Bridging the green infrastructure investment gap: Leveraging institutional investors and de-risking greenfield investment

To deliver on international climate and development goals, it is critical to shift to, and scale up, investments in green infrastructure – what we refer here to as low-carbon, climate-resilient infrastructure. Public funding will continue to be critical to meeting the goals, yet it alone will not suffice with shrinking fiscal space in many countries. Private finance, therefore, must be successfully mobilized for green infrastructure development.

Institutional investors are a key source of long-term capital for scaling up green infrastructure investment. These investors, such as pension funds, insurance companies, mutual funds, and sovereign wealth funds, have trillions of dollars in assets under management, making them central players as in the provision of long-term capital. As the appetite for diversification, search for yield, and the attraction of unlisted assets continue to grow, institutional investors’ exposure to alternative assets such as green infrastructure is increasing.

Institutional investors also have compelling reasons to engage in climate action, such as the potential impact of climate change on their performance, the need for long-term, inflation-protected returns, and the growing importance of ESG considerations in infrastructure investment. Low-carbon, climate-resilient infrastructure is a productive asset that can meet these needs.

How can these investors shift their investment more rapidly toward green infrastructure? What mechanisms can best enable that? A compelling answer lies in partnerships with entities like development financial institutions that can de-risk specific opportunities as well as the investment environment.

How do institutional investors invest in green infrastructure?

Institutional investors typically turn to closed-end funds and direct infrastructure investment to gain exposure to green infrastructure. Closed-end private funds lock up committed capital for the term of the fund, typically 7-12 years, by which time all the underlying assets are sold. These funds offer flexibility (as to when to sell assets without having to worry about maintaining liquidity), objective asset valuation, and relatively straightforward management.

However, they may not provide stable, inflation-protected, diversifying cash flows, which are ironically the main attraction of infrastructure investment. Closed funds require investors to exit their best-performing infrastructure assets instead of collecting long-term stable dividend payments. An assessment shows that the average performance of private infrastructure funds is lower than that of private equity buyout, venture capital, and real estate funds.

Direct infrastructure investment allows for greater control over the project and potentially higher returns due to lower management fees and expenses. Institutional investors can also align their investment horizons with the life of the project. However, the requirements of a large commitment to a single asset and of human capital can limit direct infrastructure investments to only the largest institutional investors.

Brownfield investments, a type of direct investment, involve acquiring operational projects with lower risk profiles, making them attractive to institutional investors (e.g., CDPQ acquiring an Indian solar company). However, scalability is limited due to the lack of a steady supply of quality projects. Also, the additionality of brownfield investments to address the investment gap is unclear since it’s not guaranteed that the capital freed by institutional investors will continue investing in green infrastructure.

Investment in greenfield (new) infrastructure is essential to closing the infrastructure gap, particularly in emerging and developing economies where private investors are more hesitant to invest and greenfield infrastructure need is greatest. Yet, there are several barriers to this, including the lack of an investible pipeline of projects (quality and size), regulatory and policy uncertainty, unfamiliarity with developing countries, and highly fragmented capital structure. Institutional investors are potential sources of funding to bridge this gap, but they face limitations due to these barriers.

Institutional investors should prioritize direct greenfield investments. De-risking can help.

Institutional investors should prioritize direct investments in greenfield projects, which offer scalability and effectiveness, rather than solely relying on closed-end funds and brownfield investments. For institutional investors to be attracted to greenfield investment in emerging and developing countries, however, it’s crucial to mitigate the various existing, perceived, or potential risks associated with such investments. De-risking, which involves reallocating, sharing, or reducing risks, can be achieved through policy and financial means:

• Policy De-Risking: Policymakers, external donors, and development financial institutions can mitigate risks related to the investment environment, project pipelines, and political stability. Investment and infrastructure planning, along with infrastructure development policies, serve as crucial tools to direct and scale capital flows towards green infrastructure.
• Financial De-Risking: Employing public financial instruments like debt, equity, and guarantees to reduce risks, a structuring mechanism also known as blended finance. Public financial entities like multilateral development banks or climate funds can share a portion of the risk, thereby improving the risk-return profile for private investors, encouraging private investors to allocate capital and stimulating long-term investment from institutional investors.

Institutional investors can strategically collaborate with public financial institutions, which can de-risk investment opportunities, create favorable investment environments, blend different sources of capital, and provide expertise in working with developing and emerging countries. Such partnerships not only signal long-term political support and stability, but also enhance project credibility.

One example is the collaboration between the International Financial Corporation (IFC) and Amundi-Acba Asset Management, Armenia's leading pension fund manager, with the goal of catalyzing private investment in Armenian infrastructure. As the lead arranger, IFC streamlines the process for multiple lenders to provide financing to companies, offering expertise in deal-structuring, due diligence, and environmental and social risk management.

Through these strategies and partnerships, institutional investors can actively participate in driving sustainable infrastructure development and maximize their impact. This approach not only supports economic growth and development in emerging markets, but also helps address environmental and social challenges, creating a win-win situation for all stakeholders involved.

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By Esther Choi, Research Associate at WRI Finance Center's International Financial Institutions and Lihuan Zhou, Associate with WRI’s Sustainable Finance Center.

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