Where there’s a will there’s not necessarily a way

Asian infrastructure continues to present a plethora of opportunities for investors willing to look in the right places. This was the prevailing view in conversations with limited partners and fund managers. Economic growth in large parts of Asia, coupled with a growing population, has meant that the supply of infrastructure in Asia is continually playing catch-up to demand.

Asia is urbanising at a rate never seen before, and the last two decades have seen a very significant chunk of the region’s population move into the middle-class bracket, which comes with greater needs and aspirations, facilitating the demand for more and better infrastructure.

Increasing urbanisation is one of the most significant phenomena of our times. According to PwC, in China and Indonesia the expectation is that 10 percent or more of the total population will shift from the countryside to cities between now and 2025. This means more urban infrastructure will be required, including water distribution and management, waste management, intra-city transport networks, and power among others.

Asia is faced with a substantial infrastructure deficit. The Asian Development Bank (ADB) estimates that, between 2010 and 2020, Asia needs to spend approximately $8 trillion on infrastructure to maintain current levels of economic growth. Governments cannot cobble together this kind of money themselves as they are already confronted with many other developmental challenges. Moreover, key governments in the region are running budget deficits (see table), further limiting their ability to fund the development and/or upgrade of infrastructure.

Different markets in Asia offer different opportunities. Allard Nooy, managing director of Markland Infrastructure Asia, an infrastructure-focused management consultancy firm, and currently senior advisor to InfraCo Asia, says that Asian infrastructure has the ability to offer large ticket sizes and diversification. Besides, “investors can see growth over a longer period of time, which is due to a combination of factors such as demand, GDP growth, population growth and demographics”.

Where investors want to park their capital is often dependent on the risk-return profile they are targeting. Hans-Martin Aerts, head of infrastructure Asia at APG Asset Management, says: “We constantly look at deals throughout Asia, but our current target countries are India, Indonesia and the Philippines. We consider these countries to be most attractive from a risk-adjusted return perspective.”

FOCUS ON THAILAND

Another interesting market at this point is Thailand, particularly since the military has taken over the reins of government and re-launched a huge infrastructure investment programme, Nooy adds. In August 2014, the regime announced it would implement a $75 billion infrastructure programme over the next eight years, mainly targeting transport infrastructure.

In Southeast Asia, Indonesia remains the most interesting market. Johan Bastin, chief executive officer at fund manager CapAsia, which recently closed a wind farm deal in the Philippines, says Indonesia is the region’s largest and deepest market in terms of infrastructure investment opportunities and will continue to see considerable economic growth.

“Even if the pace of growth is slower, as a G-20 country, the absolute size of the economy means that there is a sufficiently large pool of investment opportunities,” he says, adding that the new President recognises that “the sustainability of economic growth is predicated on infrastructure investment and has announced policies to that effect which should result in an acceleration of opportunities”.

Similarly, much is expected of the newly elected BJP government in India. Sushi Shyamal, partner, Infrastructure, Industrial & Consumer at Ernst & Young, says the government’s focus on policy initiatives, a time-bound approach and solution-based framework for attempting to resolve issues “has been able to instil confidence amongst both strategic and financial investors, both domestic and international”.

Foreign companies are showing increasing interest in India, Shyamal says. In addition to companies from the Middle East and Europe, those from Japan, China, South Korea and Southeast Asia are now also expressing interest in India’s infrastructure story. In the meantime, domestic Indian players are actively investing in infrastructure and the country has witnessed some large M&A transactions in the power sector in the recent past, for example. More importantly, the “unbundling of the railway sector could be a game changer for private sector participation in infrastructure creation,” Shyamal says.

CLEAN BREAK

Most investors agree that power and transport are the two areas requiring the most immediate attention and offering the biggest opportunities. Andrew Affleck, managing partner at Armstrong Asset Management, which manages a Southeast Asia-focused clean energy fund, believes there is much opportunity in the clean energy sector in the region as well.

He says that solar ground-mounted and rooftop projects in Thailand and the Philippines are a key focus currently, in addition to mini hydro projects in Indonesia. “The revised FIT [feed-in tariff] quota of 500MW from 50MW in the Philippines will drive investment activity over the next 24 months,” he says, adding that recent developments in Thailand should kick-start the next phase of solar development in that country as well.

However, even in markets or sectors with a lot of potential, there are not always sufficient opportunities to invest, due to regulatory or other reasons. Nooy thinks there is a lack of viable opportunities since there is a gap between the number of projects that are needed and projects that are well-prepared, well-documented and coming to market in a transparent way. There are other projects for which there is a great need but which are not able to mitigate risks sufficiently.

Vietnam is a country that should provide a robust flow of opportunities, says Bastin. “However the framework, at both the macroeconomic and fiscal level, as well as the regulatory level, is not there yet. It is a market we keep an eye on and we do follow closely, but we don’t think this is a good moment yet to enter.”
Strategic investors are entering the Vietnamese market, particularly in the power sector, but they have a longer time horizon, a higher risk appetite and often lower return expectations. This makes it difficult for fund investors to compete there for the same deals.

SLOW PROGRESS

In other markets across Asia, investors feel that while the regulatory environment is improving, progress has been too gradual. Many of the concerns associated with infrastructure investment in India have not been addressed yet and it will be a while before they are. Shyamal says “harmonious, consistent and transparent regulations are the key requirement of any investor-friendly regime”. Traditional concerns such as land clearance remain a key issue in India. “In sectors like highways, getting approvals in time has been a key reason for delay, resulting in time and cost overruns and making projects unviable,” he adds.

All of this is not for lack of effort, however. Governments across Asia are prioritising their needs and introducing initiatives to promote private sector investment in the infrastructure sector. China, for instance, which has traditionally been regarded a closed market for foreign infrastructure investors, announced in July that it will offer 80 infrastructure projects to the private sector in areas including railway and port construction, information technology, oil and gas and chemical industries, as well as renewable energy such as solar, wind and hydro.

Governments in the region are continuing to support the clean energy sector, which Affleck says will always be a key driver for investment in the region. “From the top-down approach of setting macro energy policy with a sensible and sustainable fuel mix with associated incentives, to the bottom-up approach of reducing bottlenecks in the permitting process for decentralised community solutions,” governments are promoting investment in clean energy.

Affleck says an example of this is the recent change of policy in Thailand with respect to the necessity of obtaining a factory license for rooftop solar installations of under 1MW. This has removed what was a significant barrier to implementation for many industrial customers.

Similarly, in Japan, greater attention is being paid by the government to develop renewables and, for the first time, foreign infrastructure funds are picking up large solar deals in the country.

Given the disparity between regions and the heterogeneity of the Asian infrastructure sector, how do investors go about formulating a strategy for investing? Jan Mende, a vice president at asset manager Capital Dynamics, says that with the expected population and market growth in Asia, there is “potential for expansion of brownfield assets and development of new greenfield assets which can offer potential for higher returns, in addition to the traditional mature infrastructure investment with a lower return characteristic”.

EXPERIENCE LACKING

Moreover, adds Urs Rieder, a managing director at Capital Dynamics, despite the significant growth of the infrastructure market in Asia, the number of experienced fund managers active in the region remains low relative to the market size.

“While aiming to invest across different segments of the market to achieve an investor’s desired risk/return profile, investors should not compromise on fund manager quality for the sake of portfolio construction,” he says. Particularly in Asia it is important to invest with managers that operate with experienced local teams, managers that have extensive networks that help to get deals closed, and teams with strong alignment of interest, he adds.

As of now, Bastin says that emerging markets in general – including those in Asia – are not the flavour of the day for institutional investors. Of those that private equity funds target, the larger ones are moving in the direction of direct investments, teaming up with strategic buyers in the process. On the other hand, many medium-sized institutional investors that have carved out allocations for infrastructure fund investments are going first to Europe and the US, he says.

Bastin thinks they will come back to Asia, though, because there is a considerable amount of capital available for investment in Europe but barely any growth in new opportunities. Hence, asset prices there are increasing as a result of greater competition. He says, however, that if institutional investors do come back, they will be much more selective this time and target specific markets, not just pan-Asian opportunities.

This is something the larger institutional investors are already practicing. Aerts says APG’s Asian investment strategy is quite targeted. “Our clients have a preference for infrastructure assets with substantially contracted or regulated revenue streams providing downside protection. However, we’re also targeting to build up a portfolio with a diversified revenue risk profile which will enhance the overall portfolio return. We believe this is where Asia comes into play.”

The firm is focused on specific markets and does not take a blanket approach to investing in Asian infrastructure. The asset manager’s recent foray into India is along the lines of what Bastin refers to. Aerts says APG has been putting effort and time into finding the right local partners “with the aim to build long-term partnerships”. For example, it has formed a strategic alliance with Piramal Enterprises, one of India’s largest diversified companies, to invest in infrastructure projects in the country. It is looking to set up similar partnerships across other Asian markets as well.

CHANCE TO DIVERSIFY

Asian infrastructure offers a compelling proposition for experienced infrastructure investors to diversify their portfolios, says Rieder. “An allocation to Asian infrastructure is seen as an attractive addition to an infrastructure portfolio based on mega-trends in Asia and risk premiums, which typically more than offset increased country, business and foreign exchange risks.”

Asia’s infrastructure requirements will increase substantially over the next few years as the economies in the region keep growing and this will further open up opportunities for private investment in the sector. According to PwC’s Capital Project and Infrastructure Spending: Outlook to 2025 report, Asia’s infrastructure market is expected to grow by between 7 percent and 8 percent a year over the next decade, approaching $5.36 trillion annually by 2025. By then, this figure will represent almost 60 percent of the world’s total.