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Infrastructure assets offer long-duration cash flows that are relatively stable with low default risk. They could be ideal for many pension funds, yet infrastructure investment has suffered from confusion over what it can represent and how best to gain exposure.
While infrastructure assets offer a mixture of attractive yields and high growth, they are not homogeneous. Moreover, economic exposure can be obtained in a number of different ways, including debt, unlisted equity, listed equity, and direct ownership of infrastructure assets – each with different risk-return profiles.
Macro-economic influences vary greatly across different asset classes and, as a result, the way portfolios are constructed matters if investors wish to have stable, inflation-linked cashflows across economic cycles.
Infrastructure therefore needs a better descriptive framework to outline the universe of opportunities and the characteristics of each sub-class for investors to understand how best to incorporate elements within their investment strategies.
Europe has the best available infrastructure assets on offer with a requirement for a €2trn spend by 2020. Asia is a heterogeneous region, while the US has generally poor infrastructure assets available for private investment.
Private infrastructure debt is arguably the most obvious way to gain exposure to infrastructure. This is essentially private debt linked to projects such as hospitals, schools, roads and utilities. The debt itself tends to be investment grade and senior secured, so investors have access to real assets in the case of a default.
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Going down the equity route has led to issues over structure, with the typical private equity fund maturity of 10 years being far too low for assets with lifespans of decades.
One way around this is to invest in listed infrastructure companies. In North America, for example, there is roughly $700bn (€600bn) worth of publicly traded utilities but hardly anything like a similar amount available for investment in the private markets.
There are three key risks that investors need to be aware of, according to Heiko Schupp, global head of infrastructure investments at Columbia Threadneedle Investments.
The first is operational risk in the construction and management of infrastructure assets. Managing that is the skill of fund managers, and is essentially what investors are paying them to do.
On top of that, there are also political and regulatory risks, as all infrastructure assets have some connection with government. This risk can be mitigated to some extent by diversification and through a focus on environmental, social and corporate governance issues, which can provide a safety check on possible future problems – whether a move away from coal, or a breakdown of trust with host governments.
Finally, there are macro and economic risks. Assets such as ports and toll roads are highly correlated to GDP. By combining assets with different correlations to GDP and interest rates it is possible to have a smoother distribution of portfolio returns.
Another option for investors – instead of purchasing infrastructure debt or equity – is to purchase the asset directly. Typically, these opportunities lie in assets such as wind farms, which can be run by third parties.
Managers such as AMP Capital are more ambitious and have bought major infrastructure assets such as airports. Hywel Rees, a principal in global infrastructure equity at AMP, explains that airports are of specific interest due to their complexity.
Most infrastructure assets have just one type of customer, whereas airports have two – airlines and passengers – and their interests are often conflicting. In addition, airports can generate significant revenues from a wide range of ancillary activities including hotels, property and engineering businesses that all form part of an airport ecosystem. These activities can give an element of resilience in the face of a downturn in travelling customers.
Airports also have a wide range of stakeholders, given the impact that an airport can have on a local economy. Their success or failure is heavily dependent on a wide range of factors, from the size of the market available to them locally, to their efficiency in dealing with the turnaround of planes.
Managing airports can be a challenge and, as a result, there can be big differences between their performance, particularly when they face challenges such as bad weather.
As the debate over Heathrow’s proposed third runway recently showed, politics and vested interests can also skew decision making. Not surprisingly, AMP prefers to invest in smaller regional airports rather than major hubs like Heathrow.
For pension funds, if infrastructure is ever to be a key component of a portfolio, the challenge may be for fund managers to develop more coherent analyses of what the opportunities are, and for funds to have well-defined characteristics. The problem for pension funds with an infrastructure allocation is still deciding in which bucket to place it.