Infrastructure investment has become front page news thanks to US President Joe Biden’s $1.2 trillion bipartisan infrastructure bill. Funding infrastructure has enormous societal benefits – this asset class can uplift entire countries.
Infrastructure investments provide pension funds with stable, long-term, predictable returns and cashflows. The risk profile is relatively low and returns are mostly uncorrelated to listed equity returns. Crucially, as returns are not very volatile year-to-year, there are no sudden liability gaps in a funded profile.
The McKinsey Global Institute estimates that infrastructure’s socioeconomic rate of return is around 20 percent. In other words, $1 of infrastructure investment can eventually raise GDP by 20 cents. The world spends more than $2.5 trillion annually on infrastructure, but $3.7 trillion a year will be needed through 2035 just to keep pace with projected global GDP growth. We face the challenge of scaling up investment to keep pace with these demands.
One of the critical tools to meeting this need is the use of perpetual capital vehicles. PCVs are gaining traction in more developed markets as an alternative to traditional private equity vehicles. We believe they can come into play to open up infrastructure investing in Africa on a larger scale to pension funds.
Infrastructure’s estimated socioeconomic rate of return according to McKinsey
These vehicles, also known as open-end funds, include all listed and unlisted investment holding companies. Infrastructure Investor lists 66 open-end infrastructure equity funds on its website, including IFM Global Infra Fund ($34 billion), Blackstone Infra Partners ($14 billion) and PGGM Infra Fund ($7 billion).
These PCVs share some common criteria that underline their suitability for infrastructure investing. They are structured as investment holding companies, with diverse subsidiaries but within a common vision and corporate strategy.
The management centrally controls asset allocation decisions and leverages the balance sheet to make new investments.
Critically, a PCV caters to a wide range of investors including pension funds, development finance institutions, banks, asset managers, and high-net-worth individuals and their investment horizons and liquidity requirements.
PCVs deliver a combination of growth and yield, and overall returns well above inflation, known as net real growth. This means management teams have incentive to deliver consistent net real growth in net asset value.
PCVs enable pension funds to increase their exposure in infrastructure investments in three key areas.
When a fund directly invests in an infrastructure asset, the distributions, while predictable, are back-ended as the debt reduces in a project. When it invests via a private equity fund, distributions occur mostly when the PE fund exits or sells the asset, resulting in lumpy, unpredictable and back-ended payments. Also, unexpected drawdowns can create near-term liquidity risks.
However, if a pension fund invests in an infrastructure PCV, the liquidity risk is mitigated. This is for several reasons – as the PCV owns a portfolio of assets at different maturity levels, it can make cash distributions with no ongoing drawdown risk and no need to exit a project to create liquidity for investors.
LPs can also trade or sell the shares in the PCV, whether listed or on the secondary market. They can therefore gradually increase or decrease exposure without having to force an exit of an underlying asset.
Strategic platform building
Investing directly in a single infrastructure asset or through a limited-life PE fund does not provide the ability to build long-term, strategic, sector-specific platforms and capitalise upon the demand in this asset class. Investing in an infrastructure PCV allows management to aggregate assets within a specific subsector, across different countries, to create an Africa-wide sector leader.
“Large, sector-based PCV platforms can be actively managed and deliver a combination of cash dividend yield and the ability to reinvest in new growth prospects”
This in turn improves the ability to negotiate contracts with customers and suppliers, thereby improving the success rate in tendering for competitive bids. Winning more contracts improves track record, balance sheet strength and the level of management experience.
The diversification benefits within the platform companies mean temporary problems at one or two projects do not pull the entire company down. This contributes to overall risk mitigation for the investor.
Scale and exit benefits
There has always been a challenge in exiting a minority shareholding in a single standalone African infrastructure project. The universe of buyers is basically restricted to other African infrastructure PE funds as the lack of scale and diversification benefits do not incentivise large players to even start a due diligence process.
This is again where PCVs really shine. Building large platform companies with a specific focus on key sectors, such as renewables, telecoms and airports, offers much more attractive targets with significant scale, diversification, expertise and continental reach.
These platform companies can be listed separately to achieve a partial exit and higher valuation. This in turn attracts global infrastructure funds in the $5 billion to $20 billion range, draws in multinational industry players and introduces various M&A options.
Large, sector-based PCV platforms can be actively managed and deliver a combination of cash dividend yield and the ability to reinvest in growth prospects. Another advantage is active balance sheet management to reduce the cost of capital, which can result in more competitive bidding for projects without impacting equity returns. At the holding company level, PCVs offer benefits such as ability to invest in new leading technologies via platform companies.
It has been demonstrated globally that building connectivity infrastructure such as roads, railways and telecoms drives higher GDP growth. However, to fully realise these opportunities, more innovative funding and liquidity options and investment vehicles must be developed to suit the requirements of pension funds.
Emile du Toit is managing director, fundraising and liabilities management, at Harith General Partners, a pan-Africa infrastructure fund manager based in Johannesburg