Real Assets Study 2020: An interview with Darryl Murphy

How has the pandemic shifted the investment landscape within infrastructure?

The initial impact during the early period of the pandemic was a cautious slowdown in activity. However, confidence has steadily returned, and we have seen relatively normal activity across most sectors. However, the future landscape for demand-based transport projects is particularly uncertain; for example, it will take time to assess the long-term impact on the airport sector. Activity remains focused on low-carbon energy transition and digital and we see those sectors dominating in the near-to-medium term.

To what degree is the policy environment going to shape infrastructure in the UK and Europe in the coming years; what does that mean for investors?

The key challenge for policymakers across Europe is how to stimulate the economy post-pandemic. Many countries recognise infrastructure investment has a key part to play in this objective.

The main issue for investors is to determine the role for private investors alongside government-funded investment. Whilst this increase in investment across Europe is material, it is somewhat dwarfed by the level of infrastructure investment that will be required to achieve net zero emissions by 2050. Hence, the key policy decision for investors will be for governments to set out their pathway to reach this legally binding objective, in terms of the technologies and business models needed to support investment across power generation, utilities, heat and transport.

This year’s study highlighted a bigger emphasis on investments with a positive social benefit; how will this manifest in the infrastructure world? Where are some of the key opportunities and challenges in this area?

Perhaps the best example of this is in the digital space, where the pandemic has highlighted the social impact of connecting homes with fast fibre broadband to keep people connected. What will be interesting to see develop is the role of infrastructure investment in the goal to achieve net zero and whether society increasingly considers this as much a social need as environmental. We are also likely to see a greater interest from pension holders in where their money is being invested, which may support pension funds wanting to invest greater capital into infrastructure to improve the society in which the pension holders live.

What’s Aviva Investors’ current infrastructure investment strategy?

We currently have our flagship infrastructure equity strategy along with some segregated mandates that invest in unlevered equity in UK infrastructure. Our AUM for infra equity is around £1.2 billion and our investments are in low-carbon energy projects and digital. Our unlevered approach allows us to minimise volatility from the long-term cashflows derived from infrastructure assets.

Core strategies in the fund consist of wind, solar, energy-from-waste/biomass, infrastructure leases and energy centres, anaerobic digestion plants and fast fibre broadband assets. These all provide long-term income, much of which is regulated with a target net return of around eight per cent per annum. All of the money in our current funds is external, generally from UK defined benefit corporate schemes and local pension schemes.

What about your infrastructure lending strategy?

We are one of the leading institutional investors in infrastructure debt and have been active for over 20 years, investing for internal and external clients. We have nearly £9 billion of AUM and are active in the UK and across Europe. We invest annuity money and long-term infrastructure debt is ideal for matching long-term liabilities.

Under Solvency II, our investments for our UK parent need to be investment grade, fixed or index linked and offer prepayment protection. This means we invest in long-term assets where there is less bank debt liquidity. We have diversified investments across renewables, ports, roads, airports, datacentres, fibre, meters, rolling stock and offshore transmission assets.

How resilient is infrastructure as an asset class in the current climate?

COVID-19 has demonstrated that infrastructure is a resilient asset class. The pandemic has had an acute impact on demand-based transport assets, with the major impact being to airports and toll roads. However, even in these cases we have seen strong asset-level liquidity through reserves and cash available, meaning we are not aware of any payment defaults across the sector.

Renewables have been impacted in terms of valuation from the sharp reduction in power prices, but many existing assets have prices hedged through PPA arrangements and strong subsidy support.

What are the infrastructure winners and losers from COVID-19?

The clear winner is digital – everyone will probably agree broadband is now firmly established as the fourth utility and we see a lot of investment activity in the fibre-to-the-home and business market.  The losers are transport assets, particularly airports, and airlines and airports will remain under strain into 2021. However, it is great to see equity sponsors - mainly infrastructure equity funds - committing more capital and taking a long-term view of these assets.

How is institutional investment appetite for infrastructure looking right now?

It remains high. There is a high level of liquidity from insurers, pension funds and commercial banks. COVID-19 was clearly very different to the Global Financial Crisis: there has been no credit crunch, so the capital is still present. This is positive, although it is important to monitor values carefully given the vast amount of capital chasing the asset class.

What are your views on the Government’s `Build, Build, Build’ programme?

Clearly the UK needs greater infrastructure investment, but the programme confirms the statement of the March Budget that tax-funded infra – i.e. social, road and rail - will be financed by increased public borrowing; there are limited opportunities for private investment.

The previous public-private partnership (PPP) model is now considered politically toxic and there appears no appetite to resurrect it in any new form by the government. The message for investors such as ourselves is we should focus on consumer-funded infrastructure: power and utilities and digital.

What is the ideal model for PPP?

The wider PPP model could be re-looked at – the Welsh government is procuring a road, schools and a hospital using a mutual investment model for example.

The public and private sectors will need to work together much more closely in terms of the immediate post-COVID-19 economic recovery, but moreover to provide the investment required to meet net zero carbon emissions targets. The market is changing but we need to change with it; we are not going to be investing in the infrastructure of the last 20 years in the next 20 years. That is an exciting challenge.