Infrastructure: Time of arrival
Investors are beginning to move into infrastructure in earnest. Russell Handy explores an increasingly competitive asset class
Rising demand for infrastructure among institutional investors has got the sector’s advisers and analysts talking. With a queue of capital, areas of infrastructure are becoming increasingly competitive. Where and what to invest in are the main issues – particularly for those entering the sector for the first time.
“Growth in demand for infrastructure, along with the much improved availability of debt, has resulted in greater competition for assets,” says Andrew Moylan, head of real assets products at Preqin.
Preqin estimates that there is as much as $100bn (€78.3bn) of uncalled capital – and more to come, with many investors planning to grow their allocations to both direct infrastructure and the listed sector.
Demand, says Moylan, “looks set to remain strong”, with the sector offering “fixed-income-like” returns and stability.
In October, the Macquarie Infrastructure Partners fund for North America, MIP III, closed at $3bn – well above the initial $2bn target, with Arkansas Teacher Retirement System and Illinois State Universities Retirement System both committing to the fund.
In Europe, eight institutional investors recently backed Copenhagen Infrastructure Partners with initial commitments of around DKK8bn (€1.05bn). Focusing on energy infrastructure investments in northern and western Europe, as well as in North America, the fund has been backed by DIP, JØP, Lægernes Pensionskasse, PBU, Nordea, Nykredit, PFA and PensionDanmark. The focus of the fund includes biomass-fired power plants, electricity transmission grid and onshore and offshore wind power.
Toby Buscombe, Mercer’s global head of infrastructure says renewable energy is attracting increased “investor focus”.
Energy infrastructure this year attracted APG, which is investing €250m in European hydropower infrastructure with alternative investments manager Aquila Capital.
Patrick Kanters, managing director of global real estate and infrastructure at APG said hydropower “ticks the right boxes” in terms of risk-return profile and high cash flow visibility.
Oldrik Verloop, responsible for the partnership at Hamburg-based Aquila, said hydropower offers investors stable, long-term inflation-protected yields to match pension liabilities.
Verloop said it is unlikely that institutional investors will ever be able to manage hydropower in-house. The bulk of Europe’s hydropower capacity is in Scandinavia, he said, while the Balkans and Turkey also offer potential.
Between now and 2020, the EU is planning to invest €26bn in infrastructure, according to the World Economic Forum’s Global Competitiveness Report. Duncan Yates, head of global capital markets research at Knight Frank, said despite the negative press the EU receives, it is still heavily committed to infrastructure.
Infrastructure is most popular with public pensions, according to AMP Capital’s Institutional Investor report from earlier this year. The company found that public pensions have a 3% allocation to infrastructure, compared with 2% overall – putting pensions above the average and ahead of their private contemporaries, sovereign wealth funds and insurance companies.
“The institutionalisation of the infrastructure investment space continues to accelerate – increasing the opportunity set for real assets portfolios and providing a more dynamic environment for asset owners and investors alike,” says Townsend Group’s principal for global real assets investments, Patricia Rodrigues.
Competition heats up
There is, says Buscombe, “a lot of investor capital chasing low risk, high-quality yielding, inflation-linked opportunities”.
Jörg Ambrosius, senior vice-president at State Street in Munich, says institutional investors have set a target quota for infrastructure, but are “not finding the right investments with the necessary political stability and alpha”.
As is the case in the commercial real estate sector, those investors looking to enter infrastructure – many for the first time – are naturally erring on the side of caution, taking tentative steps.
“As a consequence of the demand, investors tend to be more selective on who they partner with and what they focus on,” says Buscombe.
Brownfield and secondary stage assets already built and generating cash flow are getting a “lot of attention”, he says. “The more something look likes a regulated utility, the more interesting it gets.”
For Duncan Hale, head of infrastructure research at Towers Watson, brownfield investment is particularly attractive to clients looking for a lower risk profile, giving investors access to consistently performing assets with less “surprises”.
The return of debt has added even more firepower, rendering the sector even more competitive. Equally, additional sources of investment can help ensure major infrastructure projects become a reality at a time when “public purse strings are tight”, says Deborah Zurkow, CIO for infrastructure debt at Allianz Global Investors.
Allianz, which has invested over €2bn in infrastructure in the past 12 months for clients including Nippon Life, sees infrastructure debt as a “natural fit” for its institutional clients. “They are big buy-and-hold investors who can match their need to make payments in the future with the long-term stable cash flows that investments in infrastructure provide,” says Zurkow.
“Institutional investors want to invest in real assets – and it doesn’t get more real than infrastructure,” she adds.
By 2030, demand for global infrastructure investments could top $50trn (€39trn) according to widely quoted data from the Organisation for Economic Co-operation and Development (OECD). “Global demand for new and improved infrastructure is creating an opportunity for many companies,” says Loomis, Sayles & Co global equity analyst, Stephen McCabe, who estimates that infrastructure investment will total $7.5trn by 2017.
In a Public-Private Infrastructure Advisory Facility (PPIAF) report earlier this year, Georg Inderst said “there are huge infrastructure investment needs worldwide, but particularly so in developing countries.
“Given current constraints on traditional sources of public and private financing, institutional investors are increasingly being considered as sources of financing for infrastructure project development and maintenance,” Inderst wrote.
At the same time, investors have, he adds, started to look at infrastructure as an interesting investment opportunity for their “own reasons” – including low interest rates in many developed economies, and the search for non-correlated assets in the wake of the global financial crisis. Many pension funds and insurance companies are looking for longer-term assets, new sources of income, and better diversification in their asset allocations.
Institutional investors have their own objectives and regulations, and there are barriers on both the supply side – such as a lack of investable projects – and also on the demand side, with a lack of scale and capacity an issue.
“Such issues are particularly serious in developing countries,” Inderst said.
Towers Watson says there continues to be “significant discussion” about the role that institutional investors play in funding government-supported infrastructure projects.
India and Brazil are both significant locations for investors looking to make inroads into infrastructure.
Finding ways into a crowded sector is not an impossible task – there are areas of infrastructure that do offer opportunity. Partners Group identifies two “sweet spots” in the energy infrastructure sector – with the case for investing in them improving this year. Demand for new-build mid-stream infrastructure in North America continues to be strong on the back of shale gas exploration, Partners says. Build-out of regulated utilities in emerging markets is also seen as an opportunity.
With the onus on transportation, India’s current five-year investment plan includes a government target of $1trn for infrastructure investment.
APG – with Indian conglomerate Piramal Enterprises has committed to India. The joint venture will invest $1bn over the next three years, with both parties having made initial commitments of $375m.
The commitment from APG is its largest to Indian infrastructure so far and comes after the country voted in a new government that is seeking to promote greater foreign investment.
Hans-Martin Aerts, APG head of infrastructure Asia, said India’s infrastructure sector is at an “inflection point”, with a strong push by the new government on sector revival through conducive policy measures.
Jayesh Desai, co-head of structured investment group at Piramal, said Indian infrastructure players have “moved up the maturity scale” as the portfolio of operational projects has increased, raising visibility to future cash flows.
Brazil’s five-year infrastructure overhaul in the year running up to this summer’s World Cup is estimated to have cost around $500bn – with the country also due to host the 2016 Olympics.
Hale says with investors going to quality, there is “less appetite for some geographical areas than needed”. He adds: “That said, decision making on infrastructure investment is always case by case.”
Select global infrastructure commitments
Along with nine non-European pension funds managing a total of $1.3trn (€1trn), PensionDanmark recently signed a commitment to the UN to consider “climate-resilient” infrastructure investment.
The 10 pension funds – including the California Public Employees’ Retirement System (CalPERS) and the Ontario Teachers’ Pension Plan – also called on governments and regulators to create frameworks for climate-related infrastructure investments with long cash flows and shared risks.
Also signing the commitment were Alberta Investment, British Columbia Investment, California State Teachers’ Retirement System, Government Employees’ Pension Fund of South Africa, New York State Common Retirement Fund, New Zealand Superannuation Fund and the Office of the New York City Comptroller.
Meanwhile, Employees Retirement System of Texas is aiming for a 3% allocation to private infrastructure, investing more than $1.5bn in infrastructure during the next five years.
Oregon Public Employees Retirement Fund said it is backing Global Infrastructure Partners’ first infrastructure debt fund. The company is seeking to raise $2.5bn for its Capital Solutions Fund. Oregon PERF has committed $200m to the fund, which will invest in energy, transportation, water and waste, as well as greenfield and brownfield development.
CalPERS is raising its investment in global infrastructure by backing a platform managed by UBS. CalPERS, which currently holds $1.8bn in infrastructure assets, committed $485m to a global infrastructure partnership with UBS Global Asset Management.
CalPERS is targeting stable, risk-adjusted returns in public and private infrastructure. The transportation, power, energy and water sectors in the US and global developed markets are its main focus.
New Mexico Educational Retirement Board has also approved a $50m commitment to I Squared Capital’s Global Infrastructure Fund, which is seeking $2bn.
Asian institutions have backed Aberdeen Asset Management’s fifth infrastructure fund, Infrastructure Partners II. The fund will invest in social and economic infrastructure, including health, education, social housing, government accommodation, roads, bridges and rail, rolling stock and waste management.
Annabel Wiscarson, IFM Investors executive director for business development, agrees. “Perception is cyclical,” she says. “Sectors and locations go through popularity cycles. There are parts of Europe which are more popular than others – but who’s to say that so-called unpopular locations are off-limits?”
With a focus on core, stable, and brownfield assets, IFM invested in Poland in 2006, when the country was “less on investors’ radar”. Wiscarson says: “Eight years on, we’re very happy with that.”
Even in areas where geopolitical risk appears low, there can also be cause for concern. A few months ago Scotland would not have been at the top of the list of places to avoid. That changed in the weeks preceding September’s independence referendum. The Scottish construction industry was, according to Barbour ABI, at risk, with £7.8bn (€9.8bn) of projects potentially in jeopardy if the country voted in favour of a breakaway from the UK. Barbour’s Construction: A Bright Future? report highlighted the impact of independence when a fifth of Scotland’s planned construction projects involve investors with headquarters elsewhere.
The risk to foreign investors was in spite of construction in Scotland outperforming other areas of the UK in the last 12 months, according to Barbour’s economist Michael Dall.
Nevertheless, the UK remains a top destination for investors, with a pledge to update its infrastructure, in turn triggering private and public investments worth around $375bn between now and 2030.
The UK National Infrastructure Plan finance update, delivered alongside this year’s budget, earmarked £50bn of infrastructure projects open to private investment.
Ontario Teachers’ Pension Plan, the CAD117bn (€81.1bn) Canadian institution, took full control of Bristol Airport in September. Ontario, which had a 49% stake, took Macquarie’s 50% stake, giving the investor full ownership of the UK airport. Meanwhile, Singaporean GIC’s investment in the country’s regional airports is further evidence of international appetite.
Another Canadian pension fund, Caisse de dépôt et placement du Québec, has also invested in the UK, buying into the London Array wind farm in Kent. The UK has also attracted France’s EDF and China’s Beijing Construction Engineering Group.
Research by consultancy firm Arcadis recently found that the UK has risen in appeal. The firm’s second Global Infrastructure Investment index, which ranks 41 countries by their attractiveness to investors in infrastructure, found that the UK is one of the 10 most attractive markets in the world for investment in infrastructure. Arcadis said the improved financial and taxation environment has increased its appeal, but the UK should not be complacent.
Steve Bromhead, Arcadis UK head of infrastructure, said: “The government needs to provide long-term clarity over infrastructure policy and look at the over-prescriptive nature of regulation in several key sectors.”
With countries in increasing need of investment from the private sector, Towers Watson says incentives are the way forward.
“In economies where government budgets are heavily constrained, it is vital that those governments provide sufficient incentives for private capital to help address funding gaps,” the consultant says.
Renewed thinking about regulatory frameworks and risk transfer between the public and private sectors will, Towers Watson says, “significantly impact the amount of capital that ultimately gets invested in infrastructure assets around the world”.
Giving investors an incentive is a simple tool for governments looking to privatise and outsource key projects. There are exceptions, however. Stephan Kloess, head of KRE KloessRealEstate Consulting, says the firms in his native Switzerland, as well as in neighbouring Austria and Germany, are not used to the concept of alternative financing for infrastructure projects.
Has infrastructure become overpriced?
UK Camden Council said it is delaying its local authority pension fund’s move into infrastructure due to concerns over market pricing. A report prepared by the council’s director of finance Nigel Mascarenhas for its pensions committee said infrastructure’s “popularity may have meant it is now in demand and so at the very least is fairly priced to over-priced”.
The report said: “Given that infrastructure is relatively expensive… the fund should focus on private equity ahead of any decisions on infrastructure that are likely to be the subject of better value vehicles.”
Partners Group, which is underweight “highly-valued core infrastructure” such as highly regulated water utilities in Europe and the US, says valuations are surpassing sellers’ expectations.
“High valuations are often underpinned by ‘optimistic’ assumptions about growth and regulatory support,” Partners wrote in its most recent Private Markets Navigator report.
“The most sought-after infrastructure assets, especially regulated, availability-based core assets in developed markets, often trade at valuations that imply returns at or below 8%,” the report said. “While these returns may appear attractive compared to continuing low government bond yields, we believe that they do not adequately compensate investors for inherent business, regulatory or macro risks.”
Partners cites the AUD$7bn (€4.8bn) sale earlier this year of Australia’s Queensland Motorway – at a AUD$2bn premium above the clearing price initially expected by the state of Queensland. The sale implied a valuation of approximately 27x EBITDA, significantly above trading comparables.
“We are very cautious on core, regulated utilities, particularly in Europe where the highest valuations are observed,” Partners says.
Moylan says there is concern that some sectors are becoming overpriced – brownfield assets in particular. Increased competition for greenfield, he says, reflects the fact that it is harder to buy more established assets.
“Prices have gone up for the most established, cash flow-generating stable assets,” says Moylan. “Increased pricing and competition mean it’s harder to find value – that’s the challenge at the moment.”
Cohen & Steers said that as more capital enters the market, investors are “struggling to achieve their target allocations due to rising asset values and growing competition”.
Kloess also notes a perception problem with infrastructure investments in institutional portfolios.
“Unfortunately, infrastructure is not yet seen as an asset class in its own right,” he says. “There is also no regulatory ‘bucket’ for it – which means it is seen as an alternative investment competing against other investments.”
That may be true as things stand. However, Zurkow says that as the market develops and matures, Allianz expects “significantly more” institutional investor interest, which will “help meet society’s need for substantial infrastructure funding”.
China alone aims to spend $6trn on infrastructure over the next decade as part of its urbanisation plan, while in the Middle East $80bn of investment is planned for electricity infrastructure as well as an additional $185bn of transportation projects.
“The number of managers has also increased – but at the same time there are more assets on the market,” says Rodrigues. “Performing the requisite due diligence, underwriting and execution will continue to be essential for investors to capture value.
“Not all investors are chasing the same thing – there’s enough capital for enough opportunities and strategies.”