By their nature, large infrastructure projects, from motorways and railways to dams and viaducts, require a lot of planning. However, the global pandemic caught everyone off guard and projects around the world were heavily disrupted. Vaccination campaigns may be giving some hope for normality, but infrastructure investors are still having to think about how they can protect their exposure to future pandemics.
In 2020, some sectors were hit worse than others. A collapse in oil prices
meant hydrocarbons projects were among the hardest hit. According to Bloomberg, revenue from listed infrastructure projects in the oil and gas industry fell 20 percent in 2020.
“The oil and gas sector was not only impacted by the demand destruction from the pandemic, but also by the oil price war between Saudi Arabia and Russia,” recalls Declan O’Brien, head of infrastructure research and strategy at UBS Real Estate and Private Markets. The oil price may have recovered but revenues for 2021 are still expected to be down by more than 10 percent.
“US shale oil production growth remains depressed, as reflected in the low rig count at key shale basins,” says O’Brien. “Appetite for investments has diminished as the demand outlook remains weak, as reflected in bearish oil price futures.”
Airports were hit even harder, with unprecedented peacetime travel restrictions grounding millions of flights. According to the same Bloomberg data, revenues from listed airport infrastructure fell by nearly 50 percent, making it the worst-hit infrastructure sub-sector.
O’Brien is not optimistic about revenues from airport infrastructure returning until at least 2023. The roll-out of vaccines may ease this pressure, but the challenges facing airport investment are still significant.
“This will have a valuation impact versus pre-pandemic when airports were viewed as a high growth sector,” he says. Although successful vaccine roll-outs could release near-term pent-up demand, a weaker macroeconomic outlook and a broader decline in business travel could impact this highly cyclical sector over the longer term.
“Overall, we saw that transportation assets were very resilient once the most severe lockdowns were lifted,” adds O’Brien. “Freight-related traffic has been very robust throughout with strong port volumes, while passenger transportation volumes – air travel, passenger rail, etc – remain depressed.”
Many commentators have spoken of infrastructure’s continued resilience as an asset class. Devan Nathwani, investment strategist at SECOR Asset Management, notes that while travel restrictions will have inevitably impacted transport infrastructure, other projects have been able to withstand these headwinds.
“Transport assets such as airports and toll roads… saw their revenues fall”
SECOR Asset Management
“Infrastructure as an asset class fared well throughout the pandemic, given that these projects have highly regulated revenue streams and generally resilient balance sheets,” he says. “That being said, transport assets such as airports and toll roads that typically rely on high traffic volumes saw their revenues fall as governments globally enforced lockdowns and restricted travel.”
He notes that, conversely, digital infrastructure assets such as fibre optics did well as office workers shifted to working from home, thereby creating a demand for better internet connections.
This boost to digital infrastructure points to a longer-term theme that investors are coming to appreciate. A way to defend against future pandemics will be to pivot exposure towards more sustainable sectors that will still be relied upon in worst-case scenarios.
Assets such as fibre optic networks could become more valuable in portfolios than holdings that are vulnerable to travel restrictions. This is the view being taken by Peter Stonor, global head of transport, infrastructure and industrials at VTB Capital. “When it comes to protection against future disruption, infrastructure investors need to be prepared to shift allocations more quickly,” he says. “The pandemic has accelerated the big-picture trends that were already underway for infrastructure, perhaps by as much as 10 years.”
These include the energy transition from oil and gas into renewables; digitisation, including smart, efficient infrastructure; disruptive technology; and sustainable investment. This is not to say transport infrastructure will not have a place in portfolios.
Instead, Stonor argues that investors should be prepared to be more critical about what they are holding in light of the pandemic: “Investors need to critically assess what really fits within their traditional definition of transport infrastructure in a post-covid world.”
He identifies several criteria in light of this, such as whether a project provides an essential service to a community; whether there are high barriers to entry for investors; and whether it offers predictable cashflows. “To better understand the resilience of their infrastructure portfolios, investors must reassess their operational and financial leverage KPIs,” Stonor says. “This will then allow these portfolios to withstand prolonged shocks such as a global pandemic.”
Building an infrastructure portfolio with the resilience to survive future pandemics will not be an easy feat, and many investors will be trying to forecast what infrastructure a locked-down society will need. Fortunately, covid-19 has presented investors with new opportunities due to the unexpected side-effect of society becoming more engaged with sustainability.
According to the World Economic Forum, demand for renewable energyhas surged during the pandemic as existing fuel sources have been unable to operate because of the disruption. Consumption of renewables surpassed demand for coal in the US for the first time in 130 years. In many ways, the disruption was an opportunity to showcase renewables, and the investment case for these projects has been noted.
“Consumer sentiment towards unsustainable practices has fallen even lower over the pandemic, as people have had the opportunity to consider aspects of their lives which contribute to the sustainability issues we face,” says Peter Bachmann, managing director of sustainable infrastructure at Gresham House Asset Management.
“We suspect the appetite from millennials – and generations beyond – for fossil fuel-underpinned investments within their pension allocations will be very different to that of the baby boomer generation. We hope this is a driver for a more concerted institutional investor pivot towards sustainable infrastructure, with real asset-based solutions to environmental and societal challenges.”
Although it may be possible to identify infrastructure assets that would perform poorly again in a new lockdown, simply avoiding such holdings may not be ideal for many investors. Instead, the structuring behind such projects is being evaluated and the lessons from the pandemic means additional security is being built into them.
Infrastructure in general held up well as an asset class. However, the stasis of lockdown had an impact on particular projects that were caught out by the unexpected halt in cashflow.
According to Johnny Chow, CIO at Legal & General Retirement Institutional, this has made liquidity management an even more crucial part of infrastructure investment. “With many projects delayed due to new lockdowns, and changes around social distancing rules for construction projects, infrastructure investors are looking to ensure there are plans in place for the project to manage construction over time,” he says. “The main change has been that we are looking more into an investment’s short-term liquidity facility to ensure there are plans in place to manage construction over time – for example, in case there is another delay due to a lockdown.”
“Investors need to critically assess what really fits within their traditional definition of transport infrastructure in a post-covid world”
Though the world may be more aware of the risks pandemics pose to assets, being able to fully prepare for a genuine ‘black swan’ event is a near-impossible task. O’Brien is instead adopting a pragmatic view: that worldwide disruption will happen again at some point and so having a sensible attitude towards risk exposure is vital.
“Investors should take a more sensible approach to industry and financial forecasts to ensure there is sufficient downside protection against future demand or economic shocks,” he says. This will involve being aware of the short-term liquidity risks an investment could face: “A conservative capital structure with extensive liquidity is the best preparation that you can have for any unforeseen event.”
Covid-19 has made infrastructure investors more wary of illiquidity, with cashflow planning now a key consideration when it comes to asset selection. Governments around the world have issued expansive stimulus packages to support their economies and flood markets with liquidity, something Hari Chandra, co-head of global power, energy and infrastructure at Cantor Fitzgerald Europe, says helped support infrastructure projects in their darkest hour.
“Around a year ago [in April 2020], I sat down with my team and said this was going to be an extremely tough period and we all need to be thinking about restructurings,” he says. “A few months later, we were selling assets at their highest prices ever. That trend has been sustained for the past year.”
Although this staved off a liquidity crunch, infrastructure investment has now been widely identified as a way to stimulate economic recovery. In October 2020, the International Monetary Fund encouraged member states to make the most of low interest rates and subsidise infrastructure projects.
This may present greater opportunities for private investors, but Chandra is concerned about the unsustainability of infrastructure projects thriving off such cheap leverage. He believes investors need to be more aware of this risk.
“It shows capital markets chose to ignore the shock that happened in the real economy, continuing to finance at exceptionally cheap rates,” he says. “It has nothing to do with quality of projects or structuring. It has to do with a massive financial bubble that is a reaction to pandemic-related stimulus. It’s like being at a party at 2am and someone orders another round of drinks. It seems like a good idea at the time, but the hangover is worse.”