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Infrastructure is no longer just airports and gas pipelines
THINK about infrastructure, and you might picture a yawn-inducing mix of power plants, gas pipelines, water treatment plants, airports, railways and toll roads.
These facilities, after all, provide essential services to the economy. Yet they are not the only types of infrastructure assets out there.
Today, the infrastructure asset class is being redefined by digitalisation, urbanisation, and an ageing society. The "toll roads" of the future will be fibre networks transporting not cars, but high-speed data.
Data storage locations will be as essential to daily life as power plants.
As societies age, managed living facilities will grow in importance. And as societies go green, renewable energy will play a bigger role.
Trends like digitalisation, along with other factors, have thrust infrastructure investing back in the spotlight for both institutional and private investors. Decades of neglect and inadequate funding have resulted in a massive funding gap which can be closed only by increased cooperation between the public and private sectors.
Global infrastructure investment needs are expected to reach US$57 trillion from 2012 to 2030, a 60 per cent increase over the 1994-to-2012 period.
A report from the Organisation for Economic Co-operation and Development (OECD) shows that infrastructure investment has fallen from 4.5 per cent of gross domestic product during the1980s to only 3.1 per cent in 2015.
The need for infrastructure is frequently cited in headlines. Infrastructure investment is brandished as a policy tool by governments globally to create more jobs and stimulate the economy.
Yet with high public debt levels and a broad-based resistance to higher taxes, governments are turning to other investors to bridge the gap.
While infrastructure assets have long been the preserve of pension funds, sovereign wealth funds and insurance companies, private investors are increasingly taking notice.
After all, infrastructure is defensive in nature due to the underlying assets providing essential services. This can result in attractive and more predictable cash flows.
Rates are often determined by regulators and settled through concession agreements with governments. These agreements are long term in nature, with rates that can increase with economic growth or inflation.
The benefits do not end here. Infrastructure has also historically demonstrated an almost zero correlation to equities and to other asset classes.
Yet infrastructure investing is not without risks.
Assets are often illiquid because projects can be sizeable, take a long time to develop, and are unique. Regulations can place limits on the number of potential buyers. There are also political and legal risks for investors venturing into regions without an established regulatory framework.
An infrastructure fund should also be evaluated for its reliance on leverage as well as for its asset mix.
A fund might be involved in a number of greenfield, early-stage developments. These projects carry design and build risks, and may not generate cash flow until they are completed.
Greenfield projects can stretch over many years, and are subject to cost overruns or regulatory changes.
Depending on one's risk appetite and tolerance for illiquidity, one can invest in a variety of different infrastructure assets through vehicles like funds.
But one trend is worth noting. Large institutions like sovereign wealth funds and pension funds are making direct investments in the infrastructure space, often driving up valuations and depressing yields.
Investors seeking slightly more robust returns might want to evaluate infrastructure managers focusing on the middle-market space.
There, funds buy individual assets in the US$100 million to US$500 million range, as opposed to the billions.
This segment of the market is less efficient, hence the higher return opportunities.
By avoiding the larger multi-billion dollar deals, middle-market transactions benefit from the less competitive bidding environment. Investors are also in a better position to exert more control over the investment and its eventual outcome.
Meanwhile, it is interesting to note that infrastructure funds focusing on OECD markets have often outperformed their emerging market counterparts, possibly due to lower political risk.
Thus middle-market infrastructure investing might reward the investor by providing stable yields while still maintaining the potential for longer-term upside.
By partnering established managers with deep operational expertise, investors can still benefit from infrastructure assets for decades to come - from stodgy airports to the digital toll roads of the future.
- The writer is head of alternative fund solutions, Private Banking Asia Pacific, Credit Suisse