NBK Wealth Thought Leadership: The Role and Importance of Digital Infrastructure in Today's World

Introduction:

Digital and traditional infrastructure play complementary roles in our economies, both essential for ensuring seamless and efficient operations. Traditional infrastructure, encompassing roads, bridges, power grids, and water supply networks, provides the physical connectivity and resources fundamental for daily life. Digital infrastructure, on the other hand, comprises the technologies that support digital services, such as data centers, cloud computing, edge computing and networks, enabling the seamless flow of information. 

Digital infrastructure, comprising both physical hardware and software technologies, enables the delivery of digital services and applications. Its main objective is to facilitate seamless data sharing for use and consumption.

As a critical enabler of digital transformation, it provides the foundational support to adopt and integrate advanced technologies. By facilitating the seamless flow of data, digital infrastructure enhances efficiency and enables scalability, both of which are crucial for adapting to evolving market demands and fostering growth.

The Digital Revolution Reshapes Infrastructure Investing

Investors have recognized the utility-like characteristics of the digital infrastructure asset class, leveraging on its capacity to generate robust and stable cash flows, which are linked to its essential nature and the growing demand for digital services. As it serves as an inflation hedge, and provides diversification due to its low correlation with public markets, making it a valuable component of a balanced investment portfolio that aims to maximize returns while mitigating risk. The COVID-19 pandemic has accentuated the resilience of the asset class, emphasizing its role and importance in a diversified portfolio especially during unfavorable market conditions, further solidifying its value proposition for investors seeking long-term, stable growth.

Investment in digital infrastructure has grown significantly within the private infrastructure industry. Driven by growing economic changes, the accelerating shifts towards digitization, and the increasing demand for AI, investors are capitalizing on the ongoing digital revolution, positioning themselves for strong, long-term returns. Digital infrastructure is being recognized as a resilient asset class with strong future potential.

The COVID-19 pandemic served as a major catalyst, accelerating the rise in remote work, e-commerce, and video streaming. This surge in demand highlighted digital infrastructure’s crucial role and its countercyclical, inflation-hedging characteristics, further fueling investor interest.  Consequently, in 2023, fundraising in the digital infrastructure sector reached $63.4 billion, with $3.5 billion specifically channeled into specialist vehicles dedicated to the rapidly evolving digital infrastructure space.

Fundraising by investment vehicles focused on investing in digital infrastructure ^{(*)Source: PitchBook - Geography: Global - As of December 31, 2023}

Notes:

^(*) The universe of digital infrastructure funds contains generalist funds, which invest in digital infrastructure alongside other infrastructure or real estate sectors, and specialist funds, which exclusively or almost exclusively invest in digital infrastructure.

Risk and Return Profile of Digital Infrastructure Investments

The risk-return spectrum of digital infrastructure mirrors that of traditional infrastructure, spanning from core (low-risk, stable returns) to value-add (higher-risk, higher-return opportunities). The levels of risk and return in digital infrastructure depend on factors such as the type of assets, investment strategy, and rapid technological advancements.

This spectrum gives investors the flexibility to select assets and strategies that align with their specific investment goals and risk tolerance. While longer contracts offer stability and predictable cash flows, they also present certain drawbacks. To balance risk and reward in this fast-evolving space, investors must address challenges like technological obsolescence, cybersecurity threats, regulatory changes, and rapid market shifts.

Key Challenges and Considerations

As more devices and systems become interconnected, ensuring robust cybersecurity measures and protecting user privacy is paramount.  Digital infrastructure must be scalable and flexible to keep up with evolving technology trends, to avoid obsolescence, constant upgrades and costly hardware investments. Additionally, some types of digital infrastructure consume substantial energy, making it challenging and costly to balance high energy demands with sustainable practices.

The Future of Digital Infrastructure

While digital infrastructure has become an established asset class, it is still relatively early in its development compared to more traditional infrastructure sectors like transportation or utilities. This means that while the sector offers substantial growth potential, it also comes with the uncertainties and risks associated with emerging markets. The rapid pace of technological advancements, the increasing demand for data, and the growth of emerging technologies like 5G, AI, and cloud computing continue to shape and expand the digital infrastructure sector. These technologies are not just driving demand but are also creating new investment opportunities.

As demand for digital infrastructure grows, there will be increasing pressure to make it more sustainable, as most digital infrastructure assets consume significant energy, impacting sustainability. The future of digital infrastructure will rely on adopting sustainable practices, with a focus on energy efficiency, and smart technologies to reduce environmental impact and support long-term growth. This includes innovations like liquid cooling for data centers, the use of AI to optimize energy consumption, and the development of greener construction materials.

Digital infrastructure remains in a phase of rapid evolution and growth, with significant opportunities and challenges ahead.

Key takeaways

• Digital Infrastructure is foundational to the modern world: Digital Infrastructure is essential for global connectivity, business operations, and economic stability.
• Private investment in digital infrastructure is surging: Investing in digital infrastructure has grown significantly within the private infrastructure industry.
• Digital infrastructure offers compelling financial benefits: Digital infrastructure generates robust and stable cash flows, serves as inflation hedge, and provides diversification due to its low correlation with public markets.
• Resilience is a key feature of digital infrastructure: Digital infrastructure is essential for ensuring stability, it helps minimize the effects of disruptions especially during global crises like pandemics.
•  Sustainability is crucial for the future of the sector: The future of digital infrastructure will rely on adopting sustainable practices, to reduce environmental impact and support long-term growth.