How infrastructure can fit into your clients’ portfolios

By investing in infrastructure you are backing major government projects and services as well as essential utilities, in return for an income from operating essential amenities such as hospitals, schools, railways and energy companies.

Other benefits include the low sensitivity of the sector to changes in the economy and financial markets, highlighted by the low correlation of infrastructure investment to other asset classes. Infrastructure investments also offer long-term, predictable cash flow and typically have low default rates as the service provided by each individual scheme is essential.

In addition, many infrastructure projects offer some protection against price inflation as any government payments as well as prices charged for the services provided are linked to the pace of inflation. That means if inflation was to rise steeply then any change in fees and payments will be linked to that. On the other hand, revisions are often upward only, so if inflation declines, contracts would not necessarily be revised downward.

There are of course potential pitfalls when considering an investment into infrastructure, with politics being among them. New political regimes may introduce changes to the rules regarding private sector investment into public sector projects. Given the reliance on private sector money for the long-term availability of many infrastructure facilities, however, this is not often a major concern among the developed economies. This should be looked at as part of the investment decision as a whole.

While dividend yields maybe attractive in this area, capital growth can be limited as the majority of the return comes from income generated by the asset itself, rather than appreciation in value of the asset. But, the lower capital growth is balanced by the low risk levels associated with this type of investment as well as the length of the projected returns.

Infrastructure is a relatively new asset class available to retail investors. Following the global financial crisis of 2008, however, the opportunity for private investment into public sector projects has increased. That is because Governments sought to shore up their finances and help protect the banking sector. During that period the flow of money around the economy all but came to a standstill and many public sector projects – new schools, hospitals and roads – were put on hold.

Fast forward from 2008 to 2012, and taking the UK as an example, the International Monetary Fund praised the UK’s efforts at reducing the country’s financial deficit but said in order to boost economic growth it needed to bring forward a number of major infrastructure projects.

The opportunities to invest in global infrastructure projects and facilities look set to grow. According to a 2013 report from consultant firm McKinsey & Company, $57 trillion of investment into infrastructure around the world is needed by 2030 in order to ensure enough usable, essential facilities such as roads, hospitals and schools for the increasing population.

This area offers a wide range of risk profiles for potential investors. For instance, some infrastructure funds invest in projects from the construction phase while others choose to target those facilities which are already operational. Also, some infrastructure contracts are negotiated around the availability of the services while others are demand or usage based.

Investing in projects that are already operational such as schools, hospitals and power plants generates returns through profit from any fees paid for the service provided as well as from any Government subsidies associated with them.

Putting finance into an infrastructure project from the construction phase offers different benefits. While their earnings are restricted due to the lack of fees for the services which will be provided once the building is built and open for business, there is usually a deeper discount available to investors to make the investment more attractive where earnings are limited.

As well as traditional infrastructure investment opportunities, an environmental infrastructure sector is also developing. Environmental infrastructure investment focusses on renewable energy projects including solar, wind and waste-processing plants.

The longevity of such projects should be secure, given the growing appetite for renewable energy sources. The stability of the returns associated with such investments are still being assessed, however, as the renewable energy industry is still in its infancy, relative to other sectors.

Infrastructure represents a good investment option to help build a diverse portfolio and can provide a reliable, long-term return. While it may not offer the highest return, the risk-reward trade-off is attractive. Meanwhile, infrastructure investment responds differently from more traditional asset classes to economic and financial shocks, thus providing diversification benefits.

Stephanie Carbonneil is Senior Investment Manager at Architas