Magazine Issues » February 2019

Infrastructure funds: Arresting developments

The_ShardInfrastructure investing is booming. It could mitigate political risks, finds Nicholas Pratt, while long-term sustainability projects and the data explosion provide return opportunities.

With the Brexit debate hurtling towards a chaotic climax for the UK and Europe and Donald Trump sowing his own seeds of macro confusion, political risk has rarely been so prominent. One would also expect this risk to be an impediment to the investment world, especially any funds where governments and state bodies play a key role.

Yet infrastructure funds, so many of which invest in state-run projects, have never been more popular with investors.

In 2018, investment in private infrastructure funds globally reached a record US$85 billion (€74 billion), surpassing the $75 billion record set in 2017. And according to research firm Preqin, the appetite among investors for both listed and private infrastructure funds is set to continue in 2019. Its latest ‘Global Infrastructure Report’ forecasts that there will be 208 unlisted infrastructure funds seeking $193 billion in capital.

Infrastructure deals were especially prolific in Europe last year with 859 deals accounting for a record $152 billion in aggregate value – the highest of any region. More infrastructure funds were closed in Europe than elsewhere (33) even if the total capital was less than in North America ($35 billion compared to $44 billion).

An important factor in this rise in infrastructure fundraising has been the growth of so-called megafunds. Among the 208 new unlisted funds marked for 2019 are Brookfield Infrastructure Fund IV and Global Infrastructure Partners IV, both of which are targeting $20 billion, making them among the largest private capital funds ever raised.

The rise has been continuous over the past five years. Megafunds accounted for just 35% of fundraising in 2011 and 2012, rising to 56% in 2015. This ratio then rose to 74% and 76% in 2016 and 2017 respectively.

Big attractions
According to Preqin, investors are attracted to the idea that larger funds gain access to more attractive deals and have a proven track record. The megafunds may also be seen by investors as more resilient to growing political uncertainty. For UK and European investors, the most obvious issue is of course Brexit, but there are other causes of concern – even in Britain itself.

“Political issues have become a key consideration in infrastructure and it has been raised recently in a UK context as a result of the [opposition] Labour Party’s proposals towards nationalisation,” says Darryl Murphy, head of infrastructure debt at Aviva Global Investors. “The recent cancellation of the Ørsted distribution asset sale in Denmark suggests political risk is also present across Europe too.”

In the UK, the government has decided to scrap the private finance initiative (PFI) model and its successor PF2 due to concerns over value for money. But this raises questions over how government will deliver on a £600 billion (€685 billion) pipeline of infrastructure projects. The door has been left open for public-private partnerships (PPP) under a new model that addresses the perceived failures of the past, says Murphy.

The UK government’s Comprehensive Spending Review later this year may lead to further tension on the availability of capital investment, reopening the case for PPP.

“I would expect another collaboration between private and public sector to replace PFI and to deliver on some of the infrastructure projects,” says Tom Sumpster, head of infrastructure at Legal & General Investment Management (LGIM) Real Assets. “There is an uncertain political backdrop but an opportunity to get involved.”

Some fund managers believe that an increase in political turbulence globally will actually increase investor appetite for uncorrelated and long-term assets like infrastructure.

“This is seen both in demand from institutions such as pension funds, as well from retail investors looking to take risk out of investment portfolios and find alternative sources of income,” says Mark Brennan, senior investment manager of the FP Foresight UK Infrastructure Income Fund.

A survey of 200 UK financial advisers conducted by Foresight found that 62% predicted an increase in allocations to infrastructure over the next three years, almost double the 32% polled in 2018.

“Infrastructure is the stuff of everyday mundanity – people need roads, bridges, airports, police stations, schools, healthcare facilities, energy,” says Brennan. “Whatever is happening on the political stage, there is minimal correlation.”

A natural fit with sustainability
Renewable-themed infrastructure projects have become a focus for infrastructure funds as a way to mitigate some of the political risk associated with the asset class, says Sumpster. Again in the UK, the government has provided strong support to the renewables sector. There is some political risk but it is still likely to be a government focus for the long term, he says.

Sumpster also believes that infrastructure is an asset class that is naturally suited to the responsible investment and sustainability theme. “An offshore windfarm, for example, creates employment, is good for the environment and should have good governance around how these projects work because it is public money,” he says.

There are four advantages to sustainable infrastructure investment, says Colm O’Connor, portfolio manager at Dublin-based specialist asset manager KBI Global Investors, which launched its Global Sustainable Infrastructure Strategy in 2017.

“An investor who allocates to sustainable infrastructure assets will be investing in differentiated names not typically covered by other traditional strategies which tend to focus more on telecom, pipelines, toll roads and airports. Secondly, a significant amount of future infrastructure spend is forecast to be allocated to water and clean energy investment.”

Sustainable themes such as climate change, decarbonisation and clean water are also likely to appeal to the growing number of impact investors, he adds, and may be less exposed to the political risk that comes with an asset class where “government policy plays such a central role”.

O’Connor says: “Governments are generally more in favour of infrastructure projects with a sustainable theme. There are exceptions, of course. The US under Trump is more supportive of the coal industry. But most other G20 economies have put sustainability at the centre of their economic policies. For example, China’s 12th five-year plan places control of air pollution, treatment of waste and support of renewable energy centre-stage.”

Another potential growth area within infrastructure funds is data infrastructure. In 2018, telecoms infrastructure accounted for more than 30% of invested capital in infrastructure, with the majority of the investments in newer sub-sectors such as fibre, data centres and so-called ‘smart infrastructure’.

According to UBS Asset Management and its recently published paper ‘Data infrastructure: an infrastructure or private equity play?’, this is an attractive moment for data infrastructure due to the proliferation of high-definition on-demand video, gaming, cloud services, mobile data usage and IT outsourcing, which has in turn created a surge in mobile and fixed internet traffic.

“Growth in data usage underpins the need for further investment into data infrastructure,” states the UBS report. “Many infrastructure investors see their investment in the sector as an opportunity to own tomorrow’s essential infrastructure.”

However, there is also some political risk to consider. As UBS states, the global telecommunications crash at the turn of the millennium was partly due to firms massively overbidding for European governments’ auctions of 3G mobile spectrum licences based on “ambitious growth rates that failed to materialise within the expected investment horizons”, resulting in numerous high-profile defaults, bankruptcy filings and an estimated 100,000 job cuts across Europe alone.

Consequently infrastructure fund managers cannot afford to become complacent about political risk and should remain mindful of the need for diversity and active management. To this end, some fund managers such as KBI are focusing increasingly on listed rather than private infrastructure projects.

As KBI’s O’Connor says: “The advantage of investing in listed projects is that they are more liquid instruments and that enables you to be more dynamic as an active investor, for example when the political climate changes.”

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