In a world of correlated markets and low interest rates, investors and advisers are faced with an ongoing challenge of finding sources of return that are uncorrelated to more mainstream assets.
Investors have become increasingly sophisticated in their portfolio construction to stay a step ahead of their competitors.
This portfolio construction problem is not actually all that new, and the search for yield has led investors to variously profitable asset classes over the last couple of decades, such as property, initial public offerings (IPOs), hedge funds, private equity, collateralised debt obligations (CDOs) and commodities. We can also add to this list ‘real assets’ – or as they have now become known, infrastructure.
Infrastructure can provide a diversified source of return, but importantly advisers need to understand the particular risks.
Infrastructure – can we call it an asset class?
Very broadly, infrastructure investments refer to the investment and/or maintenance of assets that carry some social value, are usually dependent on some government funding or planning, and almost always require a long-term investment horizon.
For an investor, the investment horizon of typically 5-30 years cannot be ignored and a significant component of the income from infrastructure investing is related to the illiquidity risk it carries.
Beyond this broad term, there is a high degree of specific knowledge required to invest in infrastructure successfully. As a first point, infrastructure can contain a massive variety of asset types and projects.
These can include:
■ Social: schools, hospitals, crematoriums, prisons, student accommodation
■ Energy: resource extraction, renewables and power stations, energy distribution networks
■ Transport: roads and bridges, railways, buses, public transport, bicycle infrastructure, or possibly in the future self-driving cars
As an extreme example, consider the types of risk and return associated with investing in airport assets. An investment at Heathrow will likely provide a more reliable income stream than an investment at Blackpool airport, primarily based on the type of economic activity associated with each and the potential impact of an economic downturn.
Alternatively, if one considers energy infrastructure, compare the risk and level of exposure to volatile commodity prices of a gas pipeline vs a power station vs an end-consumer utility.
Even if strictly comparing power generation investments, levels of government backing can differ, particularly if we consider renewables or carbon emission rules.
Infrastructure projects are also referred to as ‘Core’, ‘Core +’, ‘Core ++’ etc depending on the market structure and level of government backing. This is analogous to the terms of ‘investment grade’ or ‘emerging market’ used with other investments:
Core: Fully contracted or regulated revenues eg water, flood defences, power distribution
Core+: Partially contracted or quasi-monopolies eg railways, hospitals, airports, roads
Core++: Other essential services eg public buildings, broadband and telecoms
Core+++: Other public services eg crematoriums
Investments in the above can include the construction of these projects, the annual maintenance and operation of the assets, or a combination of both.
Financing infrastructure investments
The financing of infrastructure investments can vary and will influence the riskiness of return received. As experience has been built within government and industry with various infrastructure projects, contracts have become more precise and outcome orientated.