InvestmentsDec 1 2014

Infrastructure ‘deficit’ opens door for investors

twitter-iconfacebook-iconlinkedin-iconmail-iconprint-icon
Search supported by

That’s because they have for a number of years lived amid the chaos of Crossrail, Europe’s largest infrastructure project at a projected cost of £15.9bn, which will see an entirely new railway traverse the capital.

But for those outside of London the picture is very different and in fact the nation’s infrastructure is severely in need of investment. The devastating consequences of the February 2014 floods on the Somerset Levels, for example, exposed the poor state of the UK’s water management systems.

This state of affairs was hammered home by a landmark report issued in mid-November by Standard & Poor’s, the ratings agency, which indicated a £60bn ‘infrastructure investment deficit’ in the UK.

The report goes as far as to claim the UK’s investment levels have lagged behind several other OECD economies in recent decades.

“This has put the country’s infrastructure under severe strain and the World Economic Forum’s 2014-2015 Global Competitiveness Report said that inadequate supply of infrastructure stood out as an obstacle to doing business in the country,” says S&P.

While more infrastructure investment is sorely needed in the UK, the government is scarcely in a position to provide it. More than six years on from the sub-prime financial crisis, the nation’s public debt pile remains stubbornly high at £1.45trn, as of September 2014, and its annual deficit is still one of the largest of all advanced economies.

This is in spite of a swingeing programme of ‘austerity’ cuts by the current Conservative/Liberal Democrat coalition government that has seen almost all areas of spending reined in.

Filling the gap

According to S&P, the UK’s combination of a need for infrastructure investment and poor government finances presents an opportunity to investors.

“The government has implemented a deficit reduction program and this is likely to constrain its ability to finance new infrastructure projects. The government expects to publicly fund only one-quarter of its infrastructure pipeline. There will therefore be significant opportunities for the private sector,” the report says.

S&P says it expects the UK’s infrastructure investment to increase in the next decade, and each additional £1bn of money spent on infrastructure in one year will increase the UK’s real-terms economic output by £1.9bn in a three-year period thanks to a ‘multiplier effect’.

This will “create significant opportunities for private capital investment in the sector”, according to the agency. But where will the money come from?

“The government has supported significant private sector investment in the past by providing a stable and transparent legal system, developing public/private funding schemes, and fostering strong regulatory frameworks in industries such as airports, water, and energy,” the report says.

“In our view, macroeconomic factors support an increase in private investment in infrastructure: real interest rates remain at historical lows; employment in the U.K. construction sector remains well below peak levels; and, investing in infrastructure creates jobs, generates demand, and enhances productivity.”

It appears that UK investors are set to boost their infrastructure focus ahead of this predicted growth. The latest Halifax Share Dealing Market Tracker in November found that 33.1 per cent of investors are looking to boost their focus on the nation’s infrastructure sector.

In particular, 28.2 per cent say they are considering increasing their exposure to transport projects and 23.8 per cent are eyeing up commercial construction investments.

Halifax cites in particular the recent news that China is set to make a series of gargantuan investments in UK infrastructure in the coming decade.

The world’s second-largest economy will pump a staggering £105bn into the UK’s infrastructure by 2025, according to a report by the Centre for Economics and Business Research and the law firm Pinsent Masons. The UK will rank third in the world behind the US and Japan for attractiveness to Chinese investment, the report says.

Returns potential

On a global basis, infrastructure has a long history of delivering attractive returns to investors, with a large income component, and it may also have a diversification benefit for those looking to reduce their exposure to the swings of the stockmarket.

The returns of global infrastructure investments were recently made more transparent with the launch of the world’s first index of infrastructure direct assets by MSCI’s IPD division, a specialist in direct property indexing.

Launched on 19 November, the IPD Global Infrastructure Direct Asset index is comprised initially of 132 infrastructure investments globally with 47 per cent in transport, 24 per cent in power and 22 per cent in water sector projects.

The index’s annualised return was 14.7 per cent as at June 2014, with 10.4 per cent of this made up by capital returns on infrastructure investments and the remaining 4 per cent coming from income. Certain sector streams delivered stronger returns than the average, with global transport returning 16.8 per cent and power delivering 18.3 per cent.

Without a doubt, the most eye-catching global centre of infrastructure investment today is China, now the world’s second-biggest economy with a burgeoning middle class. For example, the Chinese bought just shy of 20m cars in 2013, according to figures from the Chinese Association of Automobile Manufacturers.

And in the face of waning economic growth the nation’s central government has made it clear it is prepared to invest to rebuild momentum. Chinese president Xi Jinping in September 2013 announced an initial $40bn for what’s being termed the ‘New Silk Road’, a vast road network stretching across the nation and into Europe.

Of course with all of these positive structural themes underpinning the infrastructure asset class of late, the major risk for investors is likely to be that much of the future potential of the class is already embedded into prices.

Only time will tell whether the UK truly does increase its infrastructure investment in the next decade, and whether global projects such as the New Silk Road survive whatever lies ahead for the global economy.

john.kenchington@ft.com