2017 marked the year in which infrastructure investment gained mainstream awareness. From 2006 to 2017, more than $1.7 trillion had been raised by private capital investment in infrastructure. Due to the economic turmoil in that period, there was increasing pressure on governments and companies to reduce debt. This led to an influx of capital and investors seeking long-term stable returns. A large amount of the world’s infrastructure is owned by specialist private investors. Pension funds have taken a particular liking to infrastructure investing over the years due to the stability and long term outlook the investment offers.
What is infrastructure investment?
Infrastructure can be defined as any ‘real asset’, taking the form of energy, roads, bridges, or anything that is conducive to building and maintaining society. Historically, infrastructure was either state funded or contracted out to huge firms for them to profit exclusively. Now however, in the age of infrastructure investing, many individuals are gaining exposure to infrastructure through hedge funds. Even private equity firms are buying in to infrastructure. Quite simply, infrastructure investing is where companies and funds use their capital to invest in new and existing infrastructure, obviously aiming to profit.
What is the appeal of core infrastructure?
Institutional investors are allocating more and more of their portfolio to infrastructure assets; ranging anywhere from power, to transportation, to utilities. The idea behind this increase is that it will produce more stable and forecastable cash flows.
These investments tend to be relatively insensitive to periods of economic weakness, this is due to the natural monopolistic nature of infrastructure. Imagine the resource inefficiency, if there were two sets of train tracks nationwide, for instance. The added benefit of the infrastructure sector is that each core has a unique set of risk factors, so diversity occurs naturally within the asset class.
The D-I-Y benefits of infrastructure investment
In the modern investment climate, with corporate bonds failing to deliver on their historic averages and poor price-to-earnings ratios on economy-wide indices such as the S&P 500, investors are turning to private infrastructure more and more. Infrastructure as an asset class is said to deliver ‘D-I-Y benefits’. Namely, diversification and low correlation to other asset classes (D), protection against inflation (I) and that it will yield high and stable cash flows (Y).
Diversification: infrastructure can be used to reduce portfolio volatility
The driving factor for the increase in infrastructure investment has been the ability of the asset class to provide relatively high returns with low correlations to more traditional asset classes such as shares or real estate. So it is likely that, in times of market uncertainty, exposure to infrastructure will limit portfolio volatility. The asset class also has the added benefit of being resilient to economic decline. As mentioned previously, many infrastructure assets are natural monopolies, but with some assets natural monopolies are necessarily delivered, where alternative providers are prohibited by the state. For instance, National Rail in the UK is the only provider of train tracks by law. This monopolistic character renders these assets resilient to economic decline.
Inflation: use infrastructure to hedge inflation
An unexpected rise in the price level is an investors nightmare and can potentially be very costly. This is crucial to bear this in mind when constructing a portfolio, protecting against rising prices is essential, even in seemingly low-inflation economies. This is especially relevant in the current economic climate where US fiscal stimulus is coming to an end and Brexit is impending; where a spike in inflation is well within the realm of conceivability.
However, investments in infrastructure tend to be protected from unexpected inflation; this is especially true for transport and utilities assets. Consider, for instance, transport assets across continental Europe, the vast majority of private toll roads have their prices pegged to the domestic price level. Generally speaking, it is uncommon for infrastructure investment to be eroded by inflation.
Yield: infrastructure can generate large and steady cash flows
The high-yield potential for infrastructure is what makes the asset class stand out in today’s low yield environment. Yields across the asset class are notably resilient to economic decline. Easily forecastable cash flows, long economic lives and the presence of contracts with credible parties have all contributed to the high yield investors see from this asset class.
Infrastructure investment strategy: the right way to invest in infrastructure
The most common private infrastructure investment vehicle is what is known as a ‘commingled fund’. A commingled fund is a portfolio that consists of assets from several accounts that are blended together. Commingled funds were conceived of to reduce the costs of managing the constituent accounts separately.
By combining capital from many investors, commingled funds can lead to greater diversification than a single institution may have been able to achieve with its own capital. This type of fund also removes the need for an internal team to conduct in-depth research to acquire and manage infrastructure assets.
The best infrastructure investments involve open-ended funds. Open-ended commingled funds are more appropriate when investing in core infrastructure. Due to the long-term structure of open-ended funds, they tend to focus on the D-I-Y aspects of core investments, that have long-term outlooks. Open-ended funds also allow for an ongoing relationship between investors and fund managers, presenting opportunities to focus on specific sectors and geographies for the investors that want to.