The New Infrastructure: At a crossroads

John Campbell reflects on the evolution of the infrastructure asset class in the first of a series of six guest editorials on this topic.

Private infrastructure investing is at a crossroads. The essential role of the private sector in financing infrastructure is now internationally recognised. Governments cannot finance their needs alone.

John Campbell

Historically, publicly listed utility, energy and transport companies have been a considerable source of essential infrastructure finance. Whilst this will continue, the public company corporate finance model is not a perfect model. Public company share prices – the currency of finance of their activities – are often less correlated to the success of their business than to market sentiment as a whole. They are required to deliver short term earnings as well as long term performance and to maintain cash reserves to ride out turbulent times. Their management has to be competent not solely in the business of infrastructure but in the different business of managing public companies.

Publicly listed infrastructure investment vehicles, created by many organisations in recent times, have also suffered greatly. Lack of alignment of interest between manager and investors, badly constructed corporate models and over-leverage have brought significant pain to investors.

Private infrastructure fund activity has also developed actively in recent years. Some of these funds have been constructed on a basis of proper alignment between the interests of the investors and the managers. For others this was not the case.

The initial pioneering funds reaped the benefits of limited competition for assets and the rerating of the inherent value of long term, relatively predictable, income. Leverage encouraged many to enter the sector in pursuit of short term gain. Confusion reigned as to the real returns available from infrastructure investment.

Sadly initial investor enthusiasm often exceeded the infrastructure investment judgement of those institutions and their advisers. Many failed to sort out the sheep from the goats and have correspondingly suffered poor returns.

The world has now changed. The question today is how the private fund sector can best work in true partnership to develop the world’s much needed infrastructure.

Several key foundation stones should be incorporated into a sustainable structure. First the recognition that infrastructure is an investment class in its own right. It is not a variation of private equity, public equity, bonds or of real estate. It combines elements of all of these separate classes but it needs to be the best element of each, not the worst.

Secondly infrastructure assets are the fundamental building blocks of society. More than any other sector, infrastructure has to be a partnership with society. It is not a get-rich-quick scheme. It is a long term partnership. It involves public works and public services. The sponsoring partners, being public servants, are accountable to the people of their countries. The terms of partnership have to be politically, socially and economically robust.

Thirdly, a long term approach is required. Nuclear scientists, power plant engineers, road and rail builders all appreciate that they are required to test their structures for every eventuality over a long term asset life to ensure their robustness and achieve public safety. This is an alien concept and in deep contrast to the modern financial services sector which has often abandoned fiduciary responsibility and shown negligible concern for the long term structural robustness of their creations.

Finally, the diversity of the sector must be honoured. This applies both to the underlying assets and to fund structures. Co-mingled funds are now available with fixed lives of up to 25 years or longer. New fee structures deliver more robust alignment between the LPs and GPs. One of the biggest challenges facing many institutions is the development either in-house, or through consultants, of the skill sets to assess these subtle but fundamental differences of approach which infrastructure funds are now starting to offer.

Infrastructure investing genuinely enables investors to capture predictable long term returns less correlated to other asset classes. Infrastructure fund investing is indeed at a crossroads. But the investor has to know which road to take.

John Campbell is a senior partner at placement specialists Campbell Lutyens. This article first appeared in the April 2009 issue of Infrastructure Investor magazine.