Real Assets, Real Returns

Infrastructure assets play an important role in diversifying sovereign wealth funds’ portfolios.

With typically low volatility and reliable cash flows, infrastructure investments provide returns with a low correlation to other asset classes and over the last decade, many institutional investors have allocated to the asset class as a substitute for fixed income due to stubbornly low interest rates. COVID-19 has also had a range of effects on infrastructure. For some sub-sectors, such as passenger-linked transport assets, 2020 and 2021 were very difficult years. For others, such as digital infrastructure and renewables, they were standout.

These trends are reflected in the sovereign wealth fund direct investment activity: in 2021, they invested a total of $15.5 billion in infrastructure, almost double the $8.1 billion spent in 2020, and the highest amount ever invested since the IFSWF Database began.

According to IFSWF data, (as can be seen in the chart below) the digital infrastructure subsector, which includes telecom towers and data centres, attracted the most capital among infrastructure: $6.55 billion across eight deals. While the most sovereign wealth fund investments were in renewable infrastructure: 11 transactions at a total of $4.4 billion.

Source: IFSWF Database, 2021.

Infrastructure-focused sovereign vehicles

Two of IFSWF’s associate members are sovereign wealth funds with a mandate to attract foreign direct investment specifically into infrastructure assets: India’s National Investment and Infrastructure Fund (NIIF) and the Indonesia Investment Authority (INA), profiled in last year’s annual review. In September 2021, INA took a 5% stake in Dayamitra Telekomunikasi’s initial public offering, an infrastructure services unit of state-owned Telkom Indonesia. The company will use the proceeds to focus on the telecommunication tower business to support the 5G era in Indonesia.

Despite the push being made by INA and NIIF to attract capital to South and South-East Asian infrastructure, sovereign wealth funds still favour the developed markets of Oceania, America and Europe, which accounted for more than three quarters ($12 billion) of $15.5 billion invested in the asset class. That said, Europe is still the reference market for hard assets, having attracted over $6 billion in nine direct investments in infrastructure, or 35% of the total capital in the sector. The fact that the European Union has had a “one-stop-shop” system, for merger control, providing the European Commission with exclusive jurisdiction in Europe to review a deal, makes the acquisition process for foreign investors such as sovereign funds more seamless, which seems to have been an advantage over other regions.

However – as IFSWF members recently discussed in a webinar hosted by the international law firm, Baker McKenzie in partnership with ADIA – there are proposed new rules for investors with foreign subsidies in the EU, which are entirely separate from merger control, and these will require additional filings. These are currently subject to review by EU Parliament and EU Council and if approved will make direct investments for sovereign wealth funds domiciled outside the EU much more complex.

Renewable Energy and Climate Change

In last year’s annual review, we highlighted how sovereign wealth funds were starting to take climate change risks and opportunities more seriously and integrate them into their investment processes as well as taking advantage of energy-transition-related opportunities in renewable energy and green infrastructure.

The 2021 IFSWF-OPSWF Climate Change Survey revealed how sovereign funds have made progress in addressing climate change and have become more systematic in their approach. For example, in 2020, only 24% of respondents incorporated environmental, social and governance (ESG) considerations in their investment process and only 18% had a dedicated ESG team, while 48% did not take a systematic approach to climate change. In 2021, 71% of respondents have adopted an ESG approach and less than 10% didn’t consider climate change in their investment approach at all. Over the past year, sovereign wealth funds have rapidly expanded their use of five different methods of assessing climate-related risks and opportunities to better understand their portfolio exposure to climate-change risks, and manage their climate impact. For example, 34% of respondents have now carbon footprinted their portfolios, up from 23% last year. Similarly, 31% now use climate-scenario analysis versus 17% in 2020.

More sovereign wealth funds are, therefore, adding investments to all sub-sectors closely involved with climate-change solutions. As can be seen in the chart below investments in renewables alone almost tripled year-on-year going from $1.8 billion in 2020 to $5.5 billion in 2021.

Source: IFSWF Database, 2021.

The fact that the world’s largest sovereign wealth fund has now added unlisted renewable infrastructure to its portfolio mandate, may keep this flow of investments steady for the next few years. In April 2021, Norges Bank Investment Management, the manager of Norway’s GPFG, announced its first direct unlisted investment in renewable energy infrastructure. The fund signed an agreement to acquire a 50% stake in the Borssele 1 & 2 offshore wind farm located off the Dutch coast. Currently, this is the largest wind farm in the Netherlands and the second largest in the world, with an installed capacity of 752 MW. Norway’s GPFG is aiming to invest up to 2% of its more than $1 trillion portfolio in unlisted renewable infrastructure assets. Despite being the world’s largest sovereign fund, it has one of the most conservative investment strategies, and, consequently, its relatively late entry into renewables is currently limited to solar and wind infrastructure assets.

Other sovereign funds, however, have a much broader mandate and are scouting for startups or seasoned investment platforms in all subsectors that could benefit from the transition to a carbon-neutral future to fight climate change. Electric vehicles, battery storage, agritech, forestry, water, green/blue hydrogen, carbon capture and storage, green cement, food technology and new materials are only a few of the niches in which they are investing.

In this sector – which is relatively new for these investors – sovereign wealth funds are gaining experience by collaborating with familiar partners. For example, in 2021 QIA invested in Avangrid, which focuses on the development of power grid infrastructure and renewable energy in the US. Avangrid is a portfolio company of Spanish energy major Iberdrola, with which QIA has a long-standing relationship – it has been its largest shareholder since 2011.

Although governments from most developed markets have supported infrastructure investment in renewable energy and storage with high-tariff subsidies over the last 20 years, sovereign wealth funds have only recently increased their commitment to the sector. It will be a balancing act as to whether they continue to increase their direct investments in the sector. In some countries, there is political pressure to make climate-related investments creating considerable scope for expansion in renewable energy. However, in developed markets, the sector faces headwinds from declining subsidies, rising inflation and decreasing taxes on fossil fuels because of higher commodity prices.

High energy prices could push some energy-importing countries, particularly those reliant on gas imports from Russia, to accelerate the switch to renewables and reignite their support for green infrastructure, creating more opportunities for long-term investment. At the same time, hydrocrabon-exporting countries with a sovereign wealth fund might choose to use their fund to hedge against lower demand for oil (the ultimate result of the energy transition), which will make them more eager to pursue new opportunities in low-carbon energy technologies.

But many observers have highlighted that the transition to net-zero may be inflationary. For example, rare-earth mineral prices have increased rapidly over the past months: these minerals are the backbone of a low-carbon world, as they are widely used in electronics, electric vehicles and solar panels. Increasing investor demand for renewable infrastructure assets has already inflated the valuations of these assets, making it more difficult for new investors to enter the market, but if the appetite for private markets is of any guide,³ the high valuations won’t be an obstacle for new investors.