Institutional investors in Germany, as elsewhere, are faced with tremendous challenges to achieve their target returns with a well-diversified yet conservative investment portfolio in an environment of historically low interest rates.
In this context, the infrastructure space is gradually receiving greater attention from German institutional investors. Although infrastructure investing has been high on the agenda in many other European countries in recent years, many German investors are still monitoring developments and assessing the long-term sustainability of these investments.
German institutional investors now seem to have accepted the thesis that infrastructure investments are robust, have low volatility over the economic cycle and can therefore deliver attractive overall returns compared with other asset classes. Now that many investors are generally convinced that infrastructure investments should become part of their overall portfolio in the short- to medium-term, more technical questions are being asked.
Some of these relate to asset allocation. Is infrastructure another fashionable investment topic that can be seen as part of the real estate or buyout allocation? Or is it a whole new asset class in its own right? There are plenty of arguments to support the latter view; one of them being the distinct characteristics of infrastructure investments, which require a separate and specific expertise to analyse.
Appealing as infrastructure investments are, especially in the current investment environment, it is advisable to proceed with caution, as with any other “new” asset class. The infrastructure sector is a broad and uneven playing field. It ranges from public-private partnerships (PPPs) offering a stable, government-backed income stream, to investments in “true” infrastructure companies with full market risks – some with rather buy-out like risk/return characteristics.
Although the general decision regarding different infrastructure sub-segments is complex enough, it is not the only choice investors have to make. Geography, lifecycle stage (greenfield vs. brownfield) and proposed financing structures are just a few of the additional aspects that have to be considered.
The market is therefore characterised both by appetite among investors and a wealth of investment opportunities – from global infrastructure funds active in exotic countries around the globe to direct investments in renewable energy assets in Germany. The latter especially have featured prominently in the German institutional investor community in recent years.
So the questions investors have to ask themselves when considering making infrastructure investments include: What is the right way to enter the asset class, what are my internal resources for this venture and who is there to help me avoid typical mistakes along the way?
Building a dedicated in-house team comes at a price. It will be a strategic decision for each individual investor to establish whether this is an efficient way to enter the asset class in light of their own target investment volume. In many cases the more appropriate answer will be to join forces with someone who has done this before, allowing the investor to conserve scarce internal resources.
Companies like Golding Capital Partners, a Munich-based fund of funds and segregated accounts manager for infrastructure investments, can make an excellent sparring partner. Potential investors can discuss their strategic options and decide what steps should be taken on the path to infrastructure investing. Whether they enter the market via a broadly diversified fund of funds or by pursuing a specific strategy with a managed account solution, investors are sure of having an experienced partner at their side.
Golding Capital Partners enables investors with managed accounts to be as closely involved in the investment process as they choose. This arrangement allows the investor to move up the learning curve while operating in a relatively safe environment.
After determining the most suitable way to enter the asset class, the next question is about portfolio strategy. The following key considerations should be borne in mind when defining this strategy:
UNDERSTAND YOUR GOALS
As in any other asset class, the universe of investment opportunities caters for a wide range of different strategies, depending on the investor’s individual risk appetite and return expectations. In our experience, the main driver for German investors considering infrastructure investments as part of their overall portfolio is the desire to secure stable long-term cash flows, with a focus on early yield. Internal rates of return (IRRs) in the high single-digits to lower teens and a cash yield of around 5 percent per annum are what investors usually have in mind when evaluating infrastructure investments.
SEE WHAT'S THERE
Although infrastructure is a comparatively recent asset class for German institutional investors, many of them already have isolated infrastructure investments on their books. In many cases this will be a direct investment in a wind or solar asset, because these have been heavily advertised in recent years as an ideal entry point into infrastructure investing. The infrastructure universe as a whole is much wider of course, but existing investments nonetheless have to be taken into account when defining the strategy for the future, in order to avoid potential concentration risks in the portfolio.
DON'T GET DISTRACTED
Legal and tax considerations will always play a vital role in the investment process of institutional investors, especially for those which are regulated themselves. They become even more relevant when investors decide to take their investing activities to the international stage, which in the case of infrastructure investing seems clearly advisable for diversification purposes. But although these legal concerns have to be taken seriously, the economic viability and sustainability of a project should take priority in the decision-making process whenever possible.
BUILD A FOUNDATION AND A PLATFORM
Some strategies are more aggressive than others, so it is always advisable to begin portfolio construction with commitments to funds in the core and lower core-plus segments. These investments usually entail less risk, are less volatile and establish a decent yield and IRR for the portfolio. They can be supplemented later by more core-plus and value-add investments as the portfolio is built up.
The yields and IRRs sought by certain single funds and direct investments may be appealing, but diversification is crucial to achieving the outlined investment goal of a stable, long-term income stream. One strategy providing a balanced geographical and sector diversification could be a portfolio of 10 to 12 single funds, each investing in around 10 projects, possibly enhanced by some co-investments or even direct investments.
AVOID HOME BIAS
Particularly when it comes to infrastructure, many investors have a home bias towards funds investing in Germany or even direct investments in the home region of the individual investor. This approach may be understandable and acceptable up to a point, but it runs the risk of accumulating concentration risks within the portfolio and of neglecting interesting opportunities outside Germany. Infrastructure is a global asset class with different opportunities in different geographies, which should be reflected in the construction of the portfolio.
LOOK FOR HIDDEN CHAMPIONS
Large, well-known infrastructure funds may justify their reputation and represent a sound investment, but the market does not stop there. Though harder to find and more difficult to analyse, specialised funds and niche players can often enhance the portfolio in terms of return levels and diversification.
Often they look at assets too small for the mega funds in the market or find the particular angle that makes a deal an attractive investment opportunity. Although many small funds may not have the scale or the structures to be prominent with institutional investors, some are truly hidden champions in their field.
Building an infrastructure investment portfolio is a challenging task and there is no single strategy blueprint applicable to all institutional investors considering infrastructure investments. To maximise the chances of success it is advisable to identify the right partner, define an individual strategy and select the right investments to implement this strategy.
More and more institutional investors in the German market are applying these principles and embarking on a programme of infrastructure investing. The growing fundraising success of infrastructure funds in the German market suggests that this is a giant which is now starting to awake.