Private institutional investors’ role in meeting the world’s ever-growing infrastructure investment requirement continues to expand. This will come as a surprise to very few reading this. Against this broad trend, however, the real story lies in how the investor base is evolving. How do the newer infrastructure investors compare to their more established counterparts? What market segments are they most likely to target? And what implications does this have for market participants new and old alike?
We explore these questions by looking at supply and demand from a core brownfield infrastructure perspective.
Demand: Shifting sands
Beyond the sheer increase in capital being mobilised, the investor base is evolving in several key respects.
First, while the existing institutional investor base is dominated by mature markets such as Canada and Australia, the majority of new capital is coming from regions such as the US and developed Asia.
This is significant, as the participation of investors from the world’s largest capital markets (the US and Japan) adds a new dimension to the asset class.
Second, the category of investors is broadening. Of the three main categories of end-institutional investors – insurance firms, sovereign wealth funds and pension funds – it is the latter which have accounted for the lion’s share (roughly 70 percent) of infrastructure funds under management (FUM). This is despite insurance funds being a larger potential source of capital than pension funds globally.
On a forward-looking basis, however, our analysis reveals insurance funds are shaping as the largest single investor group, with a 44 percent share of future commitments, up from 14 percent historically. These typically conservative investors are seeking to diversify into alternatives in the face of historically low yields in order to liability-match.
Third, the prospective entrants to infrastructure are, on average, larger than their incumbent counterparts.
The world’s largest pension fund, Japan’s $1.1 trillion Government Pension Investment Fund, is yet to make its maiden infrastructure investment, having announced a feasibility study into the asset class only last year. Other large investors, such as Norway’s $700 billion sovereign wealth fund, are looking into infrastructure more closely.
Overall, the average investor’s total FUM on a forward-looking basis is $38 billion – two-thirds higher than the average of $23 billion for current investors.
Supply: Relatively steady
In the face of this growing demand, the level of core infrastructure investment opportunities has remained relatively fixed. Institutional infrastructure activity peaked in 2007, with $52 billion in M&A. However, in the ensuing five years, annual institutional M&A activity has averaged only $27 billion.
Positively, 2012 activity was up 38 percent on 2011. And at the halfway mark, indications are that 2013 will be an even stronger year in terms of activity. However, even an accelerated finish to the year is unlikely to be enough to satisfy increasing institutional demand.
This is not to say there aren’t potential release valves. Since the global financial crisis, North American activity has declined markedly – H1 2013 has been virtually neck-and-neck between Europe and Australia. Given the long-term investment horizons of most brownfield investors, they are likely to continue to prefer the relatively investor-friendly investment regimes in OECD countries. Accordingly, North America represents arguably the key supply growth opportunity.
The dominance of energy deals in the US has been offset to some extent by increasing greenfield/PPP transport deals. And while political inertia hinders further brownfield transport privatisations in the short-term, there is a sense of inevitability in the medium-term due to fiscal pressure and deteriorating infrastructure.
Corporates are another avenue. Our analysis indicates the level of corporate infrastructure M&A is roughly four times that of institutional infrastructure M&A. While not all of this may be attractive to institutional investors (electricity generation assets, for example, are plentiful but considered riskier than regulated transmission and distribution assets), they nevertheless constitute an obvious opportunity as debt-laden integrated utilities continue their multi-billion dollar divestment programmes.
The other source of potential deal flow is other institutional sellers. As the wave of closed-end funds with mid to late-2000 vintages reach the end of their fund lives, a string of assets will be recycled into the secondary market.
Investment strategy: What is the smart play?
As the number of moving parts in the market grows, the billion-dollar question on investors’ minds is: What is the smart play for core infrastructure investors?
In many instances, the answer depends on what the investor’s priorities are.
One option could be to venture into non-core strategies, taking on more greenfield, emerging market or demand risk. Investors could also explore alternatives such as infrastructure debt or listed infrastructure. However, investors must recognise that while these may be thematically linked, they offer very different risk-return characteristics.
Those maintaining a core infrastructure focus will no doubt be wary of asset price inflation appearing in certain segments of the market. But here it is crucial to understand exactly where the asset price inflation is occurring. For example, the current debate is often couched in terms of GDP-correlated versus regulated assets. Yet there are prominent examples of high multiples paid in both camps.
Our understanding of the evolving investor base, their preferences and the prevailing supply constraints suggest that a smarter distinction for investors is the size of the asset, as this is often linked to the level of competition, and hence price inflation. Vendors of larger, more visible ‘trophy’ assets are likely to go to market via an auction process in order to extract the best price.
While not impossible to find value in this segment, it is certainly more difficult, particularly as larger would-be investors enter the fray. Deployment is another challenge: there are only a handful of large deals a year. We estimate that, for the 22 institutional investors that were successful in large contested auctions since the beginning of 2012, at least 80 other investors reportedly missed out.
One area which currently offers more value is the mid-market. Our in-house analysis shows that this segment boasts a far greater number of deals, while still representing a meaningful part of the market on a deal value basis. These opportunities are often more difficult to identify and access, and are generally less competitive as a result.
Investors quick to recognise the deployment challenge and therefore readjust their investment strategies are also likely to view existing portfolios (such as open-ended funds or partly-invested funds admitting new investors at NAV) with renewed interest. These may allow value-minded investors to gain access to quality assets at attractive pricing (relative to the current market), while avoiding blind pool risk, delays and failed bid costs.
Ritesh Prasad is a senior investment analyst in infrastructure research at Colonial First State Global Asset Management (CFSGAM) in Sydney; Perry Clausen is head of global infrastructure investment at CFSGAM in Melbourne