Infrastructure as Investments

Infrastructure investments can be analysed in various dimensions, as follows:-

i) Stage of development

ii) Geography

iii) Form of investment

iv) Risk/return profile

 

Infrastructure by Stage of Development

• Infrastructure investments can be categorised by the asset’s stage of development, namely greenfield and brownfield.
• Greenfield investment refers to assets that are to be constructed or under construction. The investment intention could be to hold and/or to operate the assets over the long term or for a period of time until a sale to new investors. The sale would generally command capital appreciation to reflect the development, construction and commissioning risks undertaken.
• Investing in existing infrastructure assets, on the other hand, is referred to as brownfield investment. Typically, the assets are operational, with proven operating and financial track records. Brownfield investors may include strategic investors who specialise in the operation of the underlying assets. These investments also attract financial investors who are keen to reap the anticipated long-term stable returns.

 

Infrastructure By Geography

• Infrastructure investing must also be considered from a geographical perspective, as different locations present different risks and offer varying returns.
• The geographic locations of the underlying assets will indicate the political and macroeconomic risks involved.
• Countries with similar risk profiles may be grouped into wider categories known as ‘developed markets’ and ‘emerging markets’.
• Hence, multi-jurisdiction infrastructure investing would introduce varying uncertainties as well, such as currency risk, political risk, as well as profit-repatriation risk.
• Thus, a key consideration for investors and asset managers would be to ensure that these risks are appropriately covered and managed, such as through procurement of insurances, financial instruments, and other available mechanisms.

 

Form of Infrastructure Investments

Infrastructure investments can take various forms, with each form having its respective liquidity, cash flow and income streams characteristics.

 

a. Direct Investments

• Direct investment typically offers control and opportunity to benefit from the full value of the asset.
• However, significant investments are required, resulting in concentration and liquidity risks.
• Many direct investments are hence undertaken by a consortium of experienced partners who are able to co-leverage on each other to better manage certain risks, or with other financial / institutional investors to limit single concentration exposures.

 

b. Indirect Investments

• On the other hand, there are other investors who choose to invest indirectly.
• Such indirect vehicles include the likes of infrastructure funds, infrastructure Exchange Traded Funds, and via equities / shares of companies.
• These investments offer different asset strategies, including equity, debt and mezzanine investments.
• Investors who require flexibility and have liquidity concerns may instead opt for publicly traded infrastructure securities or master limited partnerships (MLPs).

 

Risks and Returns Profile

Risks and returns of investing in infrastructure would differ from asset to asset, depending on the asset’s underlying category, stage of development / lifecycle as well as geographic location. Additionally, the form of investment also determines the risks and expected returns from the investment.

 

As an example, publicly traded infrastructure securities typically have the benefit of liquidity, transparent governance, market prices, and portfolio diversification among underlying assets. However, returns from publicly traded infrastructure securities could arguably, at times, be capped by wider market forces beyond the asset itself.

 

On the other end of the spectrum, a direct investment into the underlying infrastructure assets provides the investors with certainty of control, management and the opportunity to capture and benefit from the full value of the infrastructure assets. However, such direct investments involve much larger investment outlays, which tend to result in higher concentration and liquidity risks to the investors.

 

Typically, infrastructure investing is divided into four main risk categories: (i) core, (ii) core-plus, (iii) value-added and (iv) opportunistic. These are commonly accepted classifications used by investors to assist in portfolio construction and ensure appropriate diversification when allocating to the asset class¹.

 

i. Core infrastructure is considered the most stable form, as these assets tend to be largely de-risked and brownfield in nature. Returns are generally derived from income with limited upside through capital gains, and assets are commonly held for the longer term (more than seven years). Revenues and cash flow are generally governed by either rate regulation, availability agreements (which provide for the payment of revenue as long as a facility is able to operate) or long-term contracts with highly creditworthy counterparties. Examples include gas, electric, water/waste and multi-utilities, contracted and renewable power generation and mature, top-tier airports, seaports or toll roads in major markets.

 

ii. Core-plus infrastructure have some similarities with core infrastructure; however, there is generally more variability associated with the cash flows of core-plus assets. Income is still a component of overall returns, but there is also scope for greater capital appreciation. The holding period for core-plus assets is typically more than six years. Core-plus infrastructure still primarily consists of brownfield assets. These assets are typically less monopolistic than core infrastructure and may include a growth or escalation component. Examples include contracted renewable power generation with some development risk, contracted oil and gas midstream assets as well as toll roads, airports, seaports with greater sensitivity to GDP.

 

iii. Value-added infrastructure typically include less monopolistic assets, assets that have a material growth, expansion or repositioning orientation, and certain greenfield assets. The holding period for value-added infrastructure is generally shorter than for core-plus infrastructure and typically ranges from five to seven years. Returns are primarily from capital appreciation rather than ongoing income. Examples include greenfield assets under construction, upstream oil and gas, data centres and fibre optic networks and assets undergoing meaningful expansion or repositioning.

 

iv. Opportunistic infrastructure have the highest degree of risk but also have the highest return potential. Assets can include those in development, those located in emerging markets, those subject to a high degree of volumetric or commodity price exposure, or those under financial distress and in need of significant repositioning. In general, opportunistic infrastructure assets share many characteristics with private equity investments. Holding periods typically range from three to five years, and returns are almost entirely from capital appreciation. Examples include infrastructure assets in developing markets, special situations, such as assets undergoing transition or financial distress, merchant power generation or merchant oil and gas midstream processing assets.

 

¹ Reference: https://www.mercer.com/content/dam/mercer/attachments/global/gl-2021-infrastructure-a-primer.pdf