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Talking point
October 2016
Invest in the bridges of tomorrow, tomorrow
Bridges, roads, hospitals and airports are just a handful of examples of the fundamental
infrastructure that facilitates the way we live. Infrastructure projects around the world
require continued funding and investment to remain fit for purpose. But is now a good
time to invest?
Opportunity lacks
Infrastructure has many characteristics of an attractive
investment, particularly for defined benefit pension schemes (see
box “Infrastructure .…interesting in theory”). However, in recent
years we have seen investors’ appetite for infrastructure assets
rise continuously. Historically low interest rates, low inflation and
moderate economic growth in developed economies have led to a
“hunt for yield” that has driven investors towards the asset class.
The chart below shows how capital has flowed into infrastructure
funds in recent years.
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P-Solve
Comparing infrastructure with other alternative asset classes we
do not believe the level of prospective return is attractive enough
to compensate investors for the risks they face – specifically the
illiquid nature of, and the political risks involved in, infrastructure
projects (see box “…but complex”).
The need for investment in infrastructure is clear. As an example,
UK infrastructure is decades old, has been extensively used
and requires refurbishment, renewal or replacement. There is
evidence that a lack of investment into infrastructure has already
been detrimental to economic growth. In 2013 a report from the
Civil Engineering Contractors Association estimated UK GDP
could have been five percentage points a year higher between
2000 and 2010 if the UK had infrastructure of a similar standard to
other leading developed economies.
120
100
($bln)
Andrew Singh
Infrastructure investment
Infrastructure Capital Raising Since 2011
80
60
40
20
0
recently paid for London City Airport by
a Canadian pension scheme consortium
is widely regarded as excessive. This is a
trend we expect to continue for at least
a while.
2011
2012
2013
2014
2015
Q1 2016
Infrastructure…interesting in theory
Trend line
For pension schemes, infrastructure investment can have
many desirable characteristics:
Source: P-Solve and Preqin - Q1 2016 Quarterly Infrastructure Update. Figures for Q1 2016 are annualised
ƒƒ stable, long-term, inflation-linked income, which will
help pay pensioner benefits;
This flow has been so great that a large imbalance now exists
between the demand for and supply of attractive infrastructure
assets. This is particularly true for core or “brownfield”
infrastructure assets, ones that have already been constructed
and are income-generating. For example, in the UK, these are
especially sought after by investors but are extremely limited in
availability following the scaling back of the government’s Private
Finance Initiative (PFI) following losses for the taxpayer. Funds are
now holding record levels of uninvested cash as they seek to find
attractive opportunities – the total is estimated at $124bn across
unlisted funds globally at the end of March1, which represents a
fifth of all capital raised in unlisted funds over the past five years.
This imbalance has elevated prices across the asset class, and
dampened expected returns. Investment managers say the total
return available to investors in core European infrastructure
projects has steadily declined over recent years from double
digits in 2012 to around 6-7% p.a. today. As an example, the £2bn
ƒƒ diversification from traditional asset classes such as
equities and bonds; and
ƒƒ resilience to economic downturns (given the essential
nature of many infrastructure assets).
Investors can tailor their infrastructure investment to suit
their risk/return profile, as investments can be made in
project equity or in debt, and either directly or through
funds (both public and private). Moreover, the relatively
long investment timeframe needed for the majority of
infrastructure investments can act as a barrier to other
investors, but is more palatable for pension schemes with
their typically longer-term investment horizons.
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Source: Preqin - Q1 2016 Quarterly Infrastructure Update
This would have resulted in a UK GDP growth rate similar to
some emerging market economies, which in our opinion is clearly
stretched; however, we believe a material positive impact on
GDP would have been likely. Moreover, over the next 20 years the
government expectation is that the population will grow by 15%,
to 73 million, which will add to the need for infrastructure.
Crucially, though, large-scale infrastructure projects usually
involve state participation, with private investors putting in their
capital alongside. A recent example would be Hinkley Point,
where the Chinese government invested capital alongside EDF, a
private energy firm, and the UK government guaranteed prices.
In the UK, the government has said it wants to invest in
infrastructure. In 2010 it detailed a National Infrastructure Plan
setting out priority projects over the next decade. Subsequently
it published plans to encourage investment via Public Private
Partnerships, and more recently it has trumpeted a “Northern
Powerhouse” initiative. However, as the government has also
been pursuing a policy of austerity in recent years, its expenditure
has been limited and true political will has been lacking.
Future outlook
There’s no reason to expect the current situation will continue
forever. There are factors that we believe could change, resulting
in market conditions that are more supportive of an infrastructure
allocation. As there is clear demand from investors in the
market place, it boils down to a question of supply of quality
infrastructure assets which are attractive for investment.
More recently, Philip Hammond in his role as newly appointed
chancellor has spoken about government infrastructure
investment as a fiscal policy going forward, which could provide
opportunities. Something more concrete can be expected in the
Autumn Statement.
In the UK, a governmental willingness to invest significantly more
in infrastructure could stimulate a new generation of infrastructure
projects and encourage meaningful and profitable private
investment. The resulting increase in supply of infrastructure
projects could soak up the money already sitting in funds, leaving
a net demand for new capital that could push up the returns on
offer. The same dynamic will work elsewhere. Globally, the amount
of capital that could usefully be invested in new infrastructure
between now and 2030 could exceed $50 trillion, dwarfing the
$124bn of dry powder currently sitting in private funds2.
…but complex
Infrastructure is a complicated asset class. Any
infrastructure asset – a dam, for instance – includes
design, building and operating stages with differing risk
and potential return associated with each stage.
Projects can range from safer, or “core”, to higher risk
“value add” or “opportunistic”. Also infrastructure projects
often have low transparency, influenced by the specific
nature of each project and the high level of private
transactions (infrastructure is not easily traded on public
markets). Moreover, an investment in infrastructure
entails a variety of specific risks.
Illiquidity – Infrastructure is inherently illiquid, with
privately listed funds typically having 10- to 15-year terms.
There is a secondary market, but it is limited.
Leverage – The majority of infrastructure projects incur
sizeable upfront costs, with most funds employing a
degree of borrowing. Increasing costs of loan repayment
and refinancing can erode returns.
Politics – For many infrastructure projects, governments
are involved to some degree. Instability affecting
investment returns could stem from a change in
government, regulatory bodies or legislation. Additionally,
direct lucrative contracts can offer the opportunity for
bribery and corruption, and reputational damage for
investors.
Construction delays – A project may be delivered late or
over-budget, cutting investment returns.
On the demand side, more investors may come to share our
current view and turn their attention away from infrastructure,
with its high due diligence requirements and long lock-up periods,
and search for high yielding investments elsewhere. An example
would be select regions and sectors of the UK commerical property
market, such as logistics outside London and the South East.
If this shift away from infrastructure is sharp enough, it could
reduce the competitive bidding for assets and leave opportunities
for pension schemes prepared to tolerate the complexities that
infrastructure entails.
In its January 2013 paper ‘Infrastructure productivity: how to save $1 trillion a year’, management consultancy McKinsey estimated that, to keep up with
projected global GDP growth, the global economy would need to invest $57 trillion in infrastructure by 2030.
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Contact the Advisory team · [email protected] · 020 3327 5100
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