Infrastructure is an attractive and growing asset class. Driving the growth are several important benefits, including stable and reliable returns, low risk, and inflation-linked returns. However, accessing the right infrastructure opportunities is not always straightforward.
“Institutional and pension fund investors should look for a fund manager with a proven approach to selecting investment opportunities and building diverse portfolios,” says Hastings executive director of infrastructure Richard Hoskins. “Quality infrastructure investments should withstand the vagaries of economic cycles and deliver the consistent and repeatable returns for which this asset class is known.”
APPROACHES TO INFRASTRUCTURE INVESTING
There are several different approaches that investors can take to infrastructure investing.
–Public listed equities: This approach provides more ready access to liquidity, but unlike investing in unlisted or private market opportunities, relies on publicly available information in order to make investment decisions. There are inherent risks that come with this limitation. Other factors relevant to this approach include higher volatility, less diversification due to correlation to public markets, and reduced inflation linkage or returns.
–Direct investments in projects: This approach requires significant scale to obtain influential stakes in opportunities and substantial internal resources with specialised expertise to manage the investment process and actively manage the investment over its investment horizon. Benefits of this approach include greater control over investment decisions and portfolio outcomes.
–Infrastructure funds: Investing in these funds can be a successful way to access the many benefits that infrastructure has to offer including scale and diversification. Existing open-ended funds often hold quality portfolios of existing investments, reducing the investment risk for new investors. Against that, investors have less influence over investment decisions and so need to take care in their choice of manager.
THE BENEFITS OF INVESTING IN INFRASTRUCTURE
Many infrastructure managers have little to no track record of success. However, with the right manager, adding infrastructure to an existing portfolio can provide investors with several important benefits. These include earnings stability. Because of its limited correlation with traditional asset classes, adding infrastructure to a portfolio can enhance diversification and reduce the volatility of the overall portfolio.
In addition, you have a dependable revenue stream. Quality portfolios of core infrastructure assets demonstrate earnings resilience, with expected net returns of between 10 to 14 percent per annum. There is also moderate volatility – infrastructure appraisal-based valuations can smooth performance volatility and provide a hedge against more the more volatile performance of other asset classes.
Furthermore, there is information transparency. Private market opportunities require managers to have access to non-public information in order to make their initial investment decision and to manage the investment over its life cycle. This substantially reduces the investment risk. And, finally, you have inflation-linked returns, which are a benefit in terms of protecting returns from the impact of inflation.
IMPORTANT LESSONS IN INFRASTRUCTURE INVESTING
Below are 10 key considerations all pension fund and institutional investors should be aware of when considering investing in infrastructure:
1: Understand what constitutes an infrastructure investment and what does not. Don’t compromise.
2: Understand that with increased returns comes risk. Don’t ignore risk in favour of return.
3: Owning an investment requires active management. Don’t underestimate the resources required to do this properly.
4: Governance structures are critical to successful long- term investing. Spend time getting these right upfront.
5: Local presence or partnerships in foreign jurisdictions are vital to managing community relationships and reducing investment risk.
6: Take a cautious approach to the political and regulatory environment. Beware investments that are dependent on social policy rather than economic rationale.
7: Don’t pay too much – sounds obvious but price discipline is essential to creating long-term value. This includes optimising capital structures, rather than merely maximising leverage.
8: Ensure you have a fundamental understanding of all risks that might affect cash flows to equity and ensure those risks are priced in or plans are in place to manage and mitigate them.
9: Ensure there is real rigour around the approach taken to asset valuations. The approach delivers robust, predictable and justifiable outcomes so you don’t suffer surprises on realisation.
10: Choose your partners wisely and ensure they have a similar investment philosophy and approach to you.
Richard Hoskins is an executive director at Hastings Funds Management in Melbourne