out the way that our businesses are actually going well above and beyond those five minimum standards.
I think ESG is so important for infrastructure assets, because these are massive physical real assets that inevitably impact the environment or impact local communities and are impacted by the environment and local communities as well.

Being proactive is key

Realising this potential and capturing available gains depends on one key action: being proactive. Company management need to understand ESG is not just a box ticking exercise. Production of a bi-annual report, a website statement or declaration they comply with UN Principles of Responsible Investment (PRI). To be real, it needs to be part of the company DNA – evident on the factory floor, not just inside the board room.

‘Management need to understand ESG is not just a box ticking exercise’

And don’t discount the impact of having an empowered and motivated workforce. Many jobs in infrastructure businesses are short on glamour and long on manual effort and dirt. Workers within these companies perform critical but often underappreciated roles. Having a reputation within the market as an employer with the highest possible standards of corporate responsibility, employee development and a positive and genuine approach to ESG values, is likely to attract the right calibre of staff.

Direct infrastructure investing provides the ideal route to capture these benefits and opportunities. Frequently the outright owners of infrastructure enterprises, asset managers such as Igneo can take a highly proactive ESG-led approach to the management of their investments. They can exercise direct influence on company management, normally with direct board representation. Bringing their wealth of experience across sectors and geographies into these businesses, real and enduring value can be realised offering highly attractive opportunities for investors. 

Important information

This material is for general information purposes only. It does not constitute investment or financial advice and does not take into account any specific investment objectives, financial situation or needs. This is not an offer to provide asset management services, is not a recommendation or an offer or solicitation to buy, hold or sell any security or to execute any agreement for portfolio management or investment advisory services and this material has not been prepared in connection with any such offer. Before making any investment decision you should consider, with the assistance of a financial advisor, your individual investment needs, objectives and financial situation.

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To the extent this material contains any expression of opinion or forward-looking statements, such opinions and statements are based on assumptions, matters and sources believed to be true and reliable at the time of publication only. This material reflects the views of the individual writers only. Those views may change, may not prove to be valid and may not reflect the views of everyone at Igneo Infrastructure Partners or First Sentier Investors.

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References to ‘we’, ‘us’ or ‘our’ are references to Igneo Infrastructure Partners or First Sentier Investors (as applicable). First Sentier Investors is a global asset management business which is ultimately owned by Mitsubishi UFJ Financial Group. Igneo Infrastructure Partners is an unlisted infrastructure asset management business and is part of the First Sentier Investors Group.

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