183. The pandemic has highlighted the importance of digital infrastructure to society

24 March 2022 (pre-recorded 15 March 2022)

Below is a transcript of the episode, modified for your reading pleasure. Please check the corresponding audio before quoting in print, as it may contain small errors. Please remember we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at your time of listening. For more information on the people and ideas in the episode, see the links at the bottom of the post.

[INTRODUCTION] 

Staci West (SW): Welcome back to the Investing on the go podcast brought to you by FundCalibre. Today we’re focusing our attention on a new fund to FundCalibre, the newly Elite Radar Schroder Digital Infrastructure fund. This fund seeks to take advantage of the increasing demand for digital infrastructure and the sustainable transition to a digital economy. Here to tell us more is co-manager Tom Walker. 

Chris Salih (CS): I’m Chris Salih and today we are joined by Tom Walker co-manager of the Elite Rated Schroder Digital Infrastructure fund. Thanks for joining us today, Tom.

Tom Walker (TW): Hi, Chris. It’s great to be here.

[INTERVIEW]

CS: Let’s start with a simple question. Could you maybe explain to listeners what digital infrastructure actually is?

TW: Yeah, so digital infrastructure really forms three key components, which are absolutely essential when it comes to communication. So we’re talking about mobile phone towers, also known as macro towers. We’re talking about fibre optic cable, which is what will then connect that signal from a macro tower to a data center where information is then stored and processed and analysed. So we’re talking about macro towers, data set, enter, and fiber optic cable. Those are the three key building blocks of digital infrastructure

CS: And you sort of hinted there, but could you maybe explain why it’s so important to the world today?

TW: Yeah, I mean, I think that, you know, there are a number of examples that we can go to, which immediately resonate with how important digital infrastructure is. So if you go back to January this year, there was a volcanic eruption in Tonga, which then triggered a tsunami and that explosion actually knocked out the one fibre optic cable, the subsea cable that connected Tonga with its internet. So if you remember back in January, it took about four or five days for any images of that disaster to come through on the news. And that’s because that fibreoptic cable was taken out. 

More recently in Ukraine, we saw Elon Musk tweet that he was going to provide satellites above Ukraine because Russia had taken out the internet capability across Ukraine. So again, he was going to provide satellites to help with that communication. And then just kind of, you know, for our experience here in the UK, during the pandemic, you know, when we think about key workers in that categorisation, generally, we’re thinking about nurses and doctors, but actually key workers were also people that worked on macro towers, data centers, and fibre optic cable, because that communication was obviously absolutely essential for us all, to be able to keep doing our jobs.

And so you can start to understand the importance, not just to just us as individuals, but also companies and governments and in society really as a whole.

CS: Again, you’ve touched on it there, we’ve obviously become increasingly more reliant on internet access and cloud-based solutions, particularly in the wake of the pandemic. Does this provide more opportunities today?

TW: Yeah, I think it does. I mean, you know, the pandemic has proved to us how much we rely on digital infrastructure on that, on this digital community indication. And I think what’s really interesting here is to look at the action of governments and we’re seeing governments around the world all coming out with their own digital policies. They all realise that actually it’s a very important social issue because if you have, for example, rural communities not c

onnected to the internet. So that will mean that those communities that are likely to fall behind economically as well as socially, you know, whether it’s access to online education, banking systems, et cetera, it can have a real impact on people without that connectivity. So yes, we’re seeing governments legislate to ensure digital infrastructure is available to everybody. And this is really as a result of what we’ve seen in the pandemic and how important it’s. So we really think that demand will continue to be exceptionally strong for all forms of digital infrastructure.

CS: And how does the sort of raft of new technology, you know, the likes of 5G, Internet of Things, artificial intelligence, and the Metaverse impact digital infrastructure.

TW: Yeah, I mean, they are all key drivers with regard to the demand for digital infrastructure. So if we just think about 5G as an example, so really in the West, we are moving from 4G to 5G really at the moment, 4G is at its capacity. And as an example of this, if you ever go to, I dunno, sports event or a concert somewhere where there’s a really high concentration of people and you try and send a text message or make a mobile phone call, you might find it doesn’t work. And that’s because it’s a great example of just too many people trying to use the 4G network. 

Whereas when we move to 5G, those sorts of issues won’t happen. It has far greater capacity to move information a lot faster. So we are really upgrading our information or our networks here in the West from 4G to 5G, that’s gonna lead to more equipment needing to go on macro towers, more data going through data centers, as well as through the fiber optic cable. And that’s just one element of this technological chain, again, thinking about cloud computing, artificial intelligence, it’s just gonna mean that more data is processed and you therefore will need more of the infrastructure to push that information around. And so, you know, we are one of the reasons why we’re so optimistic about this fund is because these structural changes going on with regard to digital communication are really moving very quickly. 

And then the Metaverse is obviously something that’s sort of, you know, been spoken about a little bit more recently. Again, that’s just gonna put far more pressure on more information going through these fixed pieces of infrastructure, which will then hopefully give pricing power to the owners of that infrastructure. And that’s what we think is very interesting, particularly as we maybe move into a more inflationary environment, pricing power is gonna be key

CS: And just looking at the portfolio in a bit more detail. Could you maybe talk about some of the opportunities you’re finding today and is there a particular subsector or region that you’re particularly interested in?

TW: Yeah, so I think with digital infrastructure, what we find is if you like, kind of, you’ve got the haves and the have nots is almost how we categorise it. 

So the haves, I would sort of refer to, you know, the Western countries, developed countries and that’s, as I mentioned, we are moving from 4G to 5G. So we’ve already got, you know, good digital infrastructure, but we need to upgrade it. We need to continue to, you know, be able to improve our user experience, you know, download a lot quicker, online gaming with low latency, you know, things like that, which will really, you know lead to sort of upgrades in the user experience. 

The have nots is really more emerging markets, less developed countries where they might only be a 2G or 3G level. So, you know, far behind thinking about upgrading their network to 5G, they won’t have as many data centers or macro towers as we have. So that communication, that ability to access the internet is much more limited. 

As an example, if you think about the US population, about 300 million people, they’ve got about 2,500 data centers across the US. India population of about 1.6 billion people, they’ve got about 127 data centers across that country. So you can start to get a feeling for how much more they need to build out. And so, as a consequence, we’re actually relatively evenly balanced in the portfolio you between developed markets and then the less developed markets, because we think that there’s equal opportunity in both parts of the world, but just with very different sort of demand drivers. One is upgrading the network and the other is actually building out that network. So we have very interesting opportunities from, you know, developed countries like the US as well as the emerging countries, whether it Indonesia, Nigeria, South Africa as a few examples of exposures we have in the portfolio

CS: I wanted to touch on one part of the world now, which is Japan, where the prime minister has included digital investments as one of the four pillars of his growth strategy and wants to create a digital garden city nation that involves things like drone delivery, autonomous driving, and super high of digital services. Are you investing in anything like or not

TW: Yeah. I mean, all of the elements of whether it’s sort of moving to sort of smart city trying to upgrade, you know, the digital infrastructure across the country, it’s gonna benefit our fund because really what you’re looking at there is more demand being placed on the existing digital infrastructure, for example, delivery of autonomous parcels, whatever it might be as well as there will then need more to be infrastructure to be built out to provide that service of across the country. Now, the interesting thing about the Japan policy that the prime minister has come out with is that actually the first step of that is actually more about connecting the rural communities. And that, again comes back to this point about social inclusion. It’s very clear that without that, you know, high quality digital infrastructure in the rural communities, they are gonna be left behind.

And so, you know, he’s looking at potentially bringing in robots to help take elderly people from rural communities, into doctors and hospitals, which to be in more urban locations. So again, it’s really interesting and it plays to every element of what we are trying to own in the digital infrastructure fund. You know, the towers, the fiber object cable, the data center, all of those assets will be processing those autonomous vehicles as they move around and deliver someone from one part of the car to another.

CS: All of these things we’ve discussed clearly require a huge amount of power. How does sustainability fit into digital structure?

TW: Yeah. Sustainability is a really interesting subject. And I think that when you think about a data center, you know, people often think of the negative and they think of maybe the pictures they might have seen of Bitcoin miners with, you know, huge racks of servers using huge amounts of power. That is absolutely not what we are investing in sustainability actually is very interesting when it comes to some of the companies that we’re investing in. 

So as an example about sort of a decade, you would read reports saying that digital infrastructure is gonna use between 5% or 10% of the world’s energy. And at that point in time, it was using about 1.1% of the world’s energy. So people were quite concerned the direction, this was gonna go fast forward, you know, 12 or so years later, 2022 digital infrastructure is still using about 1.1% of the world’s energy.

It has not grown as fast as people thought. And that is over the last 12 years when clearly traffic loads on the internet, the amount of data being processed has grown exponentially. So really, so how is this possible? How this is possible is because companies, you know, the best operators are using things like artificial intelligence to help optimise the energy needs of data centers or macro towers, digital infrastructure at its heart is about sharing resource and optimising that energy efficiency. And so, you know, we think that over the last 10 or 12 years, about 80% of energy loss has been eliminated from the process such as the improvement in things like servers and then heating techniques or cooling techniques in data centers. So again, we’ve got companies in our portfolio for instance, that have their own solar farms use their own renewable power to help, you know provide the energy for the data centers that they own. So it is, you know, again, I just want people to ensure that they’re not just focusing on that headline. It’s very easy for us to find interesting sustainable companies in this area.

CS: Do you think it’s just the tip of the iceberg on the sustainable side, do you think there’s sort of far more to move into, is it still early stage?

TW: Yeah, very much so. It’s very early stage because what you can see in digital infrastructure and it’s similar in the real estate world is that there’s clear leaders in this space. You know, one of the companies in our portfolio, they’ve got, you know, I mentioned a moment in ago, they’ve actually got their own solar farm in the Nevada desert. They’re targeting, you know, one Gigot of solar power, which is gonna, you know, gonna provide energy for the equivalent about 750,000 homes. So they would be best in class. 

And then there are other data center owners who have no sustainability policy. So we have, you know, clear leaders and clear, you know, laggards, a like, but over time, it’s very clear that all the demand for people who want to have their servers in data centers or use the macro towers, they’re gonna be pushing the landlords to use sustainable power. So, yes, I think we are in the very early days of this sector really becoming, you know, much more sustainable than it currently is today.

CS: Okay. And last couple of questions, firstly, what’s your most interesting sort of couple of holdings or ones that you could leave, could affect the most change?

TW: Yeah. So it’s a little bit like asking me to say, which of my children is favourite. And it’s sort of, you know, I have to give the political answer. I don’t have a favourite child and I don’t have a favourite holding. I think each of them are actually very interesting. So I mentioned earlier, we’ve got this holding it’s called Switch Data Centers. They’ve got their own solar farm in the Nevada desert. That for me is a really interesting company because they are absolutely pushing the boundaries of sustainability, a hundred percent renewable power. They have a partnership with Tesla so that, you know, when the sun’s not shining at nighttime, they have stored that energy on a battery that can then power the data center. I think that they’re really quite groundbreaking and that’s on the sustainability side. 

And then if I move over to, for example, a company called Helios, which is in our portfolio, which owns towers across countries in Africa, I think from the social side of things, this company can make a huge impact, you know, providing connect to rural communities, giving people access to online education banking systems, for example, is gonna have a massive impact on particular locations.

And so, you know, each company is actually making its own impact and I think actually every investment we’ve got in this fund, we are looking to identify key sustainability crisis criteria before we invest. We want each investment to be making an impact either on the environmental or the social or the governance side of things. And we’re able to achieve that. We think we’ve got an investment universe of just over 300 companies, again, both in the developed and the less developed countries. So each, each company really is quite interesting. And I could bore you for hours with each one, but there’s just two you for you.

CS: I’m gonna follow up quickly on that. I was just going to ask about the investment universe. You mentioned 300 companies, you mentioned a lot of themes and a lot of regions, how quickly is this universe growing? And will you have to sort of expand your research perhaps in the future to sort of keep up with it?

TW: Yeah. So we first sort of came up with this fund idea about two years ago. And, you know, we went to sort of our, you know, the powers that be showed us to say, this is our idea. And here we are two years later having launched the fund. When we first started talking about it, we thought we had about 200 companies to invest in. And then, you know, two years later, that’s now about 326 companies. So it’s grown. What’s interesting is that probably last year, the financial markets have obviously calm down a little bit in this risk off environment with obviously what’s going on in Ukraine at the moment. But last year, I would say we were meeting two to three companies each month, either looking to raise equity, to take advantage of the, you know, positions they have in their respective countries or new companies looking to come in IPO.

And I think, again, you know, there is a huge demand for digital infrastructure know every, you know, I don’t really need to explain it to people anymore. The pandemic has proved that. And so we expect this space to continue to grow as our needs, as individuals, companies or society grow, we are gonna need more digital infrastructure. It’s clear that we are really at the capacity of what’s possible with our existing infrastructure and it’s gonna need to be upgraded. So yes, we’re expecting it to grow quite dramatically over the next few years.

CS: And just last as another follow up, do you find that the sort of develop emerging markets, are you expecting this sort of stronger growth to come from emerging a bit further down the line and more focused developed now? Or is it very much hand in hand?

TW: Yeah, it’s hard to differentiate. I think that probably from an earnings growth perspective, some of the emerging markets do have stronger earnings growth, but clearly you are taking on different types of risk as you move into those markets. So we’ve gotta be very cognisant of that. And I think what the portfolio has is a really nice balance between the resilient compounding very high quality companies in markets like America or the UK, or, you know, France or Germany combined with some of the higher growth investments that we’ve got in places, as I mentioned, like Nigeria or Indonesia. So it’s a nice diversified portfolio across both aspects of the opportunities set.

CS: That’s great, Tom, thanks very much for joining us today.

TW: Great. Thanks for having me.

SW: It’s hard to argue against the logic of this fund. Our demand for data is insatiable and this will require ever more digital infrastructure. Yet, our digital infrastructure is way behind where it needs to be. As we’ve touched on, this gives the managers opportunities in both emerging and developed markets. To learn more about the Schroder Digital Infrastructure fund visit fundcalibre.com – and don’t forget to subscribe to the Investing on the go podcast, available wherever you get your podcasts. 

Please remember, we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at the time of listening. Elite Ratings are based on FundCalibre’s research methodology and are the opinion of FundCalibre’s research team only.