By 2030 the world population is projected to reach eight billion, 60% of whom will be city dwellers. Meeting the needs of our generation, let alone those of our children, will require significant investment in new buildings, transport, data networks and energy supplies to support urban growth. High density housing and careful use of resources will therefore only become more pressing in the future.
Beyond cities, the United Nations' Sustainable Development Goals (SDGs) will not be delivered without a fundamental rethink of our investments into infrastructure and real estate. While infrastructure development is one of the 17 SDGs, at least six of the others will not be met without significant investment in real assets.
Just taking current environmental policies into account (which, as they stand, are not sufficient to deliver the 1.5 degree goal), the International Energy Agencyestimates that $60trn (£47trn) of energy-related investment is needed by 2040. More than half of this (55%) relates to real assets, including investment in renewable energy generation and power distribution networks, transport and buildings.
Outside their environmental importance, real assets also play a critical role in the operational life of any society. Efforts to establish its real value are stepping up: designers, planners, engineers, consultants, technical specialists, academics and investors are all grappling with how to capture its worth. However, communities evaluate worth in different ways, and without understanding the subtleties, the parameters for decision-making can be limiting.
The financial case
While few among us would question that building a school or a hospital makes a positive contribution to society, without careful management of its community and environmental impact, the very same building can be viewed quite negatively by the community.
The role of the investment industry is key here as it can exert significant influence in the way that these assets are built and operated. However, evaluating projects is a complex process, which involves weighing up potentially conflicting factors - for example, scope to create jobs and enhance services, but also impacting local ecosystems. Once up and running, even factors like assessing energy efficiency, which seem straightforward, might depend on how costs are shared and whether accurate data can be consolidated.
Regardless of the project, ESG factors are very relevant in investment decision-making. And regulation is moving to recognise this. For example, the European Commission is proposing to amend various financial directives (MiFID, UCITS and AIFMD) to require ESG to be integrated into investment process and risk management.
Sensitivity to ESG issues is not just about minimising risk, however. ‘Positive ESG' is also about enhancing returns. Yet unlike public equities, real assets are largely privately owned, and it is therefore harder to show the extent to which positive ESG screening creates value. In general, though, it is easier to demonstrate positive impacts for environmental rather than social and governance factors.
The data challenge
In the public market, investors have established benchmarks and tools at their disposal to reflect their ESG preferences and guide their investment strategies. Numerous ESG data vendors such as MSCI and FTSE Russell provide these tools.
While this provides a lot of data for listed companies, it also adds complexity as the providers use different methodologies. For example, at times the carmaker Tesla has been rated ‘positive' by one ESG vendor, but ‘negative' by another.
In private markets, however, ESG disclosure is more limited. Leading fund managers and investors are encouraging the development of industry ratings and benchmarks, such as the Global Real Estate Sustainability Benchmark (GRESB) for real estate and infrastructure.
Yet while the intent is the same (benchmarking ESG performance), the factors considered in private market assessment are very different. In part, this reflects the level of data available to many infrastructure and real estate owners, which can be quite granular in terms of environmental impact, but more limited in terms of employee and board. For instance, the ‘governance' measures can vary for a private, asset-owning special purpose vehicle and a large publicly listed company. Typically, the analysis of the social aspect for public companies is focused on employee management, while the asset-backed surveys measure engagement with external parties including community and tenants.
Limited impact measures should not detract investors
Surveys are a critical method of obtaining relevant ESG data. And while the participation rate in ESG surveys is rising, they do not yet cover a high proportion of the real assets investment universe. Part of the issue is resourcing. Although large companies and asset managers have the necessary resources to report, smaller projects (for example, a wind farm) often lack the manpower and time to prepare detailed ESG reporting.
This limitation may explain why negative screening has been the most common approach adopted by real asset investors in ESG strategies to date. However, there is a potential drawback; exclusions may also result in transferring the ownership of ‘ESG sensitive' assets to investors who may be less concerned about ESG than short-term financial returns. This ‘moral hazard' can be avoided by considering new investments in terms of the actions that the owner can take to improve ESG impact or performance.
Real assets impact can be more readily measured in terms of carbon or water consumption, but infrastructure and buildings also impact the health, well being and development of their users and the community they serve. And though real asset investors can make a real difference by integrating ESG, measuring this impact remains an imprecise science.
Ultimately, however, the lack of precise metrics should not deter investors from impact investing. Over time, it is likely that more consensus will develop over the best tools to measure some of the impacts that are more complex to capture. In the meantime, thematic investment strategies and ESG integration already give investors the opportunity to select funds and managers whose investment focus is aligned with theirs.
Laurence Monnier is head of quantitative research at Aviva Investors Real Assets
International Energy Association, World Energy Outlook 2018.
ESG data: Check your meter readings. IPE Real Assets. January/February 2019.
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