Infrastructure

Transcript

Economic infrastructure assets include roads, ports, railroads, airports, electric grids, water systems, data centers, cell towers, renewable energy, energy storage, and pipelines.  Social infrastructure assets include schools, hospitals, and housing.

There are a number of beneficial qualities of investing in infrastructure. They are relatively rare assets and might have monopolistic characteristics with cash flows that may be contractually correlated to inflation.  Infrastructure assets have equity-like returns with relatively low drawdowns.  Infrastructure investments tend to have more regular cash flows than private equity or venture capital and less economic cyclicality than real estate investments.  The low cyclicality of infrastructure assets comes from the monopoly nature of the assets, which are relatively immune to competition.  A consumer’s demand for water, electricity, or heat is likely more correlated to changes in weather than stock prices or consumer confidence.

Infrastructure has gained the vast majority of real asset allocations over the last 10 years. This could be due to its attractive historical profile of high returns, a high correlation to inflation, and a low correlation to stocks and bonds.  The revenues to many infrastructure assets are inflation-linked, where customer contracts or government regulators explicitly allow prices to increase at the rate of inflation.

Infrastructure investments may be structured similarly to a private equity drawdown fund.  This fund structure is illiquid, with periodic appraisals leading to relatively low return volatility. Infrastructure assets can be compared to real estate, as both investments own hard assets that generate substantial cash flow. Infrastructure assets can also be compared to private equity, where the profitability of the asset may be improved with superior management and upgrades to facility quality and efficiency. The cash flows from infrastructure assets tend to be much more regular than those of private equity, which relies on the sale of portfolio companies to distribute cash to investors.

Many infrastructure assets can be accessed in the public equity markets, including utilities, railroads, renewable energy, and pipeline stocks, or MLPs.  Investors wanting to access infrastructure assets such as roads, airports, and seaports will need to invest in private equity infrastructure funds.  Investors in infrastructure debt lend money to owners or operators of infrastructure assets.

While infrastructure investments tend to be lower risk than most public or private equity investments, there are a number of influences on the risk of infrastructure investments. Infrastructure investments can range from low risk to high risk depending on the structure of the project and the investment vehicle.

Infrastructure debt investments tend to be lower risk, as investors are lending to operators or owners of infrastructure assets, with the loans typically secured by assets or cash flows of the projects.

Similar to real estate, core and core-plus infrastructure equity investments tend to be lower risk, while value-added and opportunistic investments tend to be higher risk.

Core assets are focused on currently operating monopolistic assets in developed markets with low degrees of leverage. You’re buying the electric grid, the water grid, the airport, and the seaport that is already operating. There’s no competing asset within a close geography.  These assets are in the G10 developed markets where there is a rule of law and strong contracts.  Core infrastructure assets are financed with low degrees of leverage.

Core-plus infrastructure assets are also focused on currently operating assets with a history of stable cash flows.  While core infrastructure investments tend to be in monopolistic assets, many core-plus investments are in assets that may have competition.  This includes assets such as schools, hospitals, workforce housing, and cell towers, among others. Core-plus funds might also invest in monopolistic assets, but do so at higher levels of leverage than core funds.

Value-added strategies seek to purchase undervalued assets and increase their value through expansion or operational improvements. An infrastructure fund might purchase an airport with low passenger growth due to its inefficiencies and a location that is difficult to access. After adding access to the airport by a new light rail route and improving efficiencies, the airport may become preferred over the larger international airports in the area. As the cash flows of the project improve, investors can benefit from an increased valuation of the asset.

Opportunistic infrastructure investments can be extraordinarily high risk. Many opportunistic investors seek to develop new infrastructure assets in greenfield projects.  Developers of new infrastructure assets take the risk of cost overruns, development delays, and environmental damages, as well as the uncertainty of the cash flows that the project will generate once it has been completed.  Investments in emerging markets may be categorized as opportunistic due to sovereign risk and currency risks.

Some opportunistic infrastructure investors may work in partnership with a governmental entity.  Perhaps the governmental entity will take the risk of delays and cost overruns, while the infrastructure operator agrees to purchase or operate the asset once it is operational.  This allows the government to build new infrastructure for its economy while recycling the proceeds of prior projects to invest in further new infrastructure projects.

Real estate investors may find it relatively easy to be a direct investor, simply purchasing a property and hiring a local manager to lease and maintain it.  Due to the capital-intensive nature and operational complexity of infrastructure investments, there is less of a tendency for institutional investors to be direct equity investors in infrastructure assets.