Social Impacts and the Practice of Direct Infrastructure Investment

Dr. Patrick Schena, Fletcher’s Adjunct Assistant Professor of International Business, and Dr. Eliot Kalter, co-head of SovereigNet at The Fletcher School, recently published research on social impacts and the practice of direct infrastructure investments.

The report, which is sponsored by Guggenheim Partners, includes key contributions from SovereigNet affiliate Matthew Gouett, Timothy Hu (MALD ’20), Rebecca Israelson-Kurland (MIB ’21), Madhuri Mukherjee (MIB ’20), and Nathaniel Leach (MA ’21).

From the Report

The World Economic Forum estimates that the world will face a $15 T infrastructure gap by 2040. To close this gap requires concerted action across stakeholders sponsoring governments, multilaterals, developers, private investors, and civil society. Their collective goal will be to identify, design, build, and finance sustainable projects that increase the stock of global infrastructure assets that are capable of delivering positive environmental, social, and economic impacts with minimal dislocation to local communities and their environments. The sustainability challenge posed by the so-called “infrastructure gap” motivates this study. Its aim is to understand, based on the practice of institutional investors, 1) the nature of social impacts arising from infrastructure investments and 2) how they are integrated into and optimized during the investment process and across the entire lifecycle of an infrastructure investment.

Social impacts and social risks co-exist in infrastructure projects and are deeply integrated across the investment process. This occurs in a continuous fashion that links investment objectives at the pre-investment phase with outcomes at the asset management phase through measurable and reportable metrics. This data-driven approach contributes to process integrity and, importantly, enhances the alignment of manager incentives with discrete social outcomes.

Among institutional managers, standards – ESG, sustainability, “impact” – matter. When implemented and observed in practice, they can signal a manager’s commitment to a robust sustainability agenda. They are often used as screening tools during the pre-investment phase, and as monitoring tools post investment. However, and importantly, evidence suggests that, for monitoring and measuring social impacts they are less relevant than well designed asset or sector-level metrics or KPIs.

The most successful practices of direct infrastructure investors are grounded in the integration of social risk and social impact across the entire investment process. This begins with sourcing and screening investment opportunities and extends to conducting due diligence and structuring and valuing deals. It is during due diligence that social risks, in particular, are identified and where risk mitigation measures are designed, analyzed, and modeled.

A Preview of Key Findings

The nature of infrastructure in terms of scale, utility, and horizon, requires that it be developed with a keen sense of awareness of its consequences – environmental, social, and governance – for affected societies. Its growth has paralleled the steady increase in demand for uncorrelated returns, prompted by severe equity market shocks over the last two decades and accentuated by record low interest rates. Demand for infrastructure as an asset class has also been favorably influenced by the progressive rise in interest in sustainable investing. Incorporating ESG factors into investment decisions has reached a point of near ubiquity among infrastructure managers. While the effects of environmental impacts on investment returns have long been studied, less well covered and understood are successful practices that integrate the social benefits of infrastructure investments with their inherent social risks.

Social impacts and social risks are both endemic to infrastructure. Broadly speaking social impacts represent collateral benefits to communities that extend from the investment. However, these often come at a cost resulting in trade-offs that must be addressed during the investment process. Thus, impacts and risks co-exist in an integrated way in large-scale infrastructure projects and are often challenging to disentangle when making investment decisions. From a practice perspective, there is a material gap in both professional and scholarly writings that is focused on the discrete social impacts of global infrastructure. What types of social impacts and social risks arise from investments in infrastructure projects? How are these identified, monitored, and their effects measured? What practices do institutional investors employ to effectively integrate social impacts and social risks throughout their investment processes? Finally, what practices do they employ to ensure their effective integration into the operational phase of their projects?

The purpose of this study is to assess the current state of practitioner experience when integrating social impacts and social risks in infrastructure investments and to highlight successful practices. This analysis was performed in two phases. During the documentary phase, institutional practices of public and private investors were studied to identify linkages between investment criteria and social impacts. This was followed by a series of interviews with a cross-section of key stakeholders to test preliminary findings and to augment practice details. Several key findings emerged:

  • Social impacts and social risks are integrated across the investment process in a continuous fashion that connects investment objectives at the pre-investment phase with outcomes at the asset management phase using measurable and reportable metrics.
  • For institutional managers, standards such as those related to ESG and sustainability, are important. However, for monitoring and measuring social impacts they are augmented by discrete key performance indicators (KPI’s) that permit analysis of a greater degree of asset- and sector-specific detail.
  • The most effective practices of direct infrastructure investors are grounded in the integration of social impacts and social risks across the entire investment process, from sourcing and screening to due diligence and deal structuring and valuation.
  • Due diligence is unquestionably the fulcrum of the investment process. It drives the identification of social risks and the design of mitigation measures that proactively engage local parties to drive positive social impacts to affected communities.
  • KPIs play a central monitoring role across the investment process in the integration of social impacts and social risks. They can also function as knowledge and capacity-building tools and serve as a medium for relationship-building and enhanced manager-client engagement on social impact.

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