Infrastructure is now broadly accepted as an asset class in its own right. The market certainly has scale – Deutsche Bank has recently estimated the size of the global infrastructure market at around $20.5trn.
This has ensured institutional investors have over the last decade or so piled into the sector, attracted primarily by the long duration, predictable cashflow and built-in inflation protection generally associated with mature infrastructure assets, as well as by the risk diversification available for larger investors in a market of such overall size.
In the UK, the generic term ‘infrastructure’ tends to cover three basic asset types:
- Essential public sector assets, such as government accommodation (eg. prisons, courts and offices), hospitals and schools, which tend to have pre-determined revenues payable generally by public sector bodies (eg. NHS Trusts in the case of hospitals, local authorities in the case of schools);
- Power, gas transmission, water, waste, etc, where revenues may be affected by price regulation and are payable for example by regulated utilities; and
- Roads, airports, ports, railways, etc, where revenues tend to depend upon usage and may be exposed to competition, and may be payable by a wide variety of private sector entities.
The risk profile of investments in the above asset types clearly differs markedly from type to type, and within the individual asset types. Moreover, the risk profile of an infrastructure investment will change over time – in particular before and after practical completion and acceptance of the relevant asset.
At what is generally perceived to be the most secure end of the infrastructure investment spectrum in the UK is the private finance initiative (PFI). PFI provides the UK Government with a way of funding major infrastructure investments without immediate use of public funds.
Project companies are contracted by the public sector to design, finance, build and manage new projects. Management contracts typically last for 30 years.
Around 800 PFI projects with a capital value of approximately £45bn have been contracted to date since the inception of the PFI in the UK in 1994. Almost 40% of all projects by value have been in the health and education sectors.
Investments in PFI transactions thus provide secure, generally public-sector-backed, predictable returns to the project company and its lenders. The assets involved are typically key to the community, and the risk of default is considered to be extremely low as the client in each case is usually a quasi-government entity.
Generally, a project company will fund an infrastructure project’s initial costs, including the construction of the asset, through a mixture of:
(i) long-term senior debt contributed by banks or through the issue of bonds, and
(ii) equity and subordinated debt contributed by the financial investors and consortium members in the project company.
The cashflow payable to the project company under the terms of the project agreement during the operational phase is used to service senior debt first, then subordinated debt, with the surplus paid to equity.
Once an infrastructure asset is constructed and accepted by the client, and the contracted cashflow commences, many of the risks associated with the project are significantly reduced.
The recent reduction in the availability of debt from banks to finance PFI projects has given rise to significant unsatisfied demand for capital from project companies. This demand has resulted in more generous pricing on both equity and debt investments than has historically been seen in the infrastructure sector.
Thus investments in PFI and similar infrastructure contracts in many cases currently present a highly attractive yet relatively secure investment opportunity. Given that payments under many PFI contracts are linked to the Retail Prices Index, such investments will in many cases yield at least partially inflation-protected returns.
The UK Government certainly appears to appreciate the importance of infrastructure investment as an economic driver in a downturn. In March 2009, the Treasury confirmed its willingness to help support the £13bn PFI projects currently in the procurement process, including £2.4bn for schools and £3.5bn in waste and environmental projects, thus safeguarding jobs in the current recession and providing critical infrastructure for local communities in preparation for economic recovery. Nevertheless, in light of the strained state of the UK Government’s balance sheet and the ongoing requirement for major public infrastructure projects, there is clearly a huge role for private investment in infrastructure generally, and PFI in particular. In addition, the reduction in the availability of bank funding and the effective closure of the bond markets means that such private investment is most likely to come increasingly from specialist infrastructure funds.
Larger institutional investors can generate exposure to the sector in a variety of ways – primarily via direct investment in individual projects, via listed infrastructure funds, and through unlisted infrastructure funds. Until recently, the opportunities for retail investment in the sector have been relatively limited. However, there are now a number of funds offering relatively broad-based exposure to the infrastructure sector for retail investors. 3i Infrastructure plc invests widely across all infrastructure sectors in Europe and North America, International Public Partnerships focuses on Europe and Australia, while HSBC Infrastructure Company and GCP Infrastructure fund are focused rather more narrowly on the most risk-averse end of the investment spectrum, being mature UK PFI investments.
In brief, an investment in the infrastructure sector can offer the following features, which potentially compare favourably with an investment in other asset classes such as non-infrastructure equities, non-infrastructure debt and real estate:
- relatively high, partially inflation-protected, predictable yields for long periods;
- access to long-term cash flows typically payable by counterparties with strong credit quality;
- low volatility returns, given that, in general, the main risks to cashflows can be quantified and mitigated; and
- low volatility, given that income and costs are generally contractually predetermined in the long term.
Stephen Ellis, partner, Gravis Capital Partners
