A survey by IPE and Stirling Capital Partners shows strong appetite for infrastructure investments among institutions
According to the inaugural Institutional Infrastructure Survey (IIS), investing in infrastructure is widespread and only likely to grow. Of a total 102 respondents, representing both public and corporate pension plans, fiduciary managers and sovereign wealth funds, nearly two-thirds already invest in infrastructure. Of those that do not, 14% have definite plans to and almost two-thirds say they may allocate in the future.
Only one-quarter (less than 9% of the entire universe) are adamant that infrastructure will never form part of their portfolios.
The popularity of this type of investment is reflected in expected allocations. Just over 5% of respondents expect to reduce their exposure to infrastructure over the next 18 months, while over 60% are set to increase their exposure. Of these, a handful of respondents will take infrastructure investments to 10% of total assets. Several others will double or treble exposure, albeit from mostly small allocations of less than 2%. The remainder, approximately 32% of institutions, said they would hold allocations steady to the end of 2014.
Steadiness is a virtue commonly associated with these types of institutions. Pension plans are frequently praised for being long-term investors – despite evidence that they follow fashions in capital markets rather too readily. In the case of infrastructure, however, the virtue of patience appears well understood: close to one-quarter of respondents say they are comfortable with holding periods in excess of 15 years. Almost one-third were happy to buy and hold for 10-15 years.
At the other end of the scale, just one institution in the survey said that its horizon for
infrastructure exposure was less than three years. The duration of holding periods was not necessarily related to size: smaller funds with €200m as well as larger peers with €50bn declared their ability to wait for the full economic return.
The overwhelming sense of long-termism was reinforced by survey responses regarding liquidity: almost 46% say it is not important. Almost 7% deem it irrelevant in the context of infrastructure. In the careful world of institutional investment management, these are bold messages.
They complement the views of those who are not currently investors in infrastructure. Among this minority of survey respondents, the most popular dissuasive factor was illiquidity, garnering almost half the votes.
Other reasons not to invest in infrastructure included scale. Three out of 10 of the investors not invested in infrastructure said their funds were too small. This reason was supported by specific answers that there were more pressing matters for the institution to deal with. One-quarter were not persuaded by the risk-return characteristics of opportunities presented to them, although one US public fund said that infrastructure would appear for the first time in its next asset allocation study. Just under 15% of respondents within the minority deemed fund vehicles to be unsuitable. It should be noted that viewed within the whole universe, most of these objections apply to fewer than 10% of respondents.
Respondents were asked how they categorised infrastructure within their wider multi-asset portfolios. Nearly one-third consider it a standalone asset class, separate from debt, equity, property and the rest. But almost as many place it within the ‘alternatives’ box, while 18.5% deemed it to be a real asset.
Some responses were strident: “The focus is all wrong,” said one UK corporate pension fund executive. “Investment in infrastructure equity is an equity risk and thus a return-seeking exercise. Pension funds need strong inflation linkage – index-linked debt, particularly supporting PFI schemes, would be very attractive.”
This is in stark contrast to a minority of responses that viewed infrastructure as forming part of a liability-driven investment strategy to generate real income. Could the positions not be reconciled by counting PFI deals as infrastructure?
Infrastructure debt has become a hot topic in the sector. A number of investment managers have launched funds seeking to move into the space vacated by traditional bank lenders that have recently retrenched from the market. Interestingly, the survey showed that more investors had a preference for investing purely in infrastructure equity (44%) rather than purely debt (4%). But it should be noted that more than half (52%) of respondents favoured a combination of the two, suggesting demand for debt investments is there but, for the most part, only in addition to traditional equity strategies.
It is a well-known fact that banks are in risk-reduction mode. A number of high-profile banking names have spun out infrastructure operations. However, some of the largest asset owners and fiduciary managers around the world appear wary about acquiring such loan books. In terms of acquiring loans being offloaded by banks, just over a fifth (22%) of investors were definitely interested in the activity and more than a quarter (27%) possibly interested. The majority (51%) were not.
When asked to give reasons for their aversion, most replied that the loans were overpriced; their structure was not attractive; the due diligence was beyond the current ability of asset owners, and the loans’ credit quality was not clear. All these four reasons garnered many votes (respondents could select more than one) with regulatory pressures appearing as a lesser, fifth reason.
What is most striking is the admission by pension funds and fiduciary managers that they lack sufficient expertise to conduct due diligence on banks’ infrastructure loans. Some of the respondents are among the top-tier asset owners globally. Elsewhere in this survey they reveal that they are sophisticated enough to invest directly in infrastructure and hold these assets for upwards of 10 years.
Geographically, these investors are as comfortable in emerging markets as they are in their home markets of Europe and North America for other asset classes. The average volume of their total assets exceeds €18.6bn. Yet it appears that bank loans are still too complex an opportunity for many to analyse. Does this mean that the intermediaries – commercial fund managers and investment banks – are failing to do their job of connecting buyers and sellers, or at least slow off the mark? After all, even the largest asset owners are prepared to outsource many peripheral investments to specialists who know minor and emerging asset classes better.
One answer is that the investment banks themselves are among those that have been deleveraging. Another weighty deterrent is cost. More than one-third of respondents said banks were asking too much for their loan books. Cost is a major concern generally for would-be buyers.
Of infrastructure broadly, one UK local authority fund said: “Pricing is beginning to look like a nascent bubble.”
It is not just costs but fees that dissatisfy a large minority of asset owners and fiduciary managers. Another UK local authority deemed the biggest obstacle to accessing existing infrastructure assets to be “the greed of fund managers and other intermediaries for managing assets with modest return expectations”.
The Nordic region is home to fewer than 25 million people, or 0.25% of the world’s population. But in spite of its size, a surprising number of investors see infrastructure opportunities in countries such as Sweden, Denmark and Finland.
More than 55% of respondents said they were already invested or interested in the Nordic region. This could not merely be a case of home bias – only 17.6% of the respondents are based in this area. In fact, there was more interest expressed by UK-based investors in the region than from Swedes and all their neighbours put together.
That does not mean there were not elements of home bias. As might be expected, Western Europe was the most popular region, appealing to 93% of the universe (another question where multiple answers were permitted). Elsewhere, every single US respondent saw opportunities in North America. But the majority of this subset also expressed an interest in Central and Eastern Europe.
Evidently, investing in infrastructure is truly an international venture. But unlike the bond and equities markets, interest in infrastructure has a clearer, more direct link to future economic growth. Thus, almost 12% of respondents said they had allocated or were considering putting capital in Africa’s infrastructure; the same figure appeared for projects in the Middle East. The securities markets do not currently cater directly for such a degree of interest in these two regions.
Before drawing too many conclusions, it is worth turning to another chart that shows that emerging markets are, by themselves, relatively unattractive to infrastructure investors. Only 2% of investors are focusing on them, although 27% are looking at them in combination with developed markets. This does not contradict the previous finding but rather underlines the fact that investors looking at the Middle East and Africa are almost all doing so as part of a wider international programme.
The head of one large Dutch pension fund said the biggest obstacle to infrastructure investing was “the lack of sufficient large and core infrastructure opportunities in OECD countries”.
It seems that new regulations will have a limited impact on investors’ allocations to infrastructure. The majority of survey respondents said regulations were unlikely to affect (35%) or would have no effect (28%) on future infrastructure allocations.
However, there were some concerns that pressure from regulations, including Solvency II, to invest in liquid assets was in direct contrast to government encouragement to invest in illiquid, long-term infrastructure projects.
One Austrian CIO said regulators placed great emphasis on liquidity and yet governments expected pension funds to participate in new infrastructure projects. One solution he desired would be a deeper, more liquid market for secondary funds. Several respondents similarly warned of the private equity nature of returns from infrastructure funds. “Newly created private-equity infrastructure funds will be still-born because of regulators’ strong emphasis on liquid investments in asset owners’ portfolios,” the Austrian said.
Finally, investors revealed which particular sectors they preferred. Earning almost three-quarters of the votes were water companies and renewables. Next with about two-thirds of all votes (respondents could select more than one category) were rail projects and toll roads. There was also a heterogeneous bundle of other ventures in process, including hospitals, social housing, telecommunications, electricity grids and parking.