Michael Howard, Head of Alternative Investments at Prudential Portfolio Management Group (PPMG), discusses the opportunities presented by infrastructure investment.
Infrastructure investment has gained in popularity over recent decades as more investors have sought diversification, stable long-term income streams and an element of inflation protection.
Infrastructure is extremely diverse but in essence refers to assets that are associated with the provision of public goods and services that ensure social and industrial productivity.
It’s important to understand that there’s a range of return expectations from the various sub-strategies. For example, most long-term institutional investors in a potential greenfield opportunity, where no revenue will be received until the project is completed, would likely anticipate an eventual annualised return between 13-15 per cent. The same investor executing a 25-year Private Finance Initiative (PFI) investment into schools or hospitals would expect to receive between 6.5-7 per cent.
Having said that, we know that performance is not guaranteed and the value of an investment can go down as well as up. Your clients could get back less than they have paid in.
Demand for infrastructure assets has been high because of demand for yield and correlation benefits. This is particularly true in the listed infrastructure sector where many stocks trade at a significant premium. Despite this, we believe infrastructure still offers an attractive yield premium to other low-risk assets.
Where are opportunities in the future?
The US opportunity set is improving with vocal support from the Trump administration. Infrastructure debt in higher-yielding senior and mezzanine debt offers the potential for similar returns to infrastructure equity with seniority in the capital structure. In UK and European renewables, consolidation is now in focus and the development and improvement in grid infrastructure will benefit existing assets. In Asia there is still a significant requirement for new renewables plants and some portfolios are now coming to market.
Asset leasing offers diversified, long-term, asset-backed cashflows. More investments are available as traditional sources of finance are unwilling or unable to commit. Some parts of the aircraft leasing market have become expensive but we are also monitoring rail, equipment and shipping.
As highlighted above, greenfield infrastructure offers very attractive returns for taking on development risk.
What about risks?
In the UK, political support and clarity over infrastructure spending have not been clear over the past 18 months although most believe spending will increase in a post-Brexit world. President Trump has previously been negative on renewables and the Paris Climate Agreement, which could have implications for renewables incentive programmes globally.
Looking further ahead, will changing technology, climate and demographics alter the way we use infrastructure? In technology, will 3D printing affect ports and rail? Will automated electric cars reduce toll road revenues and city centre parking? Some of this may not affect prices paid today but needs to be considered when making 10-year-plus investments.
Finally, due diligence is vital. Some infrastructure managers may be lightly regulated and any weak operational practices within an organisation could quickly escalate. This may be extremely problematic when liquidity is much lower and most deals have multi-year lock-in periods.
In summary, infrastructure investments can provide uncorrelated, long-term, inflation-linked returns within multi-asset portfolios. There are numerous challenges and potential pitfalls but, with an estimated $3-5tn of infrastructure projects to build globally per year until 2020, this presents significant opportunities for long-term investors.