It is difficult to think of a longer-term investment class than infrastructure: the underlying transport (ports, airports, toll roads, bridges, tunnels and railways), utility (water and power); and social infrastructure (including schools, hospitals and prisons) are often owned and constructed in partnership with governments and meant to serve society’s needs for decades.
They offer stable cash flows that are pretty much immune to the business cycle, tangible real assets that can hedge against inflation and even inflation-linked lease structures. Picked up by sophisticated institutional investors trying to match their liabilities, private banking is looking at infrastructure in a very similar way.
“We view it as a core buy-and-hold investment,” says Paul Sarosy, head of investment solutions at Credit Suisse.
Private bank clients do not seem to regard infrastructure as an asset class, but rather a theme that plays across a whole range of asset classes. Overall it can exhibit similar cash flows to a long-dated inflation-linked bond, but it involves equity ownership of real assets with capital-growth potential as well as income yield – which in turn make it feel like real estate.
“I prefer to describe it as a hybrid asset class,” says Philip Watson, head of the Investment Analysis and Advice Group at Citi Private Bank.
And what is the theme? Basically, demand for infrastructure investment, combined with government budgetary constraints, means mind-boggling private sector investment opportunity. Consultancy Booz Allen Hamilton has estimated that, over the next 25 years, the water, electricity, and transportation systems of the world’s cities will suck up $40,000bn (E25,100bn).
Developed world
The emerging-markets story is well-worn, of course, but that is not to understate the scale of the opportunity presented by the Victorian pipes and collapsing bridges of the developed world.
 | ‘I prefer to describe it as a hybrid asset class’ - Philip Watson, Citi |
“We regard the US as one of the biggest emerging markets for infrastructure anywhere in the world,” says Neil Jones, a divisional director with Macquarie, the Australian bank that has established itself as a leader in infrastructure finance and investment. “You’ve heard of power outages in New York and LA. How many stock exchange-listed airports are there in the US? None. Compare that to Australia, Asia, Europe. And other areas are also in dire need of long-term capitalisation.”
Alongside true asset-class and geographical diversification, allocators can also source investments with different lifecycles and managers with passive or active styles. Essentially there are capital-growth projects and assets (generally new builds) which eventually turn into assets that generate yield from tolls or rents. Active managers with a 5-7 year time horizon can crystallize capital growth with private equity-style exits, selling to passive managers who take the income over 10-20 years or more.
A lot of risk derives from the fact that these are assets of prime social utility – and therefore subject to the vagaries of politics. Emerging-market investors can be exposed to sovereign risks, corruption and a general absence of robust legal systems; but even in developed markets, when income depends on inflation-linked lease contracts with public bodies, it is “highly recommended that investors work with local partners who have on-the-ground knowledge of operating within different environments,” as Mr Watson puts it.
But the risk is not all political. Eventually, the income stream on your new asset tends to settle down to a growth rate in-line with GDP, but shortly after opening, traffic that used to go elsewhere “ramps-up” as it starts using your new road, airport or school. “Ramp-risk”, the risk of mispricing your tender as a result of getting ramp-up projections wrong, is crucial.
“When you forecast more traffic than your competitor, you’ll either get less subsidy or pay a premium for the right to have the concession,” explains Tony Roper, director of infrastructure investment at HSBC Specialist Fund Management. “Unfortunately a lot of people have overestimated ramp-up in the past – the Cross-City Tunnel in Sydney is a good example.”
It goes without saying that all of this makes manager selection all the more important. Then there is the question of which vehicle to use for access. Private partnerships offer the most direct route, but they can present lock-ups of 15 years or more and require minimum subscriptions of as much as $30m.
Citi Private Bank is proposing a variety of routes for its client base, including privately run partnerships, according to Mr Watson. “Here, Citi are offering wealthy investors the opportunity to invest for the long term in a diversified portfolio of infrastructure equity investments within a major emerging market country. But, as with any investment decision, we are conscious of matching the infrastructure allocation with our clients’ risk appetite, liquidity requirements and timeframes, so we also offer more liquid equity routes on other infrastructure opportunities.”
Exchange-listed funds
One liquidity solution is the growing universe of exchange-listed funds. An example is HSBC Infrastructure Company Ltd, active in the European government-sponsored yield sector, launched in March 2006 to address a gap in the market for a retail solution.
“We went out to raise £250m, and we were 50 per cent oversubscribed,” says Mr Roper. “Today our stock is over 40 per cent held by high-net-worths and other private individuals.”
 | ‘We regard the US as one of the biggest emerging markets for infrastructure’ - Neil Jones, Macquarie |
Problems that one might associate with an equity exchanged-listed solution – such as exaggerated equity-market beta or trading at a discount to NAV – have been muted because investors have understood the differentiating qualities of the underlying assets, says Mr Roper.
Then there are open-ended vehicles which invest in the shares of companies that build and maintain infrastructure. These include ETFs – such as the iShares FTSE/Macquarie Global Infrastructure 100, for example, with a TER of 0.65 per cent - but how much extra broad equity-market beta do you ship on when your underlyings are public equity?
Research by Citi Private Bank suggests that a composite of a global infrastructure securities index and a selection of open-ended funds is 59 per cent correlated with the MSCI World Index. The public-equity FTSE/Macquarie Global Infrastructure Index on its own, however, is 73 per cent correlated. But upside beta for infrastructure public equity has been in the 0.53 range, while downside beta has been limited to 0.25, according to Citi’s research.
Nevertheless, if you already have a global utilities or energy portfolio, beware of overlaps. The iShares ETF’s top-10 holdings betray its 53 per cent weighting to the electricity sector: E.On, Endesa, ENEL, National Grid and Tokyo Electric figure prominently.
“You get the inflation-hedging and diversification benefits, but the overlap issue is a fair point,” concedes Susanne Williams, iShares’ senior product development manager. “Our S&P Emerging Markets Infrastructure Index ETF has rules which facilitate a more balanced approach to the different infrastructure families, but ultimately we are focused on providing representivity.”
If you want a more active approach to infrastructure public equity in an open-ended vehicle, Macquarie’s Global Infrastructure Securities Fund may be the ticket. As well as an institutional share class asking £250,000 there is a retail class at £1,000, which buys you a portfolio of 40-50 stocks, diversified globally and across growth and income.
“It was our intention to open up the potential of infrastructure to a much broader range of investors,” says Mr Jones. “And we try to deliver the essence of infrastructure, focusing on what we call ‘user-pay’ and regulated assets: transmission wires, distribution pipes, water and waste businesses, toll roads and bridges, sea and airports, certain types of telecoms infrastructure - monopoly and quasi-monopoly businesses with high barriers to entry predictable revenues.”
The fund deliberately avoids the large-scale utilities that make up the indices because they bring exposure to customer-choice competition and energy-related cyclicality, favouring stocks like Dubai’s DP World, which sits on a strategic portfolio of global seaport businesses and is building new ports in the Middle East and India.
“There you have a compelling potential-growth portfolio combined with an already-performing portfolio,” says Mr Jones, “and until recently the entire asset was owned by the Dubai government. They IPO’d 20 per cent of it onto the Dubai Stock Exchange in November, and we participated.”
“It’s the responsibility of the private banker to make sure that the exposure is appropriate,” says Mr Sarosy of Credit Suisse. “If infrastructure makes up 10 per cent of a strategic portfolio, we need to ensure that it’s not 15 per cent or more because of doubling-up. We have to be careful about the tools we use to implement that exposure and construct the client’s portfolio.”
