Asian infrastructure, over the last couple of years, has benefitted from a significant shift towards global emerging markets investing, and today makes up the majority of the emerging markets portfolio for most investors. A large number of institutional investors are now seeking greater exposure to infrastructure in Asia.
One of the biggest attractions of investing in Asian infrastructure is the diversification it allows investors. Steve Gross, senior managing director at Macquarie Infrastructure and Real Assets (MIRA), says Asia is not homogenous so a diversified portfolio across Asia provides access to many benefits. “In terms of how we evaluate the right time to enter an infrastructure market, we look at three key factors: 1) demographics and macroeconomics; 2) the infrastructure gap; 3) infrastructure as a national priority and supportive regulation,” he says.
Moreover, MIRA, which has more than 40 infrastructure investments in Australia, China, Korea, India and the Philippines, sees “really strong opportunities” in sectors where the infrastructure gap is the greatest, and in Asia, this generally means areas such as water and wastewater, and gas distribution, he says. One reason for the opportunities in these areas is that they tend to exhibit fragmentation both geographically and along the value chain.
Benjamin Haan, who is responsible for private infrastructure investments across Asia Pacific for Partners Group, says Asia is seen as a significant source of the infrastructure opportunity set at the firm, which has deployed more than $450 million in Asian infrastructure since 2008. “All of our dedicated infrastructure programmes target meaningful exposure to Asian projects/assets, with target allocations to the region (ex-Australia/New Zealand) of between 10 percent and 30 percent,” he says.
He adds that Partners Group also runs more focused emerging markets infrastructure mandates for some of its larger pension fund clients and that these target an even higher level of exposure to Asian infrastructure.
“We believe exposure to Asian infrastructure is critical when building out a global infrastructure portfolio as both a diversifier and a return driver,” he says.
Diversification is a key draw for many investors looking at Asia. For instance, Hans-Martin Aerts, head of infrastructure Asia at APG Asset Management, says the firm has a preference for infrastructure assets which provide steady, predictable returns. “However, we’re also targeting building up a portfolio with a diversified revenue risk profile which will enhance the overall portfolio return. We believe this is where Asian infrastructure comes into play.”
APG has been focused on Asia for a while now, and the region’s “long-term compelling market dynamics” are expected to enhance the overall return for the firm’s investment portfolio and to offer further diversification benefits.
In infrastructure, Standard Chartered Bank is focused mainly on emerging Asia, says Andrew Yee, global head of infrastructure, principal finance, at the bank. Their investors are seeking higher returns of around 20 percent as compared with OECD returns of 8 percent to 12 percent. Standard Chartered continues to develop an emerging Asian infrastructure portfolio which is diversified by country (China, India, and South East Asian countries such as Indonesia, Malaysia and the Philippines), by industry sector (power, transport, water and the environment) and importantly by vintage year.
“This geographic diversification strategy was proven during the extreme volatility in the emerging markets (stock markets and currencies) as recently as mid-2013,” he says, so while India was suffering a downturn at the time and the bank’s Indian investments were marked down like everyone else’s, its overall portfolio “remains strongly positive and in the money”.
Gross speaks on behalf of many investors when discussing the drivers for Asian infrastructure. The region has a large population with a growing middle class. This means countries have an increased ability to spend and the lower dependency ratio means there are fewer pension liability issues. “The Philippines is a great example of this, but wherever you look in Southeast Asia, it delivers strongly on this measure,” he says.
Generally speaking, there is an infrastructure deficit in the region which cannot be addressed solely by governments due to a funding gap, which accentuates the importance of private funding. The Asian Development Bank estimates that Asia needs $8 trillion in infrastructure spending by 2020 and, needless to say, much of this money has to come from the private sector.
Finally, governments in the region have made, or are making, infrastructure development a core priority as they realise its importance to economic growth. This is resulting in the establishment of effective legislation and partnership structures that promote private investment.
One area that has received a lot of interest of late is renewable energy. Haan says it is “probably the most interesting infrastructure sector in Asia at the moment”. There are fewer pools of capital specifically targeting opportunities in this space as compared with other regions. “We believe very attractive returns can be generated if you are an early mover into a market where a new renewable support regime has been introduced and the market is yet to mature,” says Haan.
One such pool of capital is managed by Singapore-based Armstrong Asset Management. Andrew Affleck, managing partner at the firm, which has raised $130 million of a $150 million-target clean energy fund, says: “The depth and breadth of investment opportunities in the renewable energy space has improved considerably in the last three to four years with an increasing number of high quality solar photovoltaic (PV), wind, hydro and biomass/ biogas investment opportunities in our key markets,” adding that there is interest from both debt as well as equity providers to invest in these opportunities.
Affleck says that while solar PV’s fast-improving economics and low-risk characteristics have made it a recent focus for many renewable energy investors looking at Southeast Asia, policymakers in the region want to see more investment in small hydro and wind as they provide the lowest-cost sources of renewable energy.
Regional governments have been more supportive, and Affleck says that energy security issues and the need to reduce fossil fuel subsidies is motivating policymakers in Southeast Asia to create a more attractive set of criteria to incentivise private sector investment in renewable energy. The opportunities he sees are currently in Thailand (solar); the Philippines (solar and mini-hydro with bilateral power purchase agreements); and Indonesia (mini-hydro).
Investing in Asian infrastructure is not without its pitfalls, however. Allard Nooy, managing director at Markland Infrastructure Asia, an infrastructure-focused management consulting firm, says one of the big issues in remains the regulatory environment and the risks associated with that, which are related to protection mechanisms and tariff settings.
Bankability is also a challenge in certain markets, he says, making mention of India, Indonesia and Vietnam. “India has been a difficult debt market for a number of years and that hasn’t improved particularly. Other risks are in relation to land use rights – rights of way and rights of use – and there are significant challenges in that regard in countries such as India, Indonesia and Vietnam,” he adds.
Another area of concern is deal sourcing and due diligence by private equity investors, in his view. He says deal closing often takes a long time and there is a risk of not having the ability to close a deal, during which the development costs and deal structuring costs continue to mount up. “I think that particular aspect is keeping certain investors away from the infrastructure space in Asia,” he says.
Then there are markets that some investors find less attractive due to other reasons. Partners Group, for instance, on a relative value basis for infrastructure investment, finds China, Korea and Malaysia less attractive. “In these markets we face intense competition from domestic capital, and consequently access to deal flow and returns on offer are less attractive, [and] in some sectors even lower than what we can generate in Western Europe, the US and Australia,” he says. Several other investors also mentioned Japan and Korea as difficult markets to break into.
The greatest challenge in infrastructure investment in Asia is the region’s diversity, in Haan’s view. In order to get comfortable deploying money in any market, one needs to spend sufficient time on the ground to first properly understand that jurisdiction and what risks one will be taking, and that is very challenging in a region as diverse as Asia.
“The challenge is the diversity of Asia and the time such an effort takes, therefore the key is to focus your resources on certain themes and certain markets rather than trying to broadly cover the entire region effectively,” asserts Haan.