Speaker 1Hi, I'm Bruno Alves, and welcome to the Infrastructure Investor Podcast. In today's episode, I sit down with Esther Peiner, Global Head of Infrastructure at Swiss private markets firm Partners Group. We cover a broad range of topics, including the recent Iberian blackout and the importance of resilience, how to invest through the current volatility, why managers have to think of a world where LPs need more regular access to liquidity, and how persistent inflation could threaten the asset class's diversification benefits. Hi Esther, welcome to the podcast. So at the time of recording this, it's been just over a week since a blackout left over 50 million people in the Iberian Peninsula without electricity. I was actually in Lisbon at the time and spent roughly 11 hours with no power. So this whole topic is still kind of very. It's pretty much front of mind for me, and I feel we need to start there in a way. So as an industry, we've been talking a lot about the need to modernize the grid over the years. So I'll caveat my question to you by saying we don't yet fully know the causes of the Iberian blackout. But when you learned about the blackout, Esther, did it come as a surprise or was it the kind of event that you expected was bound to happen and now it did?
Speaker 2Good question. And actually quite an interesting question. It's quite an interesting challenge also for infrastructure in terms of what scenarios do we need to think and operate within and what's the sort of the size of the tails, right? Because I guess spontaneously I'd say what we were looking at the Iberian context, probably in hindsight, the analysis will support that this was a tail-end outcome. And the question we now need to ask ourselves, how fat are those tails? And therefore, what's the frequency of risk of this reoccurring, again, it invites the question of how much from an overall system. It's a system prepared and able to spend in order to mitigate or preempt the effects of those blackouts or of a similar blackout, should it be reoccurring. Now, am I surprised to see a blackout? No. In fact, my first thought that was triggered when I heard about it really was going back to probably five, six, seven years ago when we were debating within the team, the question of grid flexibility and grid resilience, which actually ultimately led to our investment decision. The green link interconnected between the UK and Ireland. It was actually a couple of smaller insignificance, but still at the time pretty significant blackout events that triggered our increased interest in the importance, the relative importance of fast acting relief valves or sort of frequency balancing mechanisms, which ultimately an interconnector is in the same way as, for example, a slow spinning gas turbine can be, or even a battery can be synthetically, but really it was a couple of years ago that we were observing a fundamental change in grid architecture ultimately. And I guess on the back of that thematic conviction, not only did we invest in green link in a number of different cross technology-based energy flexibility platforms across the world, but then also in adjacent infrastructure sectors.
Speaker 1So our May cover story on Infrastructure Investor was actually about resilience, funnily enough. You took part in it graciously and you made a couple of comments. One of the comments that actually caught my eye and that I wanted to discuss further here. One was about data centers, paraphrasing, you said something to the effect that they appear to have some of the best contractual provisions when it comes to resilience. And maybe for the benefit of our listeners, what are they doing right? And what do these contracts look like when it comes to risk allocation?
Speaker 2So what triggered that conversation was actually another incident that I think was widely reported in the international press. I think also really impacted a lot of people's lives. And that was the consequences of the substation fire nearby West London. And it was interesting to see because you look at Heathrow as an energy consumer, and I think it's in the scale of about 30 to 40 megawatts, give or take, of energy consumption. And you look at within literally the same system, you have a number of the large data center operators housed with pretty significant load centers. Again, you're looking probably at 5, 10, 15, 20 megawatts of capacity consumption. And it was really, really interesting as the news was unfolding around Heathrow, just watching these two sides of the same trigger event, the data center industry being now so focused on energy and baseload energy, and the sustenance of that baseload energy, observing that that has led to data center resilience planning being a fundamental necessity for large scale data center consumers. And that goes to both. In some cases, triple redundancies when it comes to grid connections. It goes to on-site backup generation as well. And the industry essentially having standardized that to a very large degree, both in terms of what's required on the asset side, but then also how one prices those resilience layers. And it was just very, very interesting to see both of that in play, right? Here's one industry that derives a lot of its value chain directly from the monetization of energy. And on the other side, you have an infrastructure asset, which has the availability of energy as a key input component. Yet the value chain that hangs on the other side of it hasn't either recognized the necessity of that resilience or potentially, and it goes back to the affordability question, when you look at how the infrastructure is priced, is there room to pay the bill for this fat
Speaker 1end? And just to pause on affordability for a second, you make that point now also in the story when it comes to these core regulated assets, it's a bit grayer, who is going to pay for that and for events that happen every once in a while. And I'm guessing maybe it's a complicated thing to pass that on to rate payers or put the mechanisms in place. Is it just a matter of hyperscalers are deep pocketed in a way that people are not when it comes to rate payers and passing on the cost?
Speaker 2If I take a step back and I look at regulation. If I look at regulation, if I take a step back and I take a step back and I say, well, I think it would be fair to say there's virtually no or very few developed global economies that haven't found a way to get rate payers to subsidize a policy shift on the energy mix. And you can, of course, argue just like that is designed to address a long-term risk and a long-term significant society cost. And in short, and paying the cost of that insurance, if we think about it from a risk transfer way on the security of supply and resilience side, could and should work to the same dynamics, right? Because just like I'm today willing and able as a society to allocate essentially a shift to a renewable energy mix for a consequential reduction in emissions and therefore a limitation of climate change effects to broader society, I think in an equal. Sort of argument that there should be a case to be made that if we want to ensure the same quality of operational readiness of our infrastructure, you know, in a more volatile world, then that also, again, under the same mechanisms could be passed on to the rate payer. I think what runs against that, and that's also why we see some pushback now, political pushback, individual pushback, individual fatigue on, you know, what is why sort of more widely denoted as ESG or wokeness is because we have affordability issues and we have prioritization issues around that affordability. So my main observation would be that it's quite a complex situation where certainly the cost of us being able to operate to the same resilience and reliability levels that we've gotten used to in certainly in Europe and I think to large parts also in North America, you know, undoubtedly that cost is under a lot of pressure now. And that's a derivative of more expensive supply chains. And it's a derivative of more volatile events around grids and around generation.
Speaker 1You know, you've just mentioned volatility, and it strikes me that we're again going through one of those moments when there's a lot of volatility in the system. I mean, we have trade wars and tariff talk and all the uncertainty that comes with a particular moment. And so I wanted to ask you, how are you at, you know, a partner's group in general, the infrastructure team in particular, how are you approaching this moment? How is it informing your decision making?
Speaker 2I think volatility per se is both a risk and an opportunity on the investment side. We find as we go through again, volatile periods and backtest does on balance, infrastructure portfolios do maintain a much better liquidity profile than say a comparable private equity portfolio, no matter whether it's a sort of geopolitical portfolio or not. And so I think that's a very, very nice feature of infrastructure. And again, I think for me as an industry, we're still quite a young industry, we've probably been as a specific asset class around 20 or 25 years, right? But to now be able to look back on a couple of events and saying, actually, from a risk downside protection perspective, the continued income generation, the continued cash flow generation of an infrastructure aspect of your portfolio holds up. And I think we would also come out. The volatility with infrastructure being a more significant part of any private investment portfolio. And I would give a positive forward-looking, I guess it's either a bet or an ambition, one of the two. But you look at the large part that a real estate allocation would historically have made up of what people would call a model portfolio for a de-risk but still return-focused investment strategy. And I do believe we'll see infrastructure content replacing more and more the other real asset content in portfolios. So that per se is a really good starting point. Now, I think the second point around volatility is it opens up opportunity. Because in a volatile world, capital allocation changes for reasons that are more decoupled from underlying fundamentals than you have in a less volatile world. I, for example, would point to geopolitical tension. Geopolitical tension also leads to redirection of investment flows. And large shifts from one part to another leave opportunity or some gaps that if you look at the right assets and the right investments, you know, that can actually allow you to invest, build, operate great infrastructure and a great return, not necessarily adding significant risk. But for example, you look at generational technologies and you look at the way we started this conversation around how could you potentially address the question of grid resilience and, you know, whether I ultimately take a battery technology to do that or I take a dispatchable gas technology to do that. That's an affordability question. And in some ways, you can co-locate both utilizing a grid access infrastructure. And that allows you to play a different set of sort of outcomes, depending by which the broader system says, I value, for example, a significantly lower carbon dispatch. And maybe for that, I need to allow for battery supply chains to again, be more affordable, right? Because that's, I think, the part on the renewable chain that I think is currently most of risk to be impacted on the tariff side. Or, you know, today, actually, the question is more one of dispatchable energy fast, in which case your existing gas infrastructure is going to be getting dispatched more. And then the question is, over time, as maybe the perception of you and the carbon pricing also changes, you still have the optionality to then very quickly scale up with an alternative technology where you're essentially lowering the CO2 intensity of your energy installation. It comes back to where does the value sit? And what is the scarce commodity? And the scarce commodity, I think, has gone from, I put the next megawatt into the grid to I have the ability to put megawatts into the grid in a flexible fashion, i.e. the underlying grid connection, I think, today holds a much, much more significant value. And I think if you build optionality in an optionality in the way you put your portfolio together, so that you are diversified across the different regulatory environments, across different geographies, and potentially also across different infrastructure sectors, I think you'll be able to navigate this volatile environment quite well, actually.
Speaker 1Let me ask you about what this environment obviously kind of makes harder, let's say. For example, I'm thinking, I think I'm right in saying that platform building has long been at the heart of your strategy at Partners Group. And obviously, you know, we've been having supply chain headaches for quite a while. Now there's tariffs. Tariffs and the idea of development becoming costlier. For example, the other day, we spoke to an LP source who told us basically that they were looking nowadays for significant operational capacity among development platforms as sort of an imperative for them to even look at deals. So, you know, is this aspect I am guessing has become harder to execute on? But I'm curious how you view it. Is this a momentary thing? And how are you, you know, hedging what's been a kind of a core part of your strategy?
Speaker 2I think fundamentally, if we stay with energy for a minute, or also, consequently, with data centers, I think you see some of the same dynamics. There's just such an excess demand that is so intense for the next 12, 18, 24, 36 months that we're finding today. It's less about the impairment of the unit economics, which, you know, would lead to you pausing platform development. In fact, it's more, you know, it's less about the impairment of the unit economics, which, you know, would lead to you pausing platform development. In fact, it's more, who can navigate supply chains, not for the lowest price, but for the fastest time. And that's different, right? Because everybody ultimately has more or less the same pricing environment when it comes to the supply chain. You can do some optimizations, but it's hardly going to so significantly differentiate you that you can keep that benefit for two, three, four, five years. But speed, timing, execution focus, ability to really plan and execute on a project timeline. There, having done it, a few times, working with, again, industry experts, overlaying experience from other projects, other platforms to a new one, can help unlock and speed up the bringing of new capacity quite a lot. And that tends to be often in volatile environments, something that's actually thought after, because that allows you to, in a very short ownership period, build up a significant operating business with then still a growth avenue on top of it. And just like you said, actually, we're finding now, we had one disposal of such a platform here in Europe with late last year, we're actually finding that in a market that's otherwise a little bit less bullish when it comes to valuations, these types of setups right now actually attract an overproportionate amount of buyer interest, right? So in some ways, I would say, you need to have a, you absolutely and always need to have an operating element. But the other thing you absolutely need to ensure now is the operational capabilities and the experience to scale these platforms fast. And if you combine those two, you're ultimately almost manufacturing then that type of content that will continue to attract buyers going forward as well. I have a couple of last
Speaker 1questions for you, Esther. One is, I think you've alluded to what could be, again, a good outcome for the asset class out of this period of volatility. But in the current moment, when you're having conversations with your LPs, for example, what are you hearing? Are you hearing about people continuing allocating as they planned? Are people talking about hitting the pause button?
Speaker 2I think the infrastructure asset class as a whole has had a tremendous boost when inflation was low and rates were low. And that's led to a proliferation of allocators doubling and tripling down into the asset class. And it's also led to a mushrooming of different strategies, different managers. to then collect and deploy that capital. And what we're now seeing in a world where, you know, rates are elevated, inflation is significantly elevated, is allocators have less to allocate, period. They, therefore, for the, I think the first time for infrastructure, rather than being net increasing allocations, they're saying, yes, I will make new allocations, but in turn, either I need to see significant distribution that I can recycle. Because I don't have as much of a growing portfolio. Or, you know, I'm looking at the universe of managers, the universe of partners I've worked with, and I'm starting to shift. So I think in infrastructure now, there's more of a re-evaluation of portfolios that is ongoing than ever before. Good in some ways, because it opens up different access points to the asset class with more and more secondary volumes coming to the market. I think we'll put continued pressure on GPs to sort of be clear and differentiated on where they play and where they do not play. And then, again, I think an increasing bifurcation of track record differentiation. And there, I think we're in the very early stages of seeing that play out, because in some ways, you look at a low inflation, low interest rate environment, where often a pure asset appreciation is a derivative of those two matters and interest rates. Infrastructure being a real asset, i.e. an asset heavy asset class, quite a lot of track record, you know, was macro driven. And a smaller part of track record was individual. Again, I'm very much generalizing here. But I think going forward, in a more difficult interest rate and in a more difficult inflation, in more difficult, I mean, increasing environment, right, in a world where affordability will dampen infrastructures, tried and tested ability to just keep passing it on. That was something people 20 years ago said, don't worry if inflation goes up, don't worry if rates go up, we'll pass it on through our regulated system. That music stopped completely. And we see that. And by the way, not just in the US, we see that everywhere, in Europe, in other markets as well. So that no longer works. I think now the onerous is back to, so how do you actually generate value? How do you drive value in investment selection, in active management, in, you know, the way that you monetize those investments, either through exits or through continued income strategies? I think we'll see a little bit more of a divergence in what top quartile looks like and what bottom quartile looks like. And that will change the industry. I think it'll change the industry in terms of some will emerge stronger, and then there will be, it's been underway for quite some time already, there'll be quite a lot of consolidation. The big challenge there I see for the infrastructure as a class as well in the whole mix is that we're moving from a world where the long dated illiquid nature of the asset class and the underlying assets was something people really appreciated and actively thought out. And I think some of the volatility and the constraints and liquidity or lack of liquidity surprises the LP community has seen in the past 24 months. I think that's something that we as an industry also need to start having more of an answer to because the, again, more volatility, you know, what will not change is that the LP will want to have a minimum return for a risk that they adopt. And therefore, how do you match that then with the fact that maybe they need to have access to more regular liquidity than some of the historical strategies can offer? And I think that'll be quite an evolving topic for us as an industry to tackle and to solve. What really worries me more broadly is the inflationary pressures that we're under. And that's maybe a finer point. I mean, that's sort of really the hair in the soup. And how big that hair is, I don't know. But I think with the current supply chain disruption and the current geopolitical tension and increased outbreaks of violence in different parts, parts of the world, I really struggle to see a scenario where we don't have to deal with persistent, sticky inflation, particularly as we keep increasing energy demand. And that ultimately will impair, you know, just as a macro effect that will have an impairment risk on asset values. You know, we might just see value corrections more broadly in private markets, but also on the infrastructure side. And that's going to, again, going back to the allocators, you know, that that's going to be the first time that the infrastructure portfolio diversification versus the balance of your market, you know, is it really that strong? And that ultimately, you asked a bit earlier about how are we thinking about this volatile environment? And I talked a lot about the opportunity and where we would invest. But when I look at my team and my team's focus today, about half their time is spent on the new conviction semantics, the new investments, but actually the other half is spent on maximizing the opportunity. And I think that that's going to be very, very important for us in the future as well. And I think that's going to be very, very important for us in the future as well. As much where we can control outcomes, where we can drive incremental operational value, value uplift and value creation aspects of an infrastructure. Let's do that relentlessly, because that is ultimately, relatively speaking, I think the best way you can address against that unknown impact of persistent inflation by just ultimately having more profitability in your portfolio. And that's probably as important in the end for us. Delivering the right outcomes as it is to be able to spot the next interesting opportunity.
Speaker 1Yeah, no, I completely agree. And I think that's a really good note to end on. Esther, thanks very much. Thank you very much for coming on and for sharing your insights. Thank you. I enjoyed the conversation, Bruder. Thank you very much. That, again, was Esther Peiner, Global Head of Infrastructure at Swiss private markets firm Partners Group. To hear more of our episodes, head over to www.infrastructureinvestment.com www.infrastructureinvestment.com forward slash podcast, or you can search and subscribe to the Infrastructure Investor Podcast, wherever you like to listen.
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