All is not what it seems

We consulted with seven experts and they told us about an amazing new asset class. Some of its distinguishing characteristics included high returns, low current income and a predominance of bank financing. They were talking about infrastructure. Though be careful: there is also a view that this is not really an asset class at all.

Read on to find out more about the “asset class” that you thought you knew.

Myth 1: Greenfield infrastructure is always riskier than brownfield infrastructure
“Many investors automatically assume that brownfield infrastructure is “safe” and greenfield infrastructure is “risky.” This view probably stems from the well-known components of construction risk: cost overruns and delays. These elements are rightly a valid concern because they have the potential to severely impact returns. However, there are good and bad assets to be found in both greenfield and brownfield infrastructure.

The risk profile of a greenfield investment can be changed dramatically by three things: first, obtaining a post-development (construction-ready) project; second, negotiating a fully-wrapped (guaranteed) engineering, procurement and construction contract with a creditworthy counterparty; and third, ensuring the project is carried out under strict project financing disciplines. These modifications will make the asset – upon completion – meet the strong appetite for operational, cash-flowing brownfield assets, creating the conditions for an exit at a nice premium.

Furthermore, there is less capital pursuing these deals, reducing pressure on entry valuations. Thus a greenfield project may sometimes be more attractive on a risk-adjusted basis.

Every underlying asset is different, making it unwise to generalise about the risk/return profile of an entire segment of the infrastructure market. This myth should be busted and investors must look at opportunities on a case-by-case basis with the appropriate expertise to assess the risk/return profile.”
Reyno Norval, senior associate, Altius Associates

Myth 2: Institutional investors are afraid of construction risk
“Institutional investors have developed an appetite for investing in large portfolios of infrastructure debt. As an asset class, infra debt exhibits higher recovery rates than corporate debt, and its long-dated returns could facilitate investors’ liability-matching investment strategies.

That said, one factor thought to cause significant concern for these investors is construction risk, as many insurance companies and pension funds are perceived as lacking the skill-set required to fully assess the risks of a project. As a consequence, there is a sense of nervousness over the large construction cost overruns frequently reported in the press.
We would argue, however, that the changes currently taking place in the infrastructure financing world are altering this mind-set.

We would argue, however, that the changes currently taking place in the infrastructure financing world are altering this mind set.

Indeed, more and more institutional investors have realised that the reported cost overruns
often refer to publicly procured projects (for which they are rare) and would be borne by the contractor within its liability cap – keeping the debt immune.

Therefore, institutional investors are now participating in large-scale infrastructure projects – often by teaming up with leading project finance lenders. This involves greenfield projects with construction risk attached. Not only are these investors leveraging banks’ expertise in advisory, origination, structuring and servicing, they are also getting used to undertaking in-depth credit analysis, including that for construction risk.

By actively seeking to invest in construction risk, investors are also giving their debt portfolios an efficient – and welcome – diversification of risk and additional source of return.”
Anne-Christine Champion, global head of infrastructure and projects, Natixis

Myth 3: Infrastructure investing delivers low returns
“There is no doubt that the wider financial services community associates the term ‘infrastructure investing’ with investment in operational assets targeting long-term, low risk return profiles. This, however, ignores an attractive subset only a handful of early-stage private equity investors with the right skillset are exploiting.

Instead of chasing operational yield, their objective is to generate capital gains. The strategy is focused on funding the development phase, de-risking the projects by managing permitting and construction and, once commissioned, selling them to investors looking for operational assets. While this approach involves investing in earlier propositions, it does not necessarily imply that risk-adjusted returns are less attractive than strategies targeting long-term yield.

The current market environment, where there is a serious lack of capital for construction equity, leads to a solid supply of early-stage projects offering attractive risk-adjusted returns while competition for operational, yielding assets is high – driving up valuations. One of the key success factors in realising capital gains is a deep understanding of a project’s risks during the development and construction phase and the ability to mitigate them.

This clearly challenges the low-risk, low-return, long-term hold label attached to infrastructure investing. Quite contrary to the myth, infrastructure investing today can deliver impressive returns.”
Erich Becker, partner, Zouk Capital

Myth 4: Infrastructure fund investing generates strong current income
“This myth at its core is about definition. For many investors, infrastructure investing is about a type of underlying asset – a “real asset” that is capital intensive, usually operating in a highly regulated environment, often operating under a long-term government concession.

Beyond that, however, there are a number of risk/return profiles in the infrastructure sector. Funds focused on greenfield investment must of course build out an asset before it starts to cash flow. Opportunistic funds usually take over assets that need capital to restructure in some manner, with much of the cash generated in the early years of ownership being ploughed back into the restructuring.

And even in core brownfield funds targeting well-maintained assets, the bidding process can drive prices so high that some managers feel the need to take on large amounts of leverage to hit their return targets – a tactic that, in the best of times, requires large amounts of cash to service the debt and, in the worst of times, can result in bankruptcy in a market downturn.

As with all investment, the devil is in the details.”
Kelly DePonte, partner, Probitas Partners

Myth 5: Infrastructure is an established global asset class
“Perceived wisdom is that investment in infrastructure is now an established asset class. Specialist funds invest exclusively in the infrastructure market, advisory firms have dedicated teams and financial institutions increasingly have specific allocations to the sector. Only last week, the World Bank proposed the creation of a Global Infrastructure Facility, to promote infrastructure development in emerging economies.

Yet, with notable exceptions, looked at globally, this current “asset class” remains subject to inconsistent deal pipeline and delivery. Some governments remain wary about the level of return private infrastructure can deliver, yet remain reluctant to share risk in way that can stabilise the return on private capital.

Private capital remains willing and able to invest in infrastructure, but public sector education on how best to utilise private capital remains embryonic in many areas (a problem not limited to the developing world). And public bodies sometimes remain unwilling and unable to address the social and political obstacles to facilitate private investment.

In the wider economy, examining global brands that are on an upward trend reveals a common theme: the success of products and services that promote a wider social goal/consumer experience, rather than just technology. In the infrastructure space, this translates to the need to establish mature structures across the asset class that deliver a fair return, across a consistent deal pipeline, and produce a “win-win” relationship with governments and consumers.

Recently, one major infrastructure company has re-branded as a “social innovation” business. If public bodies can work with private capital to deliver genuine social change through public service delivery, within structures that attract global political and social buy-in, then infrastructure as a truly global asset class will have really arrived.”
Andy Briggs, partner, Hogan Lovells

Myth 6: Bank lending is being replaced by institutional investor financing
“While structural evolution is changing the pattern of long-term financing, it would be wrong to dismiss the essential role that banks will continue to play in infrastructure projects. Multi-source funding, including both banks and institutions, will remain the standard model, with the balance of funds varying according to project type and stage, location and political scenario – but with banks absolutely in the mix.

Banks perform a vital monitoring role as syndicate agent, both helping to mitigate moral hazard as well as the risk of spiralling costs and work overruns during the construction phase of infrastructure projects. Captive financiers and project sponsors also play a key role here, as discussed in a white paper named Making the Difference published by the Financial Services Unit of Siemens (SFS). The paper illustrates that with a deep understanding of technical risks these groups work together with the banks in order to manage and price project risks effectively.

As institutional appetite continues to grow for infrastructure projects, banks and project sponsors will continue to play an important role in helping these new market entrants understand and feel comfortable with the risks involved in infrastructure. Until institutional investors have built up an established track record of experience and expertise in the asset class, banks will remain the largest private supplier of infrastructure funding.”
Johannes Schmidt, chief executive officer, project and structured finance infrastructure & cities and industry, Siemens Financial Services

Myth 7: Parking PPPs are a new phenomenon
“One parking P3 myth is that P3s or public-private partnerships are a new concept in the US and only a few have been completed. A public and private collaboration includes the transfer of risk to the private sector and utilises private expertise and investment to build, repair or update a public parking system.

Three US airports issued public bids in the 1990s and 2000s for the private sector to collaborate with the airport to build, operate and maintain new parking garages: the TF Green Airport (Rhode Island) and Bradley Airport (Connecticut) projects began in the 1990s and New Orleans Airport (Louisiana) in 2000.

On October 8, 2013, Mayor Gregory Ballard of Indianapolis (Indiana) accepted the National Parking Association’s Innovator of the Year award while speaking at their annual convention for Indianapolis’s successful launch of its public and private parking collaboration for the management and technology update of the municipal parking system in 2011.

Branding these projects P3s in the US is new but the concept and history of their success in the US is not.”
Rick West, managing member, West-FSI