For the consumer, all infrastructure assets appear to be one and the same thing: a school, toll road and sewage system all provide essential public services. But for the investor, there are fundamental differences broadly determined by the nature and security of underlying revenue streams.
The differences between availability-based or regulated revenue and demand-based revenue generates significant variation in the risk-return characteristics of the infrastructure assets we typically view as homogenous.
The former are those core infrastructure assets – like most publicly-procured schools, hospitals and public buildings – that are government-backed. The same can be said for assets that are backed by businesses operating under a regulatory regime, like most offshore energy transmission, and domestic gas distribution.
This contrasts with demand-based assets, assets like toll roads or newer renewables technologies, which rely solely on people paying to use the service or the vagaries of power prices. Whilst demand-based assets may provide the potential for enhanced returns, availability-based asset revenues are predictable, uncorrelated to GDP, and bound by government procurement or regulatory reviews which are typically around five to eight years.
Investment risk can therefore be determined by the reliability and predictability of each asset’s revenue generation, which in turn impacts the sustainability of an entire portfolio’s ultimate dividend payout.
An investment trust portfolio with a majority allocation to availability-based or regulated infrastructure assets provide guarantees in doing exactly what it says on the tin: a low-risk, long-term, secure and sustainable source of income shielded from GDP contraction.
There are a number of compelling reasons for investing in infrastructure in the current environment. Inflation is at its highest level in four years, and investors are increasingly looking for ways to protect and grow capital.
But trying to do so in an investment environment characterised by persistently low bond returns and uncertainty over the future of a bull market in equities is increasingly difficult. Listed investment companies investing in infrastructure are some of the only bright spots for generating opportunities for real income.
Owing to the lack of association with the broader market and the concession arrangements secured under the terms of the long-term asset life cycle itself, those portfolios weighted to availability-based or regulated assets provide a higher positive correlation to inflation. As far as International Public Partnerships is concerned, for every 1 per cent increase in the assumed inflation rate, the net asset portfolio value investors will benefit from is 0.89 per cent.
In the UK alone, the Government has identified the need for £300bn in investment to finance the country’s infrastructure deficit between now and 2021. This presents a significant opportunity for investors and irrespective of political persuasion, the UK is clear that the private sector must help finance a significant part of the ever-increasing demand for capital to build our schools and hospitals, to transmit our energy, protect us from floods and remove our sewage.
This demand for private sector investment is consistent across developed, OECD markets including in North America where, irrespective of whether the touted infrastructure spending boom materialises, the pipeline remains strong.
Public private partnerships, or PPP, has traditionally formed the bedrock of pipeline generation. Those investment fund companies with the necessary experience to procure assets in the primary market benefit by accessing investment opportunities on a preferential basis.
By purchasing assets either off-market or structuring them directly with government/public entities, those who have an experienced investment adviser – with a network of established relationships and niche, sector-specific expertise to boot – can avoid competitive pricing in the secondary market. This competition is becoming ever-increasing, but through primary origination, investment fund companies can avoid paying high premiums for assets.
Accessing direct infrastructure
With any investment in illiquid assets, the benefit of using investment trusts to access infrastructure comes with their liquidity profile. As close-ended funds issue a finite number of shares which are bought and sold on the stock market, there is no impact on the liquidity of the underlying portfolio. This in turn provides more freedom to take long-term positions without being concerned about having to divest assets during market sell-offs.
Infrastructure investment is defined by this long-term approach, and the security and sustainability of the asset class should not be mistaken for an illiquid investment opportunity devoid of capital growth. In particular, those investment fund companies with exposure to construction risk can provide uplift in portfolio returns, as the value of corresponding construction assets move through into operation.
Giles Frost is chief executive of Amber Infrastructure Limited, the investment advisers to International Public Partnerships (INPP)