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Anyone thinking of investing in what appears to be financially beneficial new infrastructure offering stable cash flow for decades may wish to consider the case of the Skye Road Bridge.
The bridge was opened to link the Scottish island of Skye with the British mainland in 1995. It was funded through the Private Finance Initiative, in which private investors invested in public infrastructure in exchange for a share of the tolls once the project was completed. Replacing a wobbly ferry service that had existed for centuries, the Skye bridge seems like a no-brainer.
However, locals were outraged at the cost of the tolls, leading to open civil disobedience when they drove across without paying. It took law enforcement, including the threat of jail, to enforce the tolls. Continued protests led to the bridge being nationalized and the tolls abolished in 2004.
“There are peculiar risks with investing in infrastructure, but it depends on the type,” says Steef Bergakker, who was manager of the Robeco Infrastructure Equities fund before it merged into the wider Rolinco portfolio.
“If you look at for instance concessions for tolls roads, there are huge political risks which we have seen in many countries over recent years. Although there is a contract with the company that runs the concession, governments have a habit of retroactively adjusting the terms, and that can create a huge political or regulatory risk.”
“Another category of risk is that these assets usually have an extremely long duration, and so there’s always the risk that they may become obsolete after 20 or 30 years, and who knows what the world will look like then.”
“And then is the natural disaster risk to large assets such as bridges from earthquakes or floods. Usually you can insure against these risks, but it’s difficult to price this sort of risk. Many of these assets are unique and not listed, with no daily prices to look at.”
Bergakker says there are four types of economic infrastructure which are investible either directly, or indirectly by buying the equities or bonds of the companies that build or operate them. They are:
In addition, there is social infrastructure, such as building schools, hospitals or prisons, though this sector is not normally investible. “Usually it’s restricted to economic infrastructure: you can either invest in the assets directly, or buy the shares or bonds of the companies that build or operate them, and this was the approach that we took when we had the fund,” says Bergakker.
“We were heavily focused on companies that design, build, repair or modernize infrastructure. This typically involved a lot of engineering and construction companies, but unfortunately it’s a very volatile sector of the market. Then you have the operators, which are mostly utilities, telcos or concession companies, and that was a relatively small part of the portfolio. We were positioned at the more aggressive end of the spectrum.”
Bergakker says returns will be relative to the type of infrastructure. “Investing in infrastructure is analogous to investing in real estate in a way. You can invest directly in the asset itself and collect rent as your reward, or you can invest in listed funds that invest in real estate or infrastructure assets. You can make some money in many different ways, but it comes with commensurate risks.”
“One aspect that is often underappreciated is how these assets are financed. There can be a relatively predictable stream of cash flows from funding these projects, but the overall risk profile also depends on the financial leverage that is applied. Leveraged finance risk can really go sky high for these kinds of assets, in addition to the operational risk of the asset itself.”
“So you could have a very stable asset which is generating very predictable returns, but if it is leveraged up to the hilt, it’s still a very risky proposition. Unless of course you invest in indirect infrastructure such as equities, which are usually pretty liquid, and risks can be diversified.”
The location of the infrastructure, and whether it is new build or upgrading, is also important, he says. “You have relatively defensive assets in brownfield sites where the infrastructure just needs to be rebuilt or modernized. Once you start to build new infrastructure there is a much higher risk profile and you need to be compensated with higher returns.”
‘Investing in indirect infrastructure such as equities are usually pretty liquid’
“Making existing infrastructure greener or more sustainable is a sub-category of this asset class. And there is also the relatively new area of building wind farms or solar panels for buildings, but this is still a relatively small part of the universe.”
He says another risk is knowing who your fellow investors are. “Transparency generally is quite good because it’s only a limited number of assets, and the documentation is all there, but with whom you are investing could be murky. Unlisted infrastructure funds may have limited partners and you may not know who they are, particularly in emerging markets.”
So all in all, is it worth it? “In the run up to the financial crisis we saw a boom in infrastructure funds where people thought they had a defensive asset. But because the leverage was so high, the actual results were quite shocking. Many of these funds didn’t survive the financial crisis and some people felt a bit cheated. However, it’s still a very young asset class, with not enough history to be able to draw any firm conclusions.”
And there can be tax or inflation-proof benefits. “Some types of infrastructure do offer some form of inflation protection, especially the concessions, with a sort of indexation in place. But outside the transportation infrastructure realm there isn’t much indexation – it depends on pricing power and regulation,” says Bergakker.
“Some funds have limited partnerships which are similar to REITs and are tax friendly. These funds are mostly energy-related infrastructure assets, especially pipelines, which have done very well over the past 10 years or so, with good returns and relatively low risk. It depends entirely on what you are investing in, and with whom.”