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Investing in stocks or sectors that “play on” other sectors or themes in the market is a long-standing investment practice.
Some examples are investing in:
• Oil and gas drilling services companies instead of directly investing in oil and gas exploration companies, as a play on increasing long-term demand for oil and gas
• Gold miners rather than physical gold or gold contracts, as a play on gold demand
• Global consumer brands, as a play on the development of a middle class in emerging markets instead of directly investing in those countries
Such investments have fundamentals and risks distinct from those of the related sector but can sometimes offer a less volatile—and perhaps overlooked—exposure to potential investment themes.
A ubiquitous feature of modern society is strong, growing demand for digital technology. Even before the advent of artificial intelligence (AI)—which shows signs of turbocharging that demand—there were other themes, like fifth-generation cellular (“5G”), big data, and the Internet of Things.1
And coming along for the ride has been digital infrastructure.
Digital infrastructure comprises three main subsectors: towers, fibre optics, and data centres.
Communication towers have existed since the advent of cellular telephony in the 1980s. The digital infrastructure comprises the towers themselves, their power supply, and connection to physical networks, but not the cellular equipment installed on them.
Fibre optics digital infrastructure includes the cables, but also the ability to install and maintain the (underground) conduits and the connection to the user interface.
Data centres are the newest subsector. Key features include security, power, cooling equipment, and location—a variable tied to “latency,” or how quickly changes in data need to be applied by the end user.
Like a utility—in society and in portfolios
Digital infrastructure has earned the moniker, “the fourth utility,” as it shares both functional and investment characteristics with sectors more traditionally understood as utilities, like electricity, water, and home heating gas.
As with those services, access to affordable digital technology is seen as part of a basic standard of living in modern society.
“Today, it’s an essential part of our everyday lives as both individuals and enterprises,” said David Xu, a Senior Director in Private Infrastructure at CBRE Investment Management. “It enables and connects us to work, education, and entertainment.”
From an investment perspective, digital infrastructure, like traditional utilities, comprises long-lived physical assets requiring large upfront capital investments. The upfront costs and long return horizons make private equity funds and large institutional investors among the main investors in digital infrastructure, although there are listed equities and specialized real estate investment trusts (REITs) offering retail investors direct, focused exposure (along with market beta, though).
Digital infrastructure offers steady, predictable income streams and risk-adjusted yields. Revenues are typically supported by contracts with customers underpinned by the strong market demand dynamics for the physical digital assets.
Strong growth forecasted
Tied as it is to the rapid spread of digital technology in society, digital infrastructure has seen—and is expected to continue seeing—rapid growth in demand. While certainly driven in part by the anomaly that was the COVID-19 pandemic, global data volumes are forecast to show a compound annual growth rate of more than 20 percent in the five years through 2025.2
Government investment is driving some of the demand. In the U.S., for example, the federal government is providing grants worth a total of U.S.$65 billion to support nation-wide high-speed broadband connectivity.3
Last year, McKinsey forecasted a need for more than U.S.$300 billion in investments just in data centres by 2030, a figure that has likely risen with the advent of AI.4
“Every single infrastructure manager with a focus on data centres that we talk to now says they’re going flat out to keep up with demand,” says Sebastian Nicholson, a Principal in Infrastructure Investments at Nicola Wealth Management Ltd.
Fibre’s unique characteristics
Fibre’s customer risk profile is different from that of towers and data centres, which usually depend on one or a handful of large enterprises. Fibre network users comprise thousands of individual enterprises and households, making the demand profile more akin to that of traditional utilities.
Fibre is also more affected by variable permitting approaches. Some countries, like France and New Zealand, grant fibre network monopolies where the regulatory authority sets the price. Other markets, like the U.S and Germany, have allowed competition between network installers. In those markets, seeing the success of some first-starter private fibre optic infrastructure funds, other investors have followed—sometimes even where there is an already-installed network—and run into trouble when penetration targets weren’t met.
Fibre network regulation in Canada reflects an oligopolistic industry. The Canadian Radio-television and Telecommunications Commission (CRTC) recently ruled that large operators like Bell Canada Enterprises (BCE) Inc. must allow smaller competitors access to their fibre networks. BCE Inc. is appealing the ruling.
Location is a variable with digital infrastructure. Access to property where the necessary permitting is in place (and favourable) is an advantage. Nearby data network hubs and sufficient power supplies are also key.
Latency requirements are a location driver for data centres. Uses requiring low latency, like streaming or responding to ChatGPT requests, are “edge computing” uses that typically need to be close to large population centres. Data centres focused on other uses, like running algorithms to train large language models, can be in more remote—and potentially cheaper—locations.
Energy-related sustainability risks
Data centres have received attention for their enormous power and water demands, both to run and to cool the massive banks of computers. This demand has coincided with strong demand growth related to the electrification of heating and transport. Extreme temperatures and prolonged drought in many jurisdictions worldwide are raising flags about potential water (and power) rationing to sectors like information technology.
McKinsey estimated that power consumption by U.S. data centres will more than double from 17 gigawatts in 2022 to 35 gigawatts by 2030. One data centre can consume as much power as 80,000 households.5 Generating just one image using an AI model can draw as much energy as fully charging a smartphone, some scientists estimate.6 Data released by Google in 2022 showed its data centres consumed an average 1.7 million litres of water per day in 2021.7
“Many of us enjoy this intense data consumption, but in the hierarchy of needs, water for human consumption is more important, so there is a risk at some point,” Nicholson says.
Both Xu and Nicholson believe the ongoing growth in demand for computing and data storage will remain strongly supportive macro trends for the sector for the foreseeable future. The main concern for investors will be to partner with managers with a good understanding of the risks.
“From an investment perspective, it always comes down to the specific characteristics of the company you’re investing in,” Nicholson says. “If you don’t have a manager that understands the risks, you can get into trouble, and that’s true whether you’re investing in a new-economy play like digital infrastructure or something more traditional.”
1 The “Internet of Things” refers to the interconnection via the internet of computing devices embedded in everyday objects, enabling them to send and receive data.
7 Roundy, Jacob. “How to Manage Data Center Water Usage Sustainably.” TechTarget, January 17, 2024.
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