INFRATECH Infrastructure disrupted: investing in the age of ‘unknown unknowns’ Viktor Kats, co-fund head of the IFC Global Infrastructure Fund, and Deepali Bahl, principal at the fund, argue investors need structured frameworks to be able to deal with the impact of technology I nvestors have long viewed infra- ously thought to be low-risk. Trade barri- ucts to finance to agriculture to health. So, structure as a long-term, low-risk, ers introduced by political populism and what is so special about infrastructure that inflation-linked asset class. It geopolitical shifts are affecting established we need a framework? The uniqueness of has attracted increasingly large supply chains. Emerging markets are the intersection of infrastructure investing amounts of equity capital, growing from increasingly driving demand for new infra- and technology comes from the infrastruc- $36.5 billion in new funds raised in 2010 structure. Interest rates are building their ture asset characteristics that institutional to $57.2 billion in 2017. In the first half upside momentum. While these changes investors expect – long useful life, regula- of 2018, more than $38 billion was raised in risk profile are often reflected in new tory protection, difficulty to replicate and by 29 infrastructure funds. fund strategies and new investment valu- capacity to generate stable, predictable The original promise of infrastructure ations, a coherent framework to assess the cashflows. We believe that technology is is compelling. However, some of the main impact of technology disruption on infra- going to change many of these character- assumptions of the risk-return balance for structure assets is still largely absent from istics and that long-term investment deci- the asset class have recently come under investment decision-making. sion-making will require an increasingly pressure. Investors have seen unexpected Technology is disrupting all sectors of different frame of mind as well as financing regulatory action in many markets previ- the world economy, from consumer prod- and asset management approach. Disruptive technology could enable both cost-saving and revenue-enhance- THE CHANGING NATURE OF INFRASTRUCTURE ASSETS ment opportunities across various subsec- tors. As disruptive technologies become more pervasive, new infrastructure busi- The case for decreased road The case for demand increased road demand ness models will emerge. Depending • Shared vehicle business • Car penetration will on which technologies evolve and are models will drive down rise as the cost of car adopted, and consequently in which direc- car ownership Will the demand ownership comes down for road tion the future moves, the risk profile of • AVs will result in greater • Traffic will rise as people infrastructure efficiency and less are able to move about existing assets will shift and certain assets increase over traffic with more ease and the next will face the risk of becoming stranded. efficiency • Drone taxis and other 20 years? Technology innovation today occurs new technologies (e.g., • New technologies will Hyperloop) will eat take time to win public exponentially, so, despite developing a into the passenger and confidence and become strong fundamental understanding of cargo market cost-competitive disruptive technologies and potential implications, making investment decisions in an inherently unpredictable world can Decreased demand Increased demand be risky and overwhelming. Let’s take mobility infrastructure as Source: IFC an example (see chart on the previous 4 INFRASTRUCTURE INVESTOR THE FUTURE OF INFRASTRUCTURE REPORT INFRATECH page). Business models for shared vehi- MAPPING THE TRAJECTORY OF INTERNET OF THINGS UNDER ALTERNATIVE SCENARIOS cles have taken root, and autonomous vehicle (AV) and electric vehicle (EV) Universe of Variables Impacting IoT: Regulatory behavior, public opinion, commodity prices, technologies are developing rapidly. Will global trade (dis)unity etc. these models and technologies defini- tively and significantly alter how people Chosen Variables (example): travel and commute over the long term? Regulatory behavior, public opinion The answer is difficult to predict and depends on several external variables. Scenarios (example): Unfavorable regulation Favorable regulation Even if the answer were known, what but favorable public & public opinion would it signal for the demand for road opinion vis-à-vis IoT vis-à-vis IoT infrastructure? Would demand increase Unfavorable regulation Favorable regulation or decrease over the next 20 years? As & public opinion but unfavorable public vis-à-vis IoT opinion vis-à-vis IoT shown on the previous page's chart, an equally compelling case can be made End-product: Narratives explaining the potential trajectories IoT might take under alternative scenarios and what these might mean for businesses either way. This underscores the perils of categorical predictions when making Source: IFC a long-term investment decision. THE ‘INNOVATION ECOSYSTEM’ proprietary dealflow, reference and dili- BUILDING ‘INNOVATION MUSCLE’ Defining alternative scenarios is a complex gence checks, and expertise for portfolio Because there is so little certainty around exercise. The real world consists of many companies to draw on. what the future will look like, planning variables which impact the trajectory of a for alternative scenarios is important. disruptive technology. TECHNOLOGY DISRUPTION Scenario planning prevents investors For example, how will regulators FRAMEWORK from becoming wedded to one view of the behave vis-à-vis a disruptive technology? Investors can build the scenario approach future and from getting blindsided when How will public-interest lobbies react? Will into a tool that combines structured analy- a different reality plays out. For instance, commodity-price trends have an impact? sis with judgment to produce a ‘heat map’ taking the view that utility-scale renewa- Will global trade (dis)unity influence how to facilitate decision-making. bles are the future of power generation a particular disruptive technology unfolds? Chosen scenario variables can be devel- may cause investors to miss interesting All these factors are relevant. oped into a series of metrics which help new opportunities that emerge in distrib- Let’s take the example of the Internet determine whether a technology is likely to uted generation, such as the combination of Things as a disruptive technology. Here, disrupt a sector. For example, the ‘regula- of rooftop solar and batteries. regulatory questions about cybersecurity tory-behaviour’ variable can be developed Scenario planning reinforces a disci- could be a factor. Public concerns around into metrics such as how strongly the gov- pline among investors of continuously data privacy and the prices of ‘high-tech’ ernment mandates use of the new technol- assessing the environment and refining metals such as lithium and cobalt used in ogy, the magnitude of government-provided portfolio construction and management batteries could also significantly influence financial incentives for use of the technol- strategies to achieve a better-balanced whether and how IoT is adopted. ogy (such as subsidies or tax breaks) and so risk/return. Over time, this creates It is important for infrastructure inves- on. Similarly, the ‘public-opinion’ variable ‘innovation muscle’ among investors – tors to narrow variables down to the most can be measured by unions’ support (or lack i.e., the capacity to spot early signs of important two or three so that scenarios thereof) of the new technology, consumer technology disruption in infrastructure can be simply defined. Because infrastruc- studies that measure attitudes towards a new and react either offensively (by captur- ture investors are not technology experts, technology and the like. ing new opportunities) or defensively (by it may make sense to co-opt ‘thought part- The graphic on the next page shows an protecting and adapting legacy assets). ners’, firms or people versed in technol- illustrative heat map for a portfolio with Investors with in-house ‘innovation ogy who can infuse cutting-edge thinking renewables and water exposure. muscle’ have a significant competitive into the process. Over time, this innova- The deeper green boxes show metrics advantage in today’s dynamic infrastruc- tion ecosystem of ‘thought partners’ can that are most supportive of technology ture landscape. bring several benefits to investors such as disruption, while the deeper reds show THE FUTURE OF INFRASTRUCTURE REPORT INFRASTRUCTURE INVESTOR 5 ROUNDTABLE INFRATECH HEAT MAP GRAPHIC SHOWING CONDITIONS FOR TECHNOLOGY DISRUPTION FOR THEORETICAL PORTFOLIO Sector Renewables Water Data Technologies (AI, Engineering Data technologies Engineering Technology Category Blockchain, IoT) technologies (AI, Blockchain, IoT) technologies Technology / application Smart grid / P2P Battery Distributed Smart Water AI / IoT/ smart meters trading storage / EV generation water harvesting Blockchain Regulatory Metrics How strongly is the govt mandating the use of new technology by businesses and/or end-users? How significant are govt-provided financial incentives to adopt the new technology? Additional metrics | | | | | | | Public Opinion Metrics How positive is public receptivity to the new technology based on consumer studies? How supportive are unions and other rights groups of the new technology? Additional metrics | | | | | | | Source: IFC metrics that are most restrictive. The stable asset class that is changing quickly, Consequently, actively cultivating an ‘heat map’ effectively suggests which we need to develop in-house ‘innovation innovation network or ecosystem is key externalities a portfolio manager should muscle’ to continuously evaluate the to staying abreast of new developments be most wary of or excited about, and threats and opportunities presented by and fostering a broader understanding how he or she might consider allocating technology disruption. of technology disruption over the long time and resources across the portfolio Scenario analysis is a powerful tool term. to manage technology disruption threats to build such ‘muscle’. Scenarios allow Ultimately, creating structured frame- and opportunities. investors to objectively understand works to assess the impact of technology technology disruption and its poten- disruption on infrastructure must be CONCLUSION tial impact. However, scenarios devel- married with investor experience and A dynamic environment calls for flexible oped entirely in-house may be limited judgment to make optimal investment strategies. As investors in a traditionally by institutional knowledge and bias. decisions. n 6 INFRASTRUCTURE INVESTOR THE FUTURE OF INFRASTRUCTURE REPORT