Infrastructure Investor: Actis: Generating higher returns in critical infrastructure

Neda Vakilian, Managing Director, Global Head of the Investor Solutions Group at Actis, spoke with Infrastructure Investor about how Actis generates higher returns in critical infrastructure. Click here or read on below for the full article.

 

Actis: Generating higher returns in critical infrastructure

With the right expertise and local network connections, opportunities abound for investors in critical infrastructure, says Neda Vakilian of Actis.

Investment in sustainable infrastructure, especially in assets that support the energy transition, is being observed around the globe. But capital needs are not uniform – and neither are returns. Growth markets offer some of the most attractive returns for infrastructure investors. These opportunities can be found in emerging markets and where there is potential for higher returns as a result of rapid economic or sector growth, which includes some OECD, developed markets.

Neda Vakilian, global head of the investor solutions group at global investment firm Actis, discusses the trends that are emerging around sustainable infrastructure in different markets. Risks and opportunities in these markets can differ substantially, emphasising the importance of diversified portfolios and long-term strategies.

When it comes to sustainable infrastructure, where do you see the opportunity?

In a world where infrastructure investors are seeking higher returns, this can be achieved in a couple of ways. One is by going higher up the risk curve within developed markets such as Western Europe and North America. There is still a question as to whether there is a favourable investment dynamic with a lot of capital chasing many of the same opportunities. Another is to go into our markets and invest in true critical infrastructure – the kind that powers people’s homes, for example – genuine defensive infrastructure that is socially and environmentally resilient but in markets that investors may be slightly less familiar with.

Our markets have proven to be resilient, despite the economic downturns witnessed in developed markets such as Europe. If you look at the performance of Brazil, from a monetary policy and resilience perspective, they were a step ahead of economies in Europe and the US.

If investors find the right manager to partner with, who has material experience to manage the risks of investing into those markets and navigating challenges, there is a genuine and important case to be made around exposing infrastructure portfolios to a broad variety of markets. On an allocation-wide basis that will give you greater resilience.

Another interesting opportunity is where financing has historically been very cheap and had a huge optimisation impact on investment strategies. In our markets – and at Actis in general – financing has never been the primary driver for value accretion.

When we invest in our markets, the growth of the underlying investments is the primary thesis behind how we achieve higher returns. Financing has always been more costly and, as such, never quite as material a component of our investment strategy. The impact of the cost of financing increasing in this downturn has therefore had a less material impact on our investment approach and strategy compared to some of our peers investing specifically in developed markets.

In growth markets, exits are materialising and hitting target returns, proving that if you make the right investments, aligned with sustainability objectives, there is money to be made. We have also been focused on delivering capital back to our investors. In 2022, we invested $2 billion, but returned $4 billion back to investors. We are very proud of this as our investors are regularly telling us that the challenging market has resulted in them not receiving their capital back on a timely basis.

Originating deals off-market in developed economies is extremely difficult – everyone is bidding for the same deal. Most of our deals, on the other hand, arrive in a proprietary way, off-market, and we take them into exclusivity very early. Getting the best deals here relies on a combination of the fantastic opportunity presented by our markets, our local networks, and our investment experience.

What the points above evidence is that there is a compelling case to be made to investors as they build out their allocation strategies, with regards diversification to growth markets for truly defensive, critical infrastructure. If the right management team is backed, with a track record of consistently hitting target returns, then growth markets are an excellent way to achieve higher returns, while contributing to the energy transition and riding the favourable tailwinds of digitisation.

To equip our ICs at Actis, and our LPs with nuances of how to consider the relative risk/return in each of our target markets, we have developed a new categorisation methodology called Actis Atlas.

What are some of the main investment trends you are witnessing around infrastructure?

There are several tailwinds driving infrastructure investment. Despite a challenging macroeconomic environment, there continues to be sustained interest in infrastructure assets – particularly in anything related to the energy transition.

Another trend pertains to digital infrastructure. We are witnessing a lot of interest here. The big challenge regarding these assets concerns valuations, especially in markets such as Europe and North America. However, we are not seeing similar challenges in growth markets. While it is true that peers are struggling to deploy money in the digital sector, we are still seeing a great deal pipeline and continued faith from our LPs.

Trends around strategy also remain important. Where, historically, you may have seen interest in developed markets core infrastructure or core-plus, we have noticed that many of our investors are now asking for optimised alpha generation – for higher returns from their infrastructure allocation. Against the backdrop of rising interest rates, higher returns such as core/core plus infrastructure in growth markets, or value-add infrastructure globally, is a trend we see continuing to grow. Actis is well-positioned to take advantage of such opportunities.

You cannot ignore the reemergence of transport as an attractive sub-asset class which fell out of favour of late, particularly in the aftermath of the pandemic. Such deals often have attractive characteristics such as availability-based cashflows and inflation indexation. We are active investors in toll roads already, and we are also looking at transport investments which align with the energy transition.

We are seeing a heightened focus on specialist firms and the mid-market. While there may be a significant interest in mega-cap GPs, we are also witnessing an uptick in the mid-market space. Investors can achieve good value here. In terms of specialisms, the energy transition is paramount. This suits us because the intersection of the mid-market and energy transition is exactly where we sit.

Are any of these trends specific to certain geographies? And are there any regional drivers?

In the Middle East we see increased interest in renewables and green and blue hydrogen. Local competition for “straight down the fairway” solar and wind auctions is fierce, but green hydrogen and C&I is more complex, so Actis’s skills come to the fore such that we can capitalise on the fertile investment environment.

India has one of the biggest programmes globally towards net zero, and has proven a resilient investment region despite global economic turmoil. Across Southeast Asia, we see policy and regulatory programmes kicking off for example in Malaysia and Vietnam, creating an attractive investment environment. This is driven in part by volatility in LNG pricing, as well as geopolitical uncertainty.

Digital infrastructure carve-outs are available at attractive valuations in our markets. In Asia, we have a unique play in the data centre space where we have a strong track record, tried and tested playbook and have consistently been first mover in our investment approach.

In Central Eastern Europe, energy security is a huge driver behind decarbonisation. Land availability is not an issue and the regulatory environment is helpful (the Reg 3 European Directive is soon to come into force, for example).

Moving to the Americas, Mexico is also interesting. It is the US’s largest foreign direct investment partner and given the US’s new IRA programme and the near-shoring trend, the renewables investment opportunity is re-energised there.

Actis’s footprint with over 17 offices globally, our extensive network and experience investing in each of these regions, means we are able to effectively originate proprietary opportunities and deliver platforms that implement our “builders and operators” mindset.

You mentioned currency volatility in growth markets. How does Actis manage this risk with your infrastructure investments?

Our risk-mitigation strategy for foreign currency volatility is tried, tested and proven. We do not typically hedge the currency exposure of our investments as we find that this is often too expensive and eats into the returns.

Instead, we take the following approach. First, we seek to dollarise underlying contracts at the investment level. Second, our underlying investments are often inflation-indexed and, third, the way we underwrite investments is key. We assume a degree of devaluation in our base case scenarios, and our in-house macro team inputs and guides our assumptions regarding FX fluctuation. Fourth, the way we construct our portfolios, where we try to diversify as much as possible, also serves to mitigate risk.

Finally, where we have investments which are yield-generating, regular cashflow distributions to investors are an excellent risk mitigant. Value is extracted regularly over lengthy time periods, reducing exposure to foreign currency fluctuations at any single point in time.

Why focus on sustainability?

Sustainability has been part of Actis’s DNA since day one. We focus on it because it generates value. If we do not invest sustainably, using the finely tuned parameters and tried and tested methodology developed by our sustainability team, then we will not be able to maximise the value achieved at exit. These days our investors are increasingly holding us accountable for this too.

As it happens, we also care about investing sustainably, as do our staff. They tell us they want to work for us because what we do matters. Our authenticity and integrity feeds into our sustainable investment strategies.

What is in a name?

Investors often treat markets in a homogenised way.

Commonplace labels, like developed markets, emerging markets and frontier markets, substitute simplicity for opportunity. These groupings, widely employed in investment decision-making, remove a great deal of nuance from investment strategies, resulting in missed opportunities for investors. Redefining these terms in a way that recognises the growing complexity of the investment world is needed.

To encourage a realignment of how markets are defined, investors are being asked to follow a new categorisation: The Actis ‘Atlas’. This introduces six categories – ‘Global Influencers’, ‘Big Middles’, ‘Supply Chain Heroes’, ‘Stable but Small’, ‘Natural Resource Winners’ and ‘Structurally Challenged’ – to allow for a more equitable assessment of opportunity. This taxonomy means that investors do not treat the 80-plus emerging markets as a single monolithic group and are able to balance portfolios and risk criteria across multiple geographies.

The importance of taxonomy has long been recognised in the investment world – as witnessed by the due process that has underpinned the EU’s sustainable finance taxonomy. It is hoped that by bringing similar clarity to emerging markets, it will give investors a better understanding of the risks and opportunities within these regions.