The diversification challenge

In the wake of the Spanish government’s decision to retroactively dismantle the tariff regime that renewable energy investors in the country had signed up to, there was some consolation amid the shock. This was solely a Southern European phenomenon, resulting from the harsh fiscal realities being faced in that part of the world following the global financial crisis. Wasn’t it?

Well, no. That particular comfort blanket was soon ripped from the hand and shredded as European government after European government (and European regulator after European regulator) took one look at the prevailing environment for infrastructure investors and decided to change it to something less favourable. Clearly, this was not solely a Southern problem – as investors in Norway, Germany, the UK and other Northern ‘safe havens’ will now testify.

The conclusion drawn today – and voiced at Infrastructure Investor’s European fund management roundtable in London this week (see a full write-up in the Dec/Jan issue) – is that the only way for fund investors to avoid being buffeted by these increasingly regular shocks to the system is to diversify.

The need for geographic diversification has already been alluded to. Accept that there is no such thing as a safe haven these days and you are left guessing where the next flare-up will happen. You can’t of course. And that’s why you need to have exposure to a range of countries rather than just one or two.

Then there’s the need to diversify beyond regulated assets. One roundtable participant said he once offered the opinion that regulated assets were more risky than any other kind of assets – but only in order to be provocative. These days, people may well not recognise the sense of mischief. As regulators increasingly prioritise consumer sensitivities ahead of a benign investment climate, it may pay to make sure non-regulated assets find their way into the portfolio as a risk/return hedge.

Given the much-hyped pricing pressures for core, brownfield assets, there is also a strong argument for ensuring that greenfield investments are a part of the mix. I’ll leave aside for now the debate about whether or not the greenfield market is riskier – suffice to say for current purposes it should be seen as a viable alternative.

So: time to diversify. But how? Not so easy. For one thing, the infrastructure asset class is still small. According to placement agent Probitas Partners, 110 infrastructure funds were in the market last year seeking $80 billion in capital. By contrast, in 2011 Bain & Company identified around 1,000 private equity funds trying to raise $600 billion. A simple point perhaps, but bigger numbers = greater diversification.

Of the capital targeting the infrastructure space, is it spread widely across geographies and types of investment? Far from it. Last year, Probitas concluded that around 60 percent of total capital was allocated to funds either targeting Europe or North America – only 10 percent was headed for emerging market funds. Moreover, a disproportionate amount of that capital is gravitating towards the core, brownfield space.

Diversification appears to offer an antidote to regulatory shocks, pricing pressures and other types of headache. But – whether it’s down to investors’ lemming-like tendencies or a lack of suitable offerings in the market – achieving it is easier said than done.