While a gas power plant may ‘look and feel’ like an infrastructure asset, it is the contracts shaped around it that will determine whether it actually is one from an institutional perspective, Jim Barry, managing director and chief investment officer of Blackrock’s infrastructure investment group, told journalists during a recent press roundtable on how real assets can be added to portfolios for diversification.
“Infrastructure can be a fabulous diversifier if you do it right; if you do it wrong, you won’t end up with diversification,” Barry said. “With infrastructure, you’re buying individual assets, so the specific contractual context of the asset ultimately will shape the degree – or not – of diversification of your portfolio.”
For this reason, institutional investors need to make sure they’re buying the right asset, and the first step towards accomplishing that, according to Barry, is for investors to be very clear about what they want from the asset class and to see what they are actually getting.
Part of choosing the right asset involves taking into consideration regulatory risk. “Every infrastructure asset – whether people want to admit it or not – carries regulatory risk,” Barry said. “The public sector is that one entity in the world that can and will re-trade you if it’s in its interest and most likely will get away with it.”
Evaluating risk should include looking at the constitutional law and contract law context, as well as the economics and dynamics that might re-shape policy in the future, Barry explained, emphasizing that regulatory risk is not just present in emerging markets but in developed and mature markets as well.
Learning from the past
While regulatory risk may go with the territory when it comes to infrastructure, other risks are not inherent to the asset class. Developments leading up to the global financial crisis, however, changed that.
Capital raising had its heyday in the 2000s, particularly between 2005 and 2007, Barry said. Suddenly, the amount of available capital rose sharply, significantly outpacing the number of opportunities available.
According to Barry, two things happened. “First, prices went up and, in the easy credit market pre-July 2007, a lot more debt went into the assets that really never was intended,” he said. “The second was that, in the hunt for deals, managers and institutions began to stretch their definition of infrastructure and suddenly a lot more risk – particularly GDP exposure – found its way into the asset than was ever intended. However, all that came to roost in the financial crisis.”
While the debt side has proven “extraordinarily resilient’, the equity side came under a lot of pressure and, in a number of notable transactions, went to zero.
“It was never intended as an asset to go to zero; capital preservation always has been considered core to it,” Barry stressed.
What lies ahead
As a result, many institutional investors have decided to go direct and there has been a flight towards larger managers, making the ‘big guys’ bigger in the process.
This shift poses two potential dangers, according to Barry. Large fund managers are going to be challenged in deploying the capital, which in turn may affect alignment of interest between the fund managers and their investors. For those institutional investors who prefer to invest directly, the challenge will be having the necessary expertise to do that successfully.
“You really have to build a big experienced team in order to be in the flow and in order to be disciplined about your investment,” Barry noted. “Most are not making that degree of commitment.”
BlackRock’s approach is simple: “Identify specific niches or subsectors of the market […] and go after them with deep, deep, deep sector expertise,” Barry said.